-----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, HQOdY1N505C/9gEaEKI1CZIHpUqMYi9ELq9nDoQyLM8DtHrJFNUqrsbXVbppQzLc 1DzxvmQ/tysf//Dp+c73cg== 0001116502-04-000282.txt : 20040217 0001116502-04-000282.hdr.sgml : 20040216 20040217170008 ACCESSION NUMBER: 0001116502-04-000282 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040217 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: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24968 FILM NUMBER: 04609856 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 10-Q 1 singingmachine-10q.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2003 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) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes x No 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: NUMBER OF SHARES CLASS OUTSTANDING ON DECEMBER 31, 2003 Common Stock, $0.01 par value 8,752,320 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Page No. -------- Consolidated Balance Sheets - December 31, 2003 (Unaudited) and March 31, 2003 .............................................. 3 Consolidated Statements of Operations - Three and Nine months ended December 31, 2003 (unaudited) and 2002(Unaudited,restated). 4 Consolidated Statements of Cash Flows - Nine months ended December 31, 2003(unaudited)and 2002 (Unaudited,restated)........ 5 Notes to Consolidated Financial Statements ...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................. 13 Item 3. Quantitative and Qualitative Disclosure About Market Risk ....... 27 Item 4. Controls and Procedures ......................................... 27 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................... 28 Item 2. Changes in Securities ........................................... 29 Item 3. Defaults Upon Senior Securities ................................. 30 Item 4. Submission of Matters to a Vote of Security Holders ............. 30 Item 5. Other Information ............................................... 30 Item 6. Exhibits and Reports on Form 8-K ................................ 30 SIGNATURES ............................................................... 31 2 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY PART I - FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31, 2003 2003 ------------ ------------ (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents $ 235,958 $ 268,265 Restricted Cash 866,413 838,411 Accounts Receivable, less allowances of $816,235 and $405,759 respectively 14,729,176 5,762,944 Due from manufacturer 1,112,200 1,091,871 Inventories, net 8,029,371 25,194,346 Prepaid expense and other current assets 2,294,377 1,483,602 Deferred tax asset -- 1,925,612 ------------ ------------ TOTAL CURRENT ASSETS 27,267,495 36,565,051 PROPERTY AND EQUIPMENT, at cost less accumulated depreciation of $2,567,480 and $1,472,850 respectively 1,365,687 2,026,252 OTHER ASSETS Other non-current assets 970,464 343,991 ------------ ------------ TOTAL ASSETS $ 29,603,646 $ 38,935,294 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Bank overdraft $ 85,236 $ 316,646 Accounts payable 5,331,470 8,486,009 Accrued expenses 2,587,579 1,443,406 Subordinated debt-related parties 1,000,000 400,000 Revolving credit facilities 7,115,114 6,782,824 Income taxes payable 2,872,509 3,821,045 ------------ ------------ TOTAL CURRENT LIABILITIES 18,991,908 21,249,930 ------------ ------------ LONG TERM LIABILITIES Convertible debentures, net of unamortized discount of $3,046,000 954,210 -- ------------ ------------ TOTAL LIABILITIES 19,946,118 21,249,930 SHAREHOLDERS' 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 shares authorized; no shares issued and outstanding -- -- Common stock, $0.01 par value; 18,900,000 shares authorized; 8,752,320 and 8,171,678 shares issued and outstanding 87,523 81,717 Additional paid-in capital 10,234,410 4,843,430 Retained earnings (664,405) 12,760,217 ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 9,657,528 17,685,364 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 29,603,646 $ 38,935,294 ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 3 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended December 31, December 31, ------------------------------ ------------------------------ 2003 2002 2003 2002 ------------ ------------ ------------ ------------ (as restated) (as restated) NET SALES $ 28,689,623 $ 45,659,446 $ 68,053,739 $ 81,915,443 COST OF SALES Cost of goods sold 30,782,268 36,628,126 64,948,809 64,155,095 Impairment of tooling 508,480 -- 508,480 -- ------------ ------------ ------------ ------------ GROSS PROFIT (2,601,125) 9,031,320 2,596,449 17,760,348 OPERATING EXPENSES: Compensation 1,097,327 1,257,519 3,552,718 2,827,823 Freight & handling 523,177 944,169 1,153,353 1,605,445 Selling, general & administrative expenses 3,410,116 1,748,400 8,908,899 4,675,279 ------------ ------------ ------------ ------------ TOTAL OPERATING EXPENSES 5,030,620 3,950,088 13,614,971 9,108,547 ------------ ------------ ------------ ------------ (LOSS) EARNINGS FROM OPERATIONS (7,631,744) 5,081,232 (11,018,521) 8,651,801 OTHER INCOME (EXPENSES): Other income 32,098 38,628 (50,882) 196,648 Interest expense (687,178) (117,704) (1,194,541) (228,597) Interest income -- -- -- 11,943 ------------ ------------ ------------ ------------ NET OTHER (EXPENSES) INCOME (655,079) (79,076) (1,245,422) (20,006) NET (LOSS) EARNINGS BEFORE INCOME TAX (8,286,825) 5,002,156 (12,263,944) 8,631,795 INCOME TAX EXPENSE 2,163,776 1,681,629 1,160,678 2,674,659 ------------ ------------ ------------ ------------ NET (LOSS) EARNINGS $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136 ============ ============ ============ ============ (LOSS) EARNINGS PER SHARE: Basic $ (1.20) $ 0.41 $ (1.58) $ 0.74 Diluted $ (1.20) $ 0.37 $ (1.58) $ 0.67 WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING: Basic 8,729,818 8,123,548 8,503,065 8,101,441 Diluted 8,729,818 8,944,027 8,503,065 8,947,897
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 4 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED DECEMBER 31, ------------------------------ 2003 2002 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES (restated) Net (loss) earnings $(13,424,622) $ 7,475,119 Adjustments to reconcile net (loss) earnings to net cash used in operating activities Depreciation and amortization 1,165,687 454,806 Impairment of tooling 508,480 Provision for inventory 4,996,685 -- Provision for bad debt 410,476 -- Amortization of discount on convertible debentures 444,584 -- Stock compensation expense 511,299 -- Deferred tax benefit 1,925,612 452,673 Changes in assets and liabilities: (Increase) decrease in: Accounts Receivable (9,376,708) (15,998,298) Due from manufacturer (20,329) (264,908) Inventories 12,168,290 (20,742,572) Prepaid Expenses and other assets (858,011) (1,218,091) Increase (decrease) in: Accounts payable (3,154,539) 11,203,268 Accrued expenses 653,540 3,705,878 Income taxes payable (948,536) 572,254 ------------ ------------ Net Cash Used in Operating Activities (4,998,092) (14,359,871) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (434,065) (1,112,376) ------------ ------------ Net cash used in Investing Activities (434,065) (1,112,376) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Borrowings from revolving credit facilities 27,777,630 37,612,713 Repayments to revolving credit facilities (27,445,340) (27,449,625) Proceeds from issuance of convertible debentures 4,000,000 -- Bank Overdraft (231,410) -- Restricted cash (28,002) (3,640) Payment of financing fees related to convertible debentures (255,000) -- Proceeds from subordinated debt-related parties, net 600,000 -- Proceeds from exercise of stock options and warrants 981,972 155,579 ------------ ------------ Net cash provided by Financing Activities 5,399,850 10,315,027 ------------ ------------ DECREASE IN CASH AND CASH EQUIVALENTS (32,307) (5,157,220) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,265 5,520,147 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 235,958 $ 362,927 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: CASH PAID FOR THE NINE MONTHS ENDED DECEMBER 31, 2003 Interest $ 591,817 $ 228,597 ============ ============ Income Taxes $ 1,388,102 $ 73,207 ============ ============ NON-CASH FINANCING ACTIVITIES Stock based compensation $ 511,299 $ -- ============ ============ Discounts for warrants issued in connection with and beneficial $ 3,494,274 $ -- conversion feature of convertible debentures ============ ============ Financing fees in connection with convertible debenture issuance, paid in stock and warrants 409,527 ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 5 THE SINGING MACHINE COMPANY, INC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - SUMMARY OF ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of The Singing Machine Company, Inc. and International SMC (H.K.) Ltd., its wholly-owned subsidiary (the "Company", "The Singing Machine"). All significant intercompany transactions and balances have been eliminated. The unaudited consolidated financial statements have been prepared in conformity with Rule 10-01 of Regulation S-X of the Securities and Exchange Commission and therefore do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments (consisting of normal recurring accruals), which, in the opinion of management, are necessary for a fair presentation of the financial statements, have been included. Operating results for the period ended December 31, 2003 are not necessarily indicative of the results that may be expected for the remaining quarter or the year ending March 31, 2004 due to seasonal fluctuations in The Singing Machine's business, changes in economic conditions and other factors. For further information, please refer to the Consolidated Financial Statements and Notes thereto contained in The Singing Machine's Annual Report on Form 10-K for the year ended March 31, 2003. INVENTORIES Inventories are comprised of electronic karaoke audio equipment, accessories, and compact discs and are stated at the lower of cost or market, as determined using the first in, first out method. The following table represents the major components of inventory at the dates specified. December 31, 2003 March 31, 2003 ----------------- -------------- Finished goods $ 13,463,330 $ 27,807,763 Inventory in transit 1,200,221 1,101,940 Provision for losses (6,634,180) (3,715,357) ------------ ------------ Total Inventory $ 8,029,371 $ 25,194,346 ============ ============ Although management has taken a provision, which they estimate, based on recent contacts with customers, to be a sufficient reserve for potential losses on disposal of existing inventory, the Company's sales are highly seasonal and unit sales and their related selling prices during peak seasons may not meet expectations. Therefore, management's estimates could differ significantly from actual outcome and have a material impact on future operations. The Company also made the decision to discontinue certain models from their line. A reserve was taken against the remaining inventories of these discontinued items to enable the items to be sold through alternate sales arenas, such as through liquidation facilities. Management believes that at September 30, 2003, there was not sufficient evidence warranting an additional reserve against inventory at that time, as the peak selling season had just begun and there were no indications that the inventory would not be sold. RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform to the current period presentation. STOCK BASED COMPENSATION The Company accounts for stock options issued to employees using the intrinsic value method in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation cost is measured on the date of grant as the excess of the current market price of the underlying stock over the exercise price, if any. Such compensation amounts are amortized over the respective vesting periods of the option grant. The Company applied the disclosure provisions of Statement of Financial Accounting Standards ("Statement") No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of Statement No. 123", "Accounting for Stock Based Compensation", which permits entities to provide pro forma net earnings (loss) and pro forma earnings (loss) per share disclosures for employee stock option grants as if the fair-valued based method defined in Statement No. 123 had been applied to options granted. 6 Had compensation cost for the Company's stock-based compensation plan been determined using the fair value method for awards under that plan, pursuant to Statement No. 123, the Company's net (loss) earnings would have been changed to the pro-forma amounts indicated below.
FOR THE THREE MONTHS ENDED DECEMBER 31, FOR THE NINE MONTHS ENDED DECEMBER 31, 2003 2002 2003 2002 ------------------ ------------------- ----------------- ------------------- Net (loss) earnings As reported $(10,450,601) $3,320,527 $(13,424,622) $5,957,136 Pro forma $(10,653,283) $3,291,655 $(14,032,668) $5,870,518 Net (loss) earnings per share - As reported $(1.20) $0.41 $(1.58) $0.74 basic Pro forma $(1.22) $0.41 $(1.65) $0.72 Net (loss) earnings per share As reported $(1.20) $0.37 $(1.58) $0.67 - -diluted Pro forma $(1.22) $0.37 $(1.65) $0.66
For stock options and warrants issued to non-employees, the Company applies the fair value method of accounting pursuant to Statement 123. Due to a change in status of a former employee, an expense of $220,835 was charged to compensation expense in August 2003. For financial statement disclosure purposes and for purposes of valuing stock options and warrants issued to non-employees, the fair market value of each stock option granted was estimated on the date of grant using the Black-Scholes Option-Pricing Model in accordance with Statement No. 123 using the following weighted-average assumptions: Third Quarter 2004: expected dividend yield 0%, risk-free interest rate of 2.5%, volatility 110.05% and expected term of five years. Third Quarter 2003: expected dividend yield 0%, risk-free interest rate of 6.8%, volatility 42% and expected term of two years. RECENT ACCOUNTING PRONOUNCEMENTS Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. Statement 149 is generally effective for contracts entered into or modified after June 30, 2003 (with a few exceptions) and for hedging relationships designated after June 30, 2003. The provisions of Statement 149 did not have a material impact on the Company's financial position or results of operations. Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new Statement requires that those instruments be classified as liabilities in statements of financial position. This statement is effective for instruments entered into or modified after May 31, 2003. The provisions of Statement 150 did not have a material impact on the Company's financial position or results of operations. NOTE 2 - GOING CONCERN The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern (See Management Discussion and Analysis - Liquidity and Capital Resources). On March 14, 2003, the Company was notified of its violation of the tangible net worth covenant of its Loan and Security Agreement (the "Agreement") with its commercial lender and the Company was declared in default under the Agreement. The lender amended the Agreement on August 19, 2003. Pursuant to this fourteenth amendment the loan was extended until March 31, 2004 and the condition of default was waived. As of December 31, 2003, the Company again violated the tangible net worth and working capital covenants of the Agreement. As of January 31, 2004 the loan was paid in full, the facility was terminated and the UCC filings were released. 7 NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS FOR THE FISCAL YEARS 2002 AND 2001 In June 2003, management revised its position on taxation of the income of International SMC (H.K.) Ltd., its wholly-owned subsidiary, by the United States and by the Hong Kong tax authorities for the reasons stated below. With regard to taxation in Hong Kong, International SMC had previously applied for a Hong Kong offshore claim income tax exemption based on the locality of its profits. Management believed that the exemption would be approved because the source of all profits of International SMC is from exporting to customers outside of Hong Kong. Accordingly, no provision for income taxes was provided in the consolidated financial statements as of March 31, 2002 and 2001. However, full disclosure was previously reflected in the audited financial statements for years ended March 31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax authority should the exemption be denied. Management is continuing its exemption application process. However, due to the extended period of time that the application has been outstanding, as well as management's reassessment of the probability that the application will be approved, management has determined to restate the 2002 and 2001 consolidated financial statements to provide for such taxes. The effect of such restatement is to increase income tax expense by $748,672 and $468,424 in fiscal 2002 and 2001, respectively. However, the Company can claim United States foreign tax credits in 2002 for these Hong Kong taxes, which is reflected in the final restated amounts. With regard to United States taxation of foreign income, the Company had originally taken the position that the foreign income of the Hong Kong subsidiary qualified for a deferral under the Internal Revenue Code (Section 956) allowing for such income to be indefinitely deferred and not taxed in the United States until such income is repatriated, or brought back into the United States as taxable income. It was expected that this income would remain in Hong Kong. Full disclosure of the amount and nature of the indefinite deferral for fiscal year 2002 was reflected in the income tax footnote of the consolidated financial statements for that year. The internal revenue code, regulations and case law regarding international income taxation is quite complex and subject to interpretation. Each case is determined based on the individual facts and circumstances. Due to certain inter-company loans, relating to inventory purchases, made in 2002 and 2003, the profits previously considered to be indefinitely deferred became partially taxable as "deemed dividends" under section 956 of the Internal Revenue Code. Although certain arguments against the imposition of a "deemed dividend" may be asserted, management has determined to restate the fiscal year 2002 consolidated financial statements based on its reassessment of its original position. The effect of such restatement is to increase income tax expense by $1,027,545 in fiscal year 2002, which includes the utilization of the foreign tax credits referred to above. The net effect of the above two adjustments for the quarter and nine months ended December 31, 2002 is to decrease net income by $576,060 and $1,517,983, respectively. The net effect on net income per share is to decrease net income per share basic and diluted by $0.07 and $0.06 for the quarter and $0.18 and $0.17 for the nine months ended December 31, 2002. NOTE 4 - IMPAIRMENT OF TOOLING Pursuant to Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company recorded a loss on impairment of tooling. In December 2003, and as a result of the Company's decision to discontinue certain models, management estimated that the amounts recoverable on certain tooling through future operations, on an undiscounted basis, were below their book values. An expense of $508,480 was charged to operations for this impairment. NOTE 5 - PROVISION FOR INCOME TAX Significant management judgment is required in developing the Company's provision for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. At December 31, 2003, the Company concluded that a valuation allowance was needed against all of the Company's deferred tax assets, as it is not more likely than not that the deferred taxes will be realized. For the three months ended December 31, 2003, the Company recorded a tax provision of $2.2 million. This provision was created because the valuation allowance established against the deferred tax asset exceeded the amount of the benefit created from carrying back a portion of the current period losses. The carry-back of the losses from the current period resulted in an income tax receivable of $1.2 million, which is included in prepaid and other current assets in the accompanying balance sheets. The Company's wholly-owned subsidiary, has applied for an exemption of income tax in Hong Kong. Therefore, no taxes have been expensed or provided for at the Subsidiary level. Although the governing body has reached no decision to date, the U.S. parent company has reached the decision to provide for the possibility that the exemption could be denied and accordingly has recorded a provision in fiscal 2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%. Accrued Hong Kong taxes payable on the current and prior earnings of the Company's Hong Kong subsidiary totaled $2.9 million at December 31, 2003. 8 The Company operates within multiple taxing jurisdictions and is subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management's opinion, adequate provisions for income taxes have been made. NOTE 6 - LOANS AND LETTERS OF CREDIT CREDIT FACILITY The Company's Hong Kong Subsidiary maintains separate credit facilities at two international banks. The primary purpose of the facilities is to provide the Subsidiary with the following abilities: o Overdraft protection facilities o Issuance and negotiation of letters of credit, both regular and discrepant o Trust receipts o A Company credit card The facilities are secured by a corporate guarantee from the U.S. Company, restricted cash on deposit with the lender and require that the Company maintain a minimum tangible net worth. The maximum available credit under the facilities is $5.5 million. The balance at December 31, 2003 and 2002 was $4,640,728 and $0, respectively. LOAN AND SECURITY AGREEMENT On April 26, 2001, the Company executed a Loan and Security Agreement (the "Agreement") with a commercial lender (the "Lender"), which as amended on August 19, 2003, was due to expire on March 31, 2004. At December 31, 2003 and 2002 the amount outstanding was $2,474,386 and $10,163,088, respectively. As of January 31, 2004 the loan was paid in full, the facility was terminated and the UCC filings were released. SUBORDINATED DEBT As of July 10, 2003, the Company obtained $1 million in subordinated debt financing from a certain officer, directors and an associate of a director. The loans are accruing interest at 9.5% per annum and paid quarterly. These loans were originally scheduled to be paid back by October 31, 2003; however, the notes have since been subordinated to the Company's credit facility and the total amount outstanding of $1 million will not be repaid until either the subordination is released by the Company's lender or the credit facility is closed. NOTE 7 - 8% CONVERTIBLE DEBENTURES WITH WARRANTS In September 2003, the Company issued $4 million of 8% Convertible Debentures in a private offering which are due February 20, 2006 ("Convertible Debentures"). The net cash proceeds received by the Company were $3,745,000 after deduction of cash commissions and other expenses. The Convertible Debentures are subordinated to the Company's Lender and are convertible at the option of the holders into 1,038,962 Common Shares at the conversion rates referred to below, subject to certain anti-dilution adjustment provisions, at any time after the closing date. Each Convertible Debenture may be convertible into common shares, at a conversion price of $3.85 per Common Share. of the registration statement The Convertible Debentures are subordinated to the Company's Lender and are convertible at the option of the holders into 1,038,962 Common Shares at the conversion rates referred to below, subject to certain anti-dilution adjustment provisions, at any time after the closing date. Each Convertible Debenture may be convertible into common shares, representing an initial conversion price of $3.85 per Common Share These Convertible Debentures were issued with 457,143 detachable stock purchase warrants with an exercise price of $4.025 per share. These warrants may be exercised at anytime after September 8, 2003 and before September 7, 2006 and are subject to certain anti-dilution provisions. The warrants are also subject to an adjustment provision; whereas the price of the warrants may be changed under certain circumstances. The Convertible Debentures bear interest at the stated rate of 8% per annum. Interest is payable quarterly on March 1, June 1, September 1, and December 1. The interest may be payable in cash, shares of Common Stock, or a combination thereof subject to certain provisions and at the discretion of the Company. On February 9, 2004 the stated rate of interest was raised to 8.5%. 9 In accounting for this transaction, the Company allocated $1.2 million of the proceeds to the estimated fair value of the stock purchase warrants and $2.3 million as the estimated fair value of the beneficial conversion feature. These amounts resulted in a discount in the convertible debentures of $3.5 million, which is being amortized over the life of the debt on a straight-line basis to interest expense. Total amortization for the nine months ended December 31, 2003 was $444,584. In connection with the Convertible Debentures the Company paid financing fees as follows: 103,896 stock purchase warrants, with a fair value of $264,671, 28,571 shares of common stock with a fair value of $141,141, and cash of $255,000. Total financing fees of $660,812 were recorded as deferred fees and are being amortized over the term of the debentures on a straight-line basis. The unamortized deferred fees are reported in other non-current assets in the accompanying balance sheets. NOTE 8 - COMMITMENTS AND CONTINGENCIES LEGAL MATTERS CLASS ACTION. From July 2003 through August 2003, eight securities class action lawsuits were filed against the Company and certain of its officers and directors in the United States District Court for the Southern District of Florida on behalf of all persons who purchased The Singing Machine's securities during the various class action periods specified in the complaints. These complaints have all been consolidated into one action styled Bielansky, et al. v. Salberg & Co., et al., Case No. 03-80596-ZLOCH (the Shareholder Action). The complaints in the Shareholder Action allege violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5 promulgated there under. These complaints seek compensatory damages, attorney's fees and injunctive relief. In July 2003, a shareholder filed a derivative action against the Company, its board of directors and senior management purporting to pursue the action on behalf of the Company and for its benefit. No pre-lawsuit demand was made on the board of directors for them to investigate the allegations or to bring action. The Company is named as a nominal defendant in this case. This case has been consolidated into the Shareholder Action identified above. This derivative complaint alleges claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. The complaint alleges that the individual defendants breached their fiduciary duties and engaged in gross mismanagement by allegedly ignoring indicators of the lack of control over the Company's accounting and management practices, allowing the Company to engage in improper conduct and otherwise failing to carry out their duties and obligations to the Company. The plaintiffs seek damages for breach of fiduciary duties, punitive and compensatory damages, restitution, and bonuses or other incentive-based or equity based compensation received by the CEO and CFO under the Sarbanes-Oxley Act of 2002 The court in the Shareholder Action has directed plaintiffs' counsel to file one amended consolidated complaint no later than November 14, 2003. The Company intends to vigorously defend the Shareholder Action. As the outcome of litigation is difficult to predict, significant changes in the estimated exposures could occur which could have a material affect on the Company's operations. A second shareholder derivative suit was filed in October 2003, which makes generally the same allegations. The second derivative suit has not been served on the Company or on any of its current or former officers and directors. This suit was transferred to the same judge to whom the Shareholder Action was assigned and has been consolidated into the Shareholder Action. OTHER MATTERS. In August 2003, we were advised that the Securities and Exchange Commission had commenced an informal inquiry of our company. We are cooperating fully with the SEC staff. It appears that the investigation is focused on the restatement of our audited financial statements for fiscal 2002 and 2001. We have been advised that an informal inquiry should not be regarded as an indication by the SEC or its staff that any violations of law have occurred or as a reflection upon any person or entity that may have been involved in those transactions. The Company entered into a separation and release agreement with an executive on December 19, 2003. The agreement provided for the individual to receive $159,281 in settlement of the Company's contract. The amount has been expensed as compensation at December 31, 2003. The Company entered into a settlement agreement with an investment banker on November 17, 2003. Pursuant to this agreement, the Company will pay the sum of $181,067 over a six month period and has issued to the investment banker 40,151 shares of stock with a fair value of $94,355. 10 The Company amended its convertible debenture agreements to increase the interest rate to 8.5% effective as of February 9, 2004 and to grant warrants to purchase an aggregate of 30,000 shares of the Company's common stock to the debenture holders on a pro-rata basis. These concessions are in consideration of the debenture holder's agreements to (i) enter into new subordination agreements with the Company's new lender, (ii) to waive all liquidated damages due under the transaction documents through July 1, 2004 and (iii) to extend the effective date of the Form S-1 registration statement until July 1, 2004. The new warrants have an exercise price equal to $1.52 per share, the fair market value of the Company's common stock on February 9, 2004, the date of the grant. The fair value of these warrants as calculated pursuant to Statement No. 123 is $30,981 and has been expensed as other operating expenses in the accompanying statements of operations. The Company is also subject to various other legal proceedings and other claims that arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability, if any, in excess of applicable insurance coverage, is not likely to have a material effect on the financial condition, results of operations or liquidity of the Company. However, as the outcome of litigation or other legal claims is difficult to predict, significant changes in the estimated exposures could occur, which could have a material impact on the Company's operations. NOTE 9 - STOCKHOLDERS' EQUITY COMMON STOCK ISSUANCES During the nine months ended December 31, 2003, the Company issued 580,642 shares of its common stock. Of these shares, 28,571 were issued in lieu of a cash payment of commission and closing costs relating to the Convertible Debentures. Certain executives received 63,420 shares of common stock in lieu of a portion of their cash compensation and bonuses for fiscal 2004. The fair value of this stock, $290,165 was charged to compensation expense. 40,151 shares of stock were issued in lieu of a settlement with an investment banker, at an estimated fair value of $94,355. The remaining 448,500 shares of stock issued were through the exercise of vested stock options. There were no shares of common stock issued in the nine months ended December 31, 2002. EARNINGS PER SHARE In accordance with Statement No. 128, "Earnings per Share," basic earnings per share are computed by dividing the net earnings for the period by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding including the effect of common stock equivalents. The following table presents a reconciliation of basic and diluted earnings per share:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2003 2002 2003 2002 (as restated) (as restated) Net (loss) income $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136 Loss available to common shares $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136 Weighted average shares outstanding - basic 8,729,818 8,123,548 8,503,065 8,101,441 Weighted average shares outstanding - diluted 8,729,818 8,944,027 8,503,065 8,947,897 Loss per share - Basic $ (1.20) $ 0.41 $ (1.58) $ 0.74 ============ ============ ============ ============ Loss per share -Diluted $ (1.20) $ 0.37 $ (1.58) $ 0.67 ============ ============ ============ ============
For the three months and nine months ended December 31, 2003, 1,120,120 common stock equivalents were excluded from the calculation of diluted earnings per share, as there was a net operating loss for the periods and their effects would have been antidilutive. For the three months and nine months ended December 31, 2002, 90,000 and 0 common stock equivalents were not included in the computation of diluted earnings per share because their effect was antidilutive. For the nine months ended December 31, 2003, there were 1,120,120 common stock options outstanding with exercise prices between $1.97 and $14.30. In addition, there is a potential 1,038,962 shares that may be issued in connection with the Convertible Debentures if certain conditions exist. (See Note 7.) 11 NOTE 10 - SEGMENT INFORMATION The Company operates in one segment and maintains its records accordingly. The majority of sales to customers outside of the United States are made by the Company's wholly-owned Subsidiary. Sales by geographic region for the quarters ended December 31 were as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2003 2002 2003 2002 SALES: ------------ ------------ ------------ ------------ United States $ 19,847,863 $ 41,028,985 $ 41,184,176 $ 72,402,914 Australia 582,385 286,368 892,964 529,020 Canada 307,182 706,476 832,007 733,801 Europe 8,687,809 6,178,010 26,497,706 12,998,917 Other 210,407 29,945 708,343 100,143 Less: Allowances (946,023) (2,570,338) (2,061,457) (3,243,907) ------------ ------------ ------------ ------------ Consolidated Net Sales $ 28,689,623 $ 45,659,446 $ 68,053,739 $ 83,520,888 ============ ============ ============ ============
The geographic area of sales is based primarily on the location where the product is delivered. NOTE 11 - SUBSEQUENT EVENTS On January 7, 2004, the Company entered into the fifth amendment of its licensing agreement with MTV Networks. The amendment reduced the minimum royalty guarantee for calendar 2003 from $1.5 million to $1.3 million. The amendment also extended the expiration date of the original agreement to April 30, 2004, with options to extend for an additional two periods until December 31, 2004 at the discretion of MTV. In accordance with this amendment, each of the three license periods contain minimum guarantee royalty payments of $100,000 each for a total of $300,000 if all extensions are exercised Each of the minimum guaranteed royalty payments is recoupable against sales throughout the calendar year, unless the contract is cancelled. On February 9, 2004, the Company entered into a factoring agreement with Milberg Factors, Inc. ("Milberg") of New York City. The agreement allows the Company, at the discretion of Milberg, to borrow against its outstanding receivables up to a maximum of the lesser of $3.5 million or 80% of the purchase price. The Company will pay .8% of gross receivables in fees and the average balance of the line will be subject to interest on a monthly basis at prime plus .75% with a minimum rate not to decrease below 4.75%. The agreement contains minimum aggregate charges in any calendar year of $200,000, limits on incurring any additional indebtedness and the Company must maintain tangible net worth and working capital above $7.5 million. Millberg also received a security interest in all of the Company's accounts receivable and inventory located in the United States and a pledge of 66 2/3 of the stock of International SMC, our Hong Kong subsidiary. 12 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- Q, 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. OVERVIEW The Singing Machine Company, Inc., a Delaware corporation, and our wholly-owned Hong Kong subsidiary International SMC HK Ltd. ("International SMC"), (collectively, the "Company, "Singing Machine," "we" or "us") are primarily engaged in the development, marketing, and sale of consumer karaoke audio equipment, accessories, and musical recordings. The products are sold directly to distributors and retail customers. Our electronic karaoke machines and audio software products are marketed under The Singing Machine(C) 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, Circuit City, Costco, Radio Shack, Toys R Us, Target and J.C. Penney. We had a net loss after estimated tax expense of $13,424,622 for the nine month period ended December 31, 2003. As of December 31, 2003, we had 8,752,320 shares of our common stock issued and outstanding. As of December 31, 2003, there were 1,651,159 common stock options and warrants outstanding with exercise prices between $1.97 and $14.30. In addition, we are obligated to issue 1,038,962 shares of our common stock to the holders of our convertible debentures if they elect to convert their debentures into common stock. RESTATEMENT OF FINANCIAL STATEMENTS In June 2003, our management revised its position on taxation of the income of International SMC (H.K.) Ltd., its Hong Kong subsidiary, by the United States and by the Hong Kong tax authorities for the reasons stated below. With regard to taxation in Hong Kong, International SMC had previously applied for a Hong Kong offshore claim income tax exemption based on the locality of its profits in China. Management believed, based on advice from its then auditors, that the exemption would be approved because the source of all profits of International SMC was from exporting to customers outside of Hong Kong. Accordingly, no provision for income taxes was provided in the consolidated financial statements as of March 31, 2002 and 2001. However, full disclosure was previously reflected in the audited financial statements for the fiscal years ended March 31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax authority should the exemption be denied. In June 2003, we revised our position on the taxation of the income of International SMC because we received different advice from our new auditors. We dismissed our former accountant on March 24, 2003 and engaged our new auditors effective as of March 27, 2003. Management is continuing its exemption application process. However, due to the extended period of time that the application has been outstanding, as well as management's reassessment of the probability that the application will be approved, management has decided to restate the 2002 and 2001 consolidated financial statements to provide for such taxes. The effect of such restatement is to increase income tax expense by $748,672 and $468,424 in fiscal 2002 and 2001, respectively. However, we can claim United States foreign tax credits in 2002 for these Hong Kong taxes, which is reflected in the final restated amounts. 13 With regard to United States taxation of foreign income, in fiscal 2002 and 2003 we had taken the position that the foreign income of International SMC qualified for a deferral under the Internal Revenue Code (Section 956) allowing for such income to be indefinitely deferred and not taxed in the United States until such income is repatriated, or brought back into the United States as taxable income. The basis of this position was primarily due to the fact that the amount of income in question was very low and fully repaid within a reasonable time after year end. It was expected that this income would remain in Hong Kong. Full disclosure of the amount and nature of the indefinite deferral for the income of International SMC for fiscal year 2002 was reflected in the income tax footnote of the consolidated financial statements for that year. During fiscal 2002 and 2003, International SMC paid for inventory delivered to the United States parent company, in the aggregate of approximately $10 million. Our prior auditors advised us that the funds advanced by International SMC were reimbursed by the United States parent company within a short enough time period that a deemed dividend had not occurred. Our new auditors questioned this treatment and management decided to restate the income tax expense to treat the advances as deemed dividends. The effect of such restatement is to increase income tax expense by $1,027,545 in fiscal year 2002, which includes the utilization of the foreign tax credits referred to above. The net effect of the above two adjustments is to decrease net income by $576,060 and $1,517,983 and decrease net income per share basic and diluted by $0.07 and $0.07 for the quarter and $0.18 and $0.17 for the nine months ended December 31, 2002. THREE MONTHS ENDED DECEMBER 31, 2003 COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 2002 NET SALES Net sales for the quarter ended December 31, 2003 decreased 37% percent to $28,689,623 compared to $45,659,446 for the quarter ended December 31, 2002. Sales in the United States declined 55.2%, or $24,391,452 from the quarter ended December, 2002. These decreases are composed of decreases of machine sales of 57% or $15,974,640 from $27,891,528 in 2002 and music sales of 77% or $3,757,221 from $4,885,225 in 2002. Sales decreases were partially offset by a reduction in advertising allowances of 70% or $2,124,315 from $3,070,338 in 2002 and a 35.9% increase in international sales, from $7.2 million for the quarter ended December 31, 2002 to $9.8 million for the quarter ended December 31, 2003. Decreases in domestic machine sales of machines in the United States are primarily attributable to an increase in competition at our large customers and erosion of the average selling price per unit as compared to the same period in 2002. The decrease in music sales is attributable to the loss of placement of our music at one major customer and a reduction of sales with two other major retailers. Advertising allowances consist of co-operative advertising, marketing development funds and specific advertising. GROSS PROFIT Gross profit for the quarter ended December 31, 2003 was ($2,601,125) or (8.3%) of net sales compared to $9,031,320 or 19.8% of net sales for the quarter ended December 31, 2002. This decrease in gross profit can be attributed to sales of our karaoke machines at lower prices and pricing pressure based on increased competition. In addition, we took a reserve against the value of inventory in the amount of $4,998,126 from historical cost for its anticipated recovery value. Another factor in decreased gross profit is the shortfall on the minimum royalty guarantee in our MTV license agreement. We expensed an additional $609,000 in the quarter to cover this shortfall. We also wrote down the remaining book value of dies associated with items that we are discontinuing from our line in the amount of $508,480. We anticipate that the gross profit percentage for the remainder of the fiscal year will remain below last year's. OPERATING EXPENSES Operating expenses were $5,468,029 or 19.1% of net sales for the quarter ended December 31, 2003 compared to operating expenses of $3,950,088 or 8.7% for the quarter ended December 31, 2002. The expenses increased over prior year by $1.1 million. The primary factors that contributed to the increase in operating expenses for the quarter ended December 31, 2003 are: (i) Increased sales and music costs of $562,028 made up of increased commissions of $257,456, increase in freight to customers of $192,220, increased payroll and related costs of $255,313 which are offset by decreases in advertising and public relations of $92,394, reduced handling charges of $27,116 and other decreases totaling $23,451 primarily made up of decreases in showroom rent and sales expenses. (ii) Increases in expenses at the wholly-owned Hong Kong subsidiary totaling $554,588 which is primarily comprised of increases in depreciation of newly acquired assets of $109,588, $392,000 for the recognition of bad debts and the remaining increases of $53,000 is primarily bank charges and development expenses. 14 (iii) Increased in SG&A of the Florida Operations of $189,571 which is primarily attributable to increases in accounting of $66,541, amortization of loan costs $48,704, bad debt expense $249,512, legal costs $90,964, and consulting fees of $117,981 which were offset by decreases in payroll and related costs of $296,592, and other decreases totaling $87,539 consisting of primarily insurance, travel and outside computer services. (iv) Decreases in warehousing expenses offset the above increases by $174,017 which was consisted of reductions in payroll and related costs of $219,408, lower packaging and warehouse expenses totaling $62,359 which were offset by increased rent paid to store the additional inventory carried forward from fiscal 2003 of $86,302, and other increases totaling $21,449 which was primarily additional repairs and maintenance. OTHER EXPENSES Net other expenses were $655,079 for the quarter ended December 31, 2003 compared with net expenses of $79,076 at December 31, 2002. Our interest expense increase significantly to $687,178 in the quarter ended December 31, 2003 compared to interest expense of $117,704 in the quarter ended December 31, 2002. Our increased interest expense was due to the increased use of our credit facility at a higher interest rate than the prior year and the amortization of deferred fees and discounts associated with our convertible debentures. INCOME TAXES Significant management judgment is required in developing the Company's provision for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. At December 31, 2003, the Company concluded that a valuation allowance was needed against all of the Company's deferred tax assets, as it is not more likely than not that the deferred taxes will be realized. For the three months ended December 31, 2003, the Company recorded a tax provision of $2.2 million. This occurred because the valuation allowance established against the deferred tax asset exceeded the amount of the benefit created from carrying back a portion of the current period losses. The carry-back of the losses from the current period resulted in an income tax receivable of $1.2 million, which is included in prepaid and other current assets in the accompanying balance sheets. The Company has now exhausted its ability to carry back any further losses and therefore will not be able to recognize tax benefits on future losses including its expected fourth quarter loss. The Company's wholly-owned subsidiary, has applied for an exemption of income tax in Hong Kong. Therefore, no taxes have been expensed or provided for at the Subsidiary level. Although the governing body has reached no decision to date, the U.S. parent company has reached the decision to provide for the possibility that the exemption could be denied and accordingly has recorded a provision in fiscal 2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%. Current Hong Kong taxes payable on the earnings of the Company's Hong Kong subsidiary totaled $2.9 million at December 31, 2003. The Company operates within multiple taxing jurisdictions and is subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management's opinion, adequate provisions for income taxes have been made. NET LOSS (EARNINGS) As a result of the forgoing, our net loss for the three months ended December 31, 2003 was $10,450,601 as compared with net income of $3,320,527 for the three months ended December 31, 2002. NINE MONTHS ENDED DECEMBER 31, 2003 COMPARED TO THE NINE MONTHS ENDED DECEMBER 31, 2002 NET SALES Net sales for the nine months ended December 31, 2003 decreased 16.9% to $68,053,739 as compared to $81,915,443 for the nine months ended December 31, 2002. Sales to International customers increased $14.6 million over the same period in the prior year, as sales in the United States decreased $33.7 million. New customers and increased purchases by existing customers contributed to the increase in the European market. Our sales in the United States decreased primarily because of the increased competition in this market. Approximately $5.6 million of this decrease is from the music sector of our business. We lost one significant customer and had reduced sales in two other major retailers. A portion of the decreased sales in the United States can be attributed to advertising allowances accrued for customers. Advertising allowances consist of co-operative advertising, marketing development funds and specific advertising. These allowances are variable and are negotiated every year and since there is no separate and identifiable benefit to the company, such amounts are recorded as a reduction of sales. 15 GROSS PROFIT Gross profit for the nine months ended December 31, 2003 was $2,596,449 or 3.8% of sales as compared to $17,760,348 or 21.7% of sales for the nine months ended December 31, 2002. The decrease in gross profit during the nine months ended December 31, 2003 is a result of: - Competitive pricing pressure on machine pricing - Sales of excess inventory at significantly reduces prices - A 31% decline in the sales of higher margin music - A reserve against the value of inventory on hand at December 31, in the amount of $4,998,126 for our anticipated recovery value - An impairment charge for tools in the amount of $508,480 - Increased sales from International SMC to international and domestic customers. These sales usually carry lower gross margins, as the customer pays for the ocean freight and clearance of the goods. - Increased expense of the guaranteed minimum royalty on our MTV license of $998,000. Even though we have taken a reserve that we believe is sufficient to cover any losses against the value of inventory, there can be no assurance that we will be able to recover its remaining value through sales of the products. Any additional reduction that may be necessary may have a material impact in future periods. As we continue to reduce the amount of inventory in our warehouses, we anticipate gross margins to remain low. OPERATING EXPENSES Operating Expenses increased over the same period in the prior year to $13.6 million from $11.5 million. The primary reasons for the increase in operating expenses are as follows: i) Increases in total cash and stock compensation of $724,895 ii) Increases in bad debt expense and at the wholly-owned Hong Kong subsidiary of $392,000 iii) Increases with respect to the need to warehouse the excess inventory carried over from March 2003 totaling $492,119 iv) Increases paid to legal, accounting fees totaling $626,185 v) Increased costs related to the amendments required to secure the financing from LaSalle and related consulting costs totaling $432,223 vi) Increases in bad debts for the domestic operations attributable to the KB Toys and FAO bankruptcy filings of $263,289 vii) Increase in charitable contributions, insurance and fixing fees associated with the production of music and customer service totaling $304,134 viii) Offset by a decrease to direct advertising $697,119 and decreases in freight to customers of $452,092 OTHER EXPENSES Other expenses were $1,245,424 for the nine months ended December 31, 2003 compared to net other expenses of $20,006 at December 31, 2002. Our interest expense increased by $965,944 during the nine months ended December 31, 2003 compared to interest expense in the same period of the prior year. Our interest expense increased due to the increased use of our credit facility at a higher interest rate than the prior year, as well as the amortization of deferred expenses associated with the convertible debentures. The remaining $259,474 is attributable to other miscellaneous expenses such as exchange differences. INCOME TAXES Significant management judgment is required in developing the Company's provision for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. At December 31, 2003, the Company concluded that a valuation allowance was needed against all of the Company's deferred tax assets, as it is not more likely than not that the deferred taxes will be realized. For the nine months ended December 31, 2003, the Company recorded a tax provision of $1.2 million. This occurred because the valuation allowance established against the deferred tax asset exceeded the 16 amount of the benefit created from carrying back a portion of the current period losses. The carry-back of the losses from the current period resulted in an income tax receivable of $1.2 million, which is included in prepaid and other current assets in the accompanying balance sheets. The Company has now exhausted its ability to carry back any further losses and therefore will not be able to recognize tax benefits on future losses including its expected fourth quarter loss. The Company's wholly-owned subsidiary, has applied for an exemption of income tax in Hong Kong. Therefore, no taxes have been expensed or provided for at the Subsidiary level. Although the governing body has reached no decision to date, the U.S. parent company has reached the decision to provide for the possibility that the exemption could be denied and accordingly has recorded a provision in fiscal 2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%. Current Hong Kong taxes payable on the earnings of the Company's Hong Kong subsidiary totaled $2.9 million at December 31, 2003. The Company operates within multiple taxing jurisdictions and is subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management's opinion, adequate provisions for income taxes have been made. NET LOSS (EARNINGS) As a result of the forgoing, our net loss for the nine months ended December 31, 2003 was $13,424,622 compared with net income of $5,957,136 for the nine months ended December 31, 2002. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2003, we had cash on hand of $235,958 and a bank overdraft of $85,236 compared to cash on hand of $268,265 and a bank overdraft of $316,646 at March 31, 2003. Our current assets consist predominantly of accounts receivable and inventory. Our accounts receivable increased to $14,729,176 for the nine months ended December 31, 2003 due to the amount of sales that occurred in November and December, as well as some customer terms which exceed 45 days. Our inventory has been steadily decreasing since March 31, 2003, as we are shipping goods to our customers. As of December 31, 2003, we had $8 million in inventory, net of a provision for loss of $6,195,197 compared to $25 million as of March 31, 2003. Our current liabilities decreased to $18,911,314 as of December 31, 2003, compared to $21,249,930 at March 31, 2003. Current liabilities consist of accounts payable of $5,329,648, accrued expenses of $2,587,567, accrual for income taxes of $2,872,509, subordinated debt of $1 million, bank overdraft of $85,136 and the revolving credit facilities of $7,109,622. Approximately $2.7 million or 51% of our accounts payable are due to two factories in China. This amount is aged beyond the terms originally set by the factories.. We have been in contact with these factories regarding these amounts and they have not pursued any means of collection. We intend to enter into payment plans with these factories, but cannot ensure that this will occur. If these factories pursue any claims against us, it could have a material effect on our operations. The remainder of accounts payable of $2.6 million are within terms set by our vendors. During fiscal 2003, we had a credit facility with LaSalle Business Credit, LLC. Under this agreement, LaSalle advanced up funds to us based on our eligible accounts receivable and inventory. The loan was secured by a first lien on all of present and future assets, except specific tooling located in China. During fiscal 2004, the maximum amount that we were permitted to borrow under the credit facility was $7.5 million. Because we had minimal liquidity and had defaulted under our credit agreement with LaSalle, we received a going concern paragraph from our independent certified public accountants for our audited financial statements for fiscal 2003. On March 14, 2003, we were notified by LaSalle that we were in violation of the tangible net worth covenant in our credit facility and were declared in default. LaSalle amended the credit facility on August 19, 2003 in a fourteenth amendment, which extended the loan until March 31, 2004 and the condition of default was waived. On December 31, 2003, we violated the tangible net worth requirement and working capital requirement of our credit facility. On January 31, 2004, we paid this loan in full, terminated this credit facility and LaSalle released its security interest in our assets. On February 9, 2004, we executed a factoring agreement with Milberg Factors, Inc. Pursuant to the agreement, Milberg, at its discretion, will advance the Company the lesser of 80% of our accounts receivable or $3.5 million. All receivables submitted to Milberg are subject to a fee equal to 0.8% of the gross invoice value. The average monthly balance of the line will incur interest at a rate of prime plus .75%. Other terms of the agreement include minimum fees of $200,000 per calendar year, $7.5 million tangible net worth and $7.5 million working capital. To secure these advances, Milberg received a security interest in all of our accounts receivable and inventory located in the United States and a pledge of 66 2/3% of the stock in International SMC (HK) Ltd, our wholly-owned subsidiary. This agreement is effective for an initial term of two years, with successive automatic renewals unless either party gives notice of termination. Although this credit line is not equivalent to our previous lines, we believe that advances under this credit facility, as well as collection of our outstanding accounts receivable, will allow us enough available cash flow to continue operations until August 2004 and prepare for the upcoming fiscal year. We have been receiving collections of accounts receivable since the termination of our LaSalle agreement, which have served as working capital and enabled us to pay our obligations. In order to further increase our liquidity, we are selling our excess inventory and reducing our cost structure. As of February 11, 2004, we have orders on hand of about $2.5 million and had already shipped over $1.0 million, which is ahead of our projected target for most of the old inventory. Our goal is to sell $3 to $4 million of old inventory by March 31, 2004. However, we can not provide you with any assurances that we will be able to sell this inventory. 17 We have taken several steps to decrease our costs. Since June 2003, we have had two rounds of lay-offs at our company. In January 2004, our senior executive officers agreed to take 20% salary reductions and other employees also agreed to salary reductions. Additionally, we have also subleased some of our warehouse space in California and Florida and hope to sublease out more. As our plans are put into place we should see reductions of our overhead expenses by more than 20% of last years amounts. We do not intend to enter into any additional material commitments for the Company in the near future. We will be incurring only normal course of business expenses such as: rent, utilities, salaries and related expenses, accounting, legal, bank charges, interest, office supplies, and other expenses that may become necessary as they relate to repairs and maintenance of our leased facilities and computer equipment. We will also incur expenses for any outstanding operating leases that are currently in place (see commitment table below). We intend to finance our business in fiscal 2005 through: (i) Continued support from our Chinese factories in financing our purchases and entering into agreements for payment of old receivables; (ii) Selling the remainder of our inventory on hand; (iii) Continuing to reduce costs; (iv) Using our credit facility with Milberg Factors; and (v) Utilizing credit facilities that are available to our wholly-owned subsidiary to finance all direct shipments. In order to reduce the need to maintain inventory in United States locations in fiscal 2005, we intend to generate a larger share of our total sales through FOB sales from our wholly-owned subsidiary. These sales are shipped directly to our customers from the ports in China and are primarily backed by letters of credit. The customers take title to the merchandise at their consolidators in China and are responsible for their shipment, duty, clearance and freight charges to their locations. We will also assist our customers in the forecasting and management of their inventories of our product. If we need additional financing during our peak selling season, we intend to approach Milberg. If Milberg is not willing to provide us with additional financing, we will need to seek additional capital from other sources. However, we can not assure that we will be able to obtain additional financing or that the terms will be acceptable to us. If we need to obtain additional financing and fail to do so, it may have a material adverse effect on our ability to meet our financial obligations and continue to operate. Debt and Contractual Obligations Our commitments for debt and other contractual arrangements are summarized as follows:
Years ending March 31, ------------------------------------------------------------------- Total 2004 2005 2006 2007 2008 -------------- -------------- ------------ -------------- ------------ ----------- Merchandise License Guarantee $1,595,000 $1,395,000 $150,000 $50,000 -- -- Property Leases $3,638,771 $1,330,158 $924,338 $517,071 $495,545 $371,659 Equipment Leases $86,016 $46,525 $19,965 $10,322 $7,969 $1,235 Revolving Credit Facilities $7,115,114 $7,115,114 -- -- -- -- Convertible Debentures $4,000,000 -- -- $4,000,000 -- --
Merchandise license guarantee reflects amounts that we are obligated to pay as guaranteed royalties under our various license agreements. In fiscal 2003, we had guaranteed minimum royalty payments under our license agreements with MTV Networks, Nickelodeon, Hard Rock Academy and Motown (Universal Music). In fiscal 2004, we have guaranteed minimum royalty payments under the license agreement with MTV and Motown (Universal Music). We have leases for property in Rancho Dominguez and Compton California, as well as in Coconut Creek, Florida. We have equipment leases for forklifts and copy machines. Our revolving credit facility represents our credit facility with LaSalle Business Credit, LLC, which was terminated as of January 31, 2004. On September 8, 2003, we issued an aggregate of $4,000,000 of 8% convertible debentures in a private offering to six accredited investors. The debentures initially are convertible into 1,038,962 shares of common stock at $3.85 per share, subject to adjustment in certain situations. We also issued an aggregate of 457,143 warrants to the investors. The exercise price of the warrants is $4.025 per share and the warrants expire on September 7, 2006. We have an obligation to register the shares of common stock underlying the debenture and warrants and filed a registration statement on Form S-1 to register the shares on October 9, 2003. Effective as of February 9, 2004, we amended the convertible debenture agreements to increase the interest rate to 8.5% per annum effective as of February 9, 2004, and grants warrants to purchase an aggregate of 30,000 shares of the Company's common stock to the debenture holders on a pro-rata basis. These concessions were in consideration of the debenture holder's agreements to (i)enter into new subordination agreements with the Company's new lender, Milberg Factors, (ii) to waive all liquidated damages due under the convertible debentures and related transaction documents through July 1, 2004 and (iii) to extend the effective date of the Form S-1 registration statement until July 1, 2004. The new warrants have an exercise price equal to $1.52 per share, the fair market value of the Company's common stock on February 9, 2004, the date of the grant. Sources and uses of Cash Cash flows used in operating activities were $4,998,092 for the nine months ended December 31, 2003. Cash flows were used in operating activities primarily due to increases in accounts receivable in the amount of $9.4 million, decreases in accounts payable of $3.2 million and decreases in existing inventory of $12.2 million, as well as the loss for the period and other non-cash expenses such as the tooling impairment and provision for inventory losses. Cash used in investing activities for the nine months ended December 31, 2003 was $434,065. Cash used in investing activities resulted from the purchase of fixed assets in the amount of $434,065. The purchase of fixed assets consists of the tooling and molds required for production of new machines for this fiscal year. Tooling and molds are depreciated over three years. 18 Cash flows provided by financing activities were $5,399,851 for the nine months ended December 31, 2003. This consisted of proceeds from the exercise of options in the amount of $981,972. We also issued convertible debentures with detachable stock purchase warrants. This transaction resulted in a gross increase in cash of $4 million. We received subordinated debt from related parties of $1 million in July of 2003 and paid $400,000 to a director who had previously loaned money to our Company on a short term basis. The remainder of cash provided from financing activities was provided by net repayments on the credit line at LaSalle National Bank in the amount of $4,308,438 and borrowings on the credit lines in Hong Kong in the amount of $4,640,728 to fund ongoing operations. EXCHANGE RATES We sell all of our products in U.S. dollars and pay for all of our manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of the Hong Kong office are paid in Hong Kong dollars. We cannot assure you that the exchange rate fluctuations between the United States and Hong Kong currencies will not have a material adverse effect on our business, financial condition or results of operations. SEASONAL AND QUARTERLY RESULTS Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our fiscal second and third quarter, combined, accounted for approximately 85% of net sales in fiscal 2003, 81% of net sales in fiscal 2002 and 75% of net sales in fiscal 2001. Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis. INFLATION Inflation has not had a significant impact on our operations. We have historically passed any price increases on to its customers since prices charged by us are generally not fixed by long-term contracts. CRITICAL ACCOUNTING POLICIES The U.S. Securities and Exchange Commission defines critical accounting policies as "those that are both most important to the portrayal of a company's financial condition and results, and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our management believes that a high degree of judgment or complexity is involved in the following areas: Reserves on Inventories. We establish a reserve on inventory based on the expected net realizable value of inventory on an item-by-item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews our investment in inventories for such declines in value. Income Taxes. Significant management judgment is required in developing the Company's provision for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. At December 31, 2003, the Company concluded that a valuation allowance was needed against all of the Company's deferred tax assets, as it is not more likely than not that the deferred taxes will be realized. For the nine months ended December 31, 2003, the Company recorded a tax provision of $1.2 million. This occurred because the valuation allowance established against the deferred tax asset exceeded the amount of the benefit created from carrying back a portion of the current period losses. The carry-back of the losses from the current period resulted in an income tax receivable of $1.2 million, which is included in prepaid and other current assets in the accompanying balance sheets. The Company has now exhausted its ability to carry back any further losses and therefore will not be able to recognize tax benefits on future losses including its expected fourth quarter loss. The Company's wholly-owned subsidiary, has applied for an exemption of income tax in Hong Kong. Therefore, no taxes have been expensed or provided for at the Subsidiary level. Although the governing body has reached no decision to date, the U.S. parent company has reached the decision to provide for the possibility that the exemption could be denied and accordingly has recorded a provision in fiscal 2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%. Current Hong Kong taxes payable on the earnings of the Company's Hong Kong subsidiary totaled $2.9 million at December 31, 2003. 19 The Company operates within multiple taxing jurisdictions and is subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management's opinion, adequate provisions for income taxes have been made. Collectibility of Accounts Receivable. Our allowance for doubtful accounts is based on management's estimates of the creditworthiness of its customers, current economic conditions and historical experience, and, in the opinion of management, is believed to be an amount sufficient to respond to normal business conditions. Management sets 100% reserves for customers in bankruptcy and other reserves based upon historical collection experience. Should business conditions deteriorate or any major customer default on its obligations to our Company, this allowance may need to be significantly increased, which would have a negative impact on operations. Other Estimates. We make other estimates in the ordinary course of business relating to sales returns and allowances, warranty reserves, and reserves for promotional incentives. Historically, past changes to these estimates have not had a material impact on our financial condition. However, circumstances could change which may alter future expectations. RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK RISKS RELATED TO THE COMPANY'S BUSINESS AND OPERATIONS WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS AND IF WE ARE UNABLE TO OBTAIN ADDITIONAL FINANCING, WHEN NEEDED, WE MAY NOT HAVE SUFFICIENT CASH FLOW TO RUN OUR BUSINESS As of February 13, 2004, our cash on hand is limited. During the next three months, we plan on financing our working capital needs from the collection of accounts receivable and using the funds that are advanced to us by Milberg under our factoring agreement. We also plan on selling our remaining inventory on hand. If these sources do not provide us with adequate financing, we may try to seek financing from a third party; however, we will have to obtain consent from Mlberg prior to obtaining any other financing. If we are not able to obtain adequate financing, when needed, it will have a material adverse effect on our cash flow and our ability to run our business. If we have a severe shortage of working capital, we may not be able to continue our business operations and may be required to file a petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code or enter into some liquidation or reorganization proceeding. WE MAY BE DEEMED TO INSOLVENT AND WE MAY GO OUT OF BUSINESS As of February 9, 2004, our cash position is limited. We are not able to pay all of our creditors on a timely basis. We are not current on approximately $2.7 million of outstanding accounts payable, which represents accounts payable to factories in China. If we are not able to pay our current debts as they become due, we may be deemed to be insolvent and we may go out of business. OUR INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS RAISED SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN FOR THE FISCAL YEAR ENDED MARCH 31, 2003- We received a report dated June 24, 2003 (except for Note 9, as to which the date is July 8, 2003 and Note 15, as to which the date is July 10, 2003) from our independent certified public accountants covering the consolidated financial statements for our fiscal year ended March 31, 2003 that included an explanatory paragraph which stated that the financial statements were prepared assuming the Company would continue as a going concern. This report stated that a then-existing default under our credit agreement with LaSalle Business Credit raised substantial doubt about our ability to continue as a going concern. We paid our loan with LaSalle in full effective as of January 31, 2004 and terminated the agreement. We will replaced the LaSalle credit facility by entering into a factoring agreement with Milberg Factors, Inc., effective as of February 9, 2004. Pursuant to the agreement, Milberg, at its discretion, will advance the Company with the lesser of 80% of our eligible accounts receivable or $3.5 million. We do not know if this factoring agreement will provide us with sufficient capital. If the agreement with Milberg does not provide sufficient capital or that we are unable to obtain additional financing, we may have a liquidity problem and this would affect our ability to continue our business operations. A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY REDUCE OUR REVENUES, PROFITABILITY AND CASH FLOW We rely on a few large customers to provide a substantial portion of our revenues. As a percentage of total revenues, our net sales to our five largest customers during the fiscal period ended March 31, 2003, 2002 and 2001 were approximately 67%, 77% and 87% respectively. In fiscal 2003, three major 20 customers accounted for 21%, 17% and 15% of our net sales. We do not have long-term contractual arrangements with any of our customers and they can cancel their orders at any time prior to delivery. A substantial reduction in or termination of orders from any of our largest customers would decrease our revenues, profitability and cash flow. WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY In February 2002, one of our largest customers, Best Buy returned approximately $2.75 million in karaoke products to us that it had not been able to sell during the Christmas season. Best Buy kept this inventory in its retail stores, but converted the sales to consignment sales. Although we were not contractually obligated to accept this return of the karaoke products, we did this because we valued our relationship with Best Buy. Because we are dependent upon a few large customers, we are subject to the risk that any of these customers may elect to return unsold karaoke products to us in the future. If any of our customers were to return karaoke products to us, it would reduce our revenues and profitability. WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTIONS, FINANCIAL INCENTIVES AND OTHER RISKS THAT FORCE US TO BEAR THE RISKS AND COSTS OF CARRYING INVENTORY, AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY Because there is intense competition in the karaoke industry, we are subject to pricing pressure from our customers. Many of our customers have demanded that we lower our prices or they will buy our competitor's products. If we do not meet our customer's demands for lower prices, we will not sell as many karaoke products. In the nine months ended December 31, 2003, our sales to customers in the United States decreased because of increased competition and the increased amount of inventory that we had on hand, which was sole near or below cost. We are also subject to the risk that our customers might demand certain financial incentives, such as large advertising or cooperative advertising allowances, which effectively reduce our selling prices. Additionally, many of our customers place orders with us several months prior to the holiday season, but they schedule delivery two or three weeks before the holiday season begins. As such, we are subject to the risks and costs of carrying inventory during the time period between the placement of the order and the delivery date, which reduces our cash flow. OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT THE TREND TO CONTINUE Over the past year, our gross profit margins have decreased. In the nine months ended December 31, 2003, our gross profit margin was 4.6% compared to 21.7% in the nine months ended December 31, 2002 and for the three months ended December 31, 2003 and 2002, our gross margin was (9.1%) and 19.8%, respectively. This decline resulted from price competition and a shift in customer orders from our parent company in the United States to our Hong Kong subsidiary, International SMC. International SMC delivers our karaoke products to customers directly from our manufacturer's factories in China and therefore does not provide logistics, handling, warehousing and just in time inventory support, which services are provided by our parent company in the United States. Accordingly, the average sales price per unit realized by International SMC is significantly lower than that of our parent company in the United States. We expect further price competition and a continuing shift of sales volume to International SMC. Accordingly, we expect that our gross profit margin will decrease in fiscal 2004. OUR SENIOR CORPORATE MANAGEMENT TEAM IS NEW TO THE SINGING MACHINE AND IS REQUIRED TO DEVOTE SIGNIFICANT ATTENTION TO OUR FINANCING AGREEMENTS AND SETTLING OUR CLASS ACTION LAWSUITS. Beginning on May 2, 2003, through the present date, we have had two Chief Executive Officers and a Chief Operating Officer resign. Additionally, four out of the five directors serving on our Board on May 2, 2003 have resigned since that date. We hired a new Chief Operating Officer, Yi Ping Chan on March 31, 2003 and appointed two new directors, Bernard Appel and Richard Ekstract, on October 31, 2003. We are in the process of searching for a new Chief Executive Officer. It will take some time for our new management and our new board of directors to learn about our business and to develop strong working relationships with each other and our employees. In particular, coordination between various divisions of our company have not been systematized and morale has suffered as a consequence. Our new senior corporate management's ability to complete this process has been and continues to be hindered by the time that it needs to devote to other pressing business matters. New management needs to spend significant time on restructuring our financing agreements and overseeing legal matters, such as our class action lawsuit. We cannot assure you that this major restructuring of our board of directors and senior management and the accompanying distractions, in this environment, will not adversely affect our results of operations. 21 THE SEC IS CONDUCTING AN INFORMAL INVESTIGATION OF THE COMPANY AND IF WE HAVE DONE SOMETHING ILLEGAL, WE WILL BE SUBJECT TO FINES, PENALTIES AND OTHER SANCTIONS BY THE SEC In August 2003, we were advised that the SEC had commenced an informal investigation of our company. It appears that the investigation is focused on the restatement of our financial statements in fiscal 2002 and 2001; however, the SEC may be reviewing other issues as well. If the SEC finds that our company has not fully complied with all applicable federal securities laws, we could be subject to fines, penalties and other sanctions imposed by the SEC. WE ARE NAMED AS A DEFENDANT IN A CLASS ACTION LAWSUIT RELATING TO THE RESTATEMENT OF OUR FINANCIAL STATEMENTS FOR FISCAL 2002 AND FISCAL 2001, WHICH IF DETERMINED ADVERSELY TO US, COULD RESULT IN THE IMPOSITION OF DAMAGES AGAINST US AND HARM OUR BUSINESS AND FINANCIAL CONDITION We are named as a defendant in a class action lawsuit which arose from the restatement of our financial statements for fiscal 2002 and 2001. In this lawsuit, the plaintiffs allege that our executive officers and our company violated Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5. The plaintiffs seek compensatory damages, attorney's fees and injunctive relief. While the specific factual allegations vary slightly in each case, the complaints generally allege that our officers falsely represented the Company's financial results during the relevant class periods. As of December 31, 2003, we had incurred approximately $125,000 of legal fees to defend the class action lawsuit and it has significantly diverted the attention of our management team. There can be no assurance that we will be able to settle this litigation on acceptable terms or obtain a favorable resolution in court if we do not settle this matter. If a significant monetary judgment is rendered against us, we are not certain that we will have the ability to pay such a judgment. Any losses resulting from these claims could adversely affect our profitability and cash flow. OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE WERE TO LOSE OUT MTV LICENSE IT WOULD AFFECT OUR REVENUES AND PROFITABILITY Our license with MTV Networks is important to our business. We generated $30,884,344 or 32.3% of our net sales from products sold under the MTV license in fiscal 2003. During the nine months ended December 31, 2003, we generated only $8.3 million or 12.2% of our net sales under this MTV license agreement. Our MTV license was extended until April 30, 2004 with options for MTV to renew for two additional periods through December 31, 2004; however, MTV can terminate the license agreement for certain reasons over the course of the calendar year 2004. If we were to lose our MTV license, it would have an effect on our revenues and net income. WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS Because of our reliance on manufacturers in Asia for our machine production, our production lead times range from one to four months. Therefore, we must commit to production in advance of customers orders. It is difficult to forecast customer demand because we do not have any scientific or quantitative method to predict this demand. Our forecasting is based on management's general expectations about customer demand, the general strength of the retail market and management's historical experiences. As of December 31, 2003, we had $14.2 million in inventory against which a $6.2 million reserve has been taken.. We will attempt to liquidate this inventory over the next six months. However, if we are unable to sell this inventory, our revenues, cash flow and profitability will be reduced. OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND, IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ended September 30 and the third quarter ended December 31. Sales in our second and third quarter, combined, accounted for approximately 85.6% of net sales in fiscal 2003, 81% of net sales in fiscal 2002 and 75% of net sales in fiscal 2001. Our sales would be disproportionately adversely affected by terrorist attacks, military engagements or other extraordinary events that negatively affect the retail environment or consumer buying patterns. IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND NET PROFITABILITY WILL BE REDUCED Our major competitors for karaoke machines and related products are Craig and Memorex. We believe that competition for karaoke machines is based primarily on price, product features, reputation, delivery times, and customer support. Our primary competitors for producing karaoke music are Compass, Pocket Songs, Sybersound, UAV and Sound Choice. We believe that competition for karaoke music is based primarily on popularity of song titles, price, reputation, and delivery times. To the extent that we lower prices to attempt to enhance or retain market share, we may adversely impact our operating margins. Conversely, if we opt not to match competitor's price reductions we may lose market share, resulting in decreased volume and revenue. To the extent our leading competitors reduce prices on their karaoke machines and music, we must remain flexible to 22 reduce our prices. If we are forced to reduce our prices, it will result in lower margins and reduced profitability. 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. IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE TO GROW The karaoke industry is characterized by rapid technological change, frequent new product introductions and enhancements and ongoing customer demands for greater performance. In addition, the average selling price of any karaoke machine has historically decreased over its life, and we expect that trend to continue. As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands. The development of new products is complex, and we may not be able to complete development in a timely manner, or at all. During the past twelve years, Edward Steele, our former Chief Executive Officer, oversaw new product development. Mr. Steele will be retiring from our company on February 28, 2004 and we have not yet identified a successor who will oversee new product development. To introduce products on a timely basis, we must: - accurately define and design new products to meet market needs; - design features that continue to differentiate our products from those of our competitors; - transition our products to new manufacturing process technologies; - identify emerging technological trends in our target markets; - anticipate changes in end-user preferences with respect to our customers' products; - bring products to market on a timely basis at competitive prices; and - respond effectively to technological changes or product announcements by others. We believe that we will need to continue to enhance our karaoke machines and develop new machines to keep pace with competitive and technological developments and to achieve market acceptance for our products. OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY We rely principally on four contract ocean carriers to ship virtually all of the products that we import to our warehouse facilities in Compton and Rancho Dominguez, California. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in California or China, caused by labor strikes, other labor disputes, terrorism, and international incidents or otherwise prevent or delay our customers' receipt of inventory. If we our customers do not receive their inventory on a timely basis, they may cancel their orders or return products to us. Consequently, our revenues and net income would be reduced. OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY BE REDUCED. We are dependent upon six factories in the People's Republic of China to manufacture all of our electronic products. Our arrangements with these factories are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, foreign currency fluctuations, limitations on the repatriation of earnings and political instability, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by our third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our revenues, profitability and cash flow. WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS WILL BE SEVERELY DAMAGED Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of karaoke machines and our electronic products. We rely on third party suppliers to produce the parts and materials we use to manufacture and produce these products. If our suppliers are unable to provide our factories 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. In the last several years, there have been shortages of certain chips that we use in our karaoke machines. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems, which would impact our sales. 23 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 machines and music 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 sales growth and profitability. WE MAY HAVE INFRINGED ON THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES Over the past two years, we have received notices from three music publishers who have alleged that we did not have the proper copyright licenses to sell certain songs included in our CD+G's. We have settled all of these copyright infringement issues with these publishers. If we discover that we do not have the proper copyright licenses for any other songs that are included in our CD+G's and cassettes, we will be subject to additional liability under the federal copyright laws, which could include settlements with the music publishers and payment of monetary damages. WE MAY BE INFRINGING UPON THE COPYRIGHTS OF THIRD PARTIES AND IF WE ARE DOING SO, OUR PROFITABILITY WILL BE REDUCED 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 and that our suppliers have complied with these 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 and may result in a fine or damages being assessed against our company. WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS AND ANY CLAIMS ASSERTED AGAINST US COULD AFFECT OUR NET PROFITABILITY 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. During fiscal 2000, Tanashin Denki, Ltd., a Japanese company that holds a patent on a cassette tape drive mechanism alleged that some of our karaoke machines violated their patents. We settled the matters with Tanashin in December 1999. Subsequently in December 2002, Tanashin again alleged that some of our karaoke machines violated their patents. We entered into another settlement agreement with them in May 2003. In addition to Tanashin, we could receive infringement claims from other third parties. Any infringement claims may have a negative effect on our profitability and financial condition. WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR REVENUES AND PROFITABILITY WILL BE REDUCED We sell products to retailers, including department stores, lifestyle merchants, direct mail retailers, which are catalogs and showrooms, national chains, specialty stores, and warehouse clubs. Some of these retailers, such as K-Mart, FAO Schwarz and KB Toys, have engaged in leveraged buyouts or transactions in which they incurred a significant amount of debt, and operated under the protection of bankruptcy laws. As of February 4, 2004, we are aware of only two customers, FAO Schwarz and KB Toys, which are operating under the protection of bankruptcy laws. In fiscal 2003, FAO Schwarz and KB Toys represented less than 1% of our revenues and we expect that revenues from this account will be less than 2% of our revenues in fiscal 2004. Despite the difficulties experienced by retailers in recent years, we have not suffered significant credit losses to date. Deterioration in the financial condition of our customers could result in bad debt expense to us and have a material adverse effect on our revenues and future profitability. A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA COULD IMPACT OUR ABILITY TO DELIVERY MERCHANDISE TO OUR STORES, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY A significant amount of our merchandise is shipped to our customers from one of our three warehouses, which are located in Compton, California, Rancho Dominguez, California and Coconut Creek, Florida. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our customers, which could substantially decrease our revenues and profitability. 24 OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE WEST COAST During fiscal 2003, approximately 48% of our sales were domestic sales, which were made from our warehouses in California and Florida. During the third quarter of fiscal 2003, the dock strike on the West Coast affected sales of two of our karaoke products and we estimate that we lost between $3 and $5 million in orders because we couldn't get the containers of these products off the pier. If another strike or work slow-down occurs and we do not have a sufficient level of inventory, a strike or work slow-down would result in increased costs to us and may reduce our profitability. THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS TO LOSE ALL OR A PORTION OF THEIR INVESTMENT From December 1, 2002 through December 1, 2003, our common stock has traded between a high of $13.10 and a low of $2.15. During this period, we have restated our earnings, lost senior executives and Board members, had liquidity problems and defaulted on our line of credit with LaSalle. Our stock price may continue to be volatile based on similar or other adverse developments in our business. In addition, the stock market periodically experiences significant adverse price and volume fluctuations which may be unrelated to the operating performance of particular companies. IF INVESTORS SHORT OUR SECURITIES, IT MAY CAUSE OUR STOCK PRICE TO DECLINE During the past year, a number of investors have held a short position in our common stock. Based on reports received from ViWes InvestInfo, the ratio for the number of shares short compared to the daily average volume in our stock as of the dates was as follows: Shares Average Daily Month* Short Volume Ratio ------ ----- ------ ----- 8/03 437,590 53,721 8.15 7/03 423,623 167,066 2.54 6/03 600,440 68,480 8.77 5/03 606,841 30,280 20.04 4/03 584,510 27,359 21.36 3/03 584,185 22,195 26.32 *Monthly data as of settlement on the 15th of each month. The anticipated downward pressure on our stock price due to actual or anticipated sales of our stock by some institutions or individuals who engage in short sales of our common stock could cause our stock price to decline. Additionally, if our stock price declines, it may be more difficult for us to raise capital. OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS Our employment agreements with Yi Ping Chan, April Green, Jack Dromgold and John Dahl require us, under certain conditions, to make substantial severance payments to them if they resign after a change of control. As of September 30, 2003, Mr. Chan, Ms. Green, Mr. Dromgold and Mr. Dahl are entitled to severance payments of $250,000, $73,600, $135,000 and $75,000, respectively. These provisions could delay or impede a merger, tender offer or other transaction resulting in a change in control of the Company, even if such a transaction would have significant benefits to our shareholders. As a result, these provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR EXISTING SHAREHOLDERS WILL SUFFER DILUTION As of December 31, 2003, there were outstanding stock options to purchase an aggregate of 1,120,120 shares of common stock at exercise prices ranging from $1.97 to $14.00 per share, not all of which are immediately exercisable. The weighted average exercise price of the outstanding stock options is approximately $4.81 per share. As of December 31, 2003, there were outstanding immediately exercisable warrants to purchase an aggregate of 561,039 shares of our common stock. In addition, we have issued $4,000,000 of convertible debentures, which are initially convertible into an aggregate of 1,038,962 shares of common stock. To the extent that the aforementioned convertible securities are exercised or converted, dilution to our stockholders will occur. 25 THE $4 MILLION PRIVATE PLACEMENT THAT WE CLOSED IN SEPTEMBER 2003 WILL AFFECT OUR ABILITY TO RAISE CAPITAL IN THE FUTURE On September 8, 2003, we closed a private offering in which we issued $4 million of convertible debentures and stock purchase warrants to six institutional investors. As part of this investment, we agreed to several limitations on our corporate actions, some of which limit our ability to raise financing in the future. If we enter into any financing transactions during the one year period after the registration statement, of which this Prospectus is a part, is effective we need to offer the institutional investors the right to participate in such offering in an amount equal to the greater of (a) the principal amount of the debentures currently outstanding or (b) 50% of the financing offered to the outside investment group. For example, if we offer to sell $10 million worth of our securities to an outside investment group, the institutional investors will have the right to purchase up to $5 million of the offering. This right may affect our ability to attract other investors if we require external financing to remain in operations. Furthermore, for a period of 90 days after the effective date of the registration statement, we cannot sell any securities. Additionally, we can not: - sell any of our securities in any transactions where the exercise price is adjusted based on the trading price of our common stock at any time after the initial issuance of such securities. - sell any securities which grant investors the right to receive additional shares based on any future transaction on terms more favorable than those granted to the investor in the initial offering These limitations are in place until the earlier of February 20, 2006 or the date on which all the debentures are converted into equity. IF WE SELL ANY OF OUR SECURITIES AT A PRICE LOWER THAN $3.85 PER SHARE, THE CONVERSION PRICE OF OUR DEBENTURES AT $3.85 PER SHARE WILL BE REDUCED AND THERE WILL BE ADDITIONAL DILUTION TO OUR SHAREHOLDERS Given that our common stock is trading at a price of $2.22 per share as of December 2, 2003, it is possible that we may need to sell additional securities for capital at a price lower than $3.85 per share. If we sell any securities at a price lower than $3.85 per share, the conversion price of our debentures currently set at $3.85 per share will be reduced and there will be more dilution to our shareholders if and when the debentures are converted into shares of our common stock. If we issue or sell any securities at a price less than $3.85 per share prior to September 8, 2004, the set price of the debentures will be reduced by an amount equal to 75% of the difference between the set price and the effective purchase price for the shares If such dilutive issuances occur after September 8, 2004 but before the earlier of February 20, 2006 or when all the debentures are converted into shares of our common stock, the set price will be reduced by an amount equal to 50% of the difference between the set price and effective purchase price of such shares. So, if we sold 1 million shares of our common stock on December 1, 2003 for a price of $2.85 per share, the set price of the debentures would be reduced by $1.22 to $2.63 and the aggregate number of shares of our common stock that would be issued upon conversion of the debentures would be increased from 1,038,963 shares to 3,278,689 shares. FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY DEPRESS OUR STOCK PRICE As of December 31, 2003, there were 8,756,318 shares of our common stock outstanding. Of these shares, approximately 5,954,796 shares are eligible for sale under Rule 144. We have filed two registration statements registering an aggregate 3,794,250 of shares of our common stock (a registration statement on Form S-8 to registering the sale of 1,844,250 shares underlying options granted under our 1994 Stock Option Plan and a registration statement on Form S-8 to register 1,950,000 shares of our common stock underlying options granted under our Year 2001 Stock Option Plan). An additional registration statement on Form S-1, of which this Prospectus is a part, was filed in October 2003, registering an aggregate of 2,795,465 shares of our common stock. 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. OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK Our Certificate of Incorporation authorizes the issuance of 18,900,000 shares of common stock. As of December 31, 2003, we had 8,756,318 shares of common stock issued and outstanding and an aggregate of 1,580,439 shares issuable under our outstanding options and warrants. We also have an obligation to issue up to 1,038,962 shares upon conversion of our debentures and have reserved 207,791 additional shares for interest payment on the debentures. As such, our Board of Directors has the power, without stockholder approval, to issue up to 7,423,561 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 26 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 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and interest rates. We are exposed to market risk in the areas of changes in United States and international borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all our inventory from companies in China, and, therefore, we are subject to the risk that such suppliers will be unable to provide inventory at competitive prices. While we believe that, if such an event were to occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. Historically and as of December 31, 2003, we have not used derivative instruments or engaged in hedging activities to minimize market risk. INTEREST RATE RISK: Our exposure to market risk resulting from changes in interest rates relates primarily to debt under our credit facility with LaSalle. Under our credit facility, our interest rate is LaSalle's prime rate plus 2.5% per annum ("current interest rate"). As of December 31, 2003, our outstanding balance under our credit facility was $2,474,386 and we are accruing interest at the prime plus 2.5% per annum. This loan was paid in full on January 30, 2004. We do not believe that near-term changes in the interest rates, if any, will result in a material effect on our future earnings, fair values or cash flows. On September 8, 2003, we issued convertible notes in the amount of $4 million with a fixed interest rate of 8% per annum. FOREIGN CURRENCY RISK: We have a wholly-owned subsidiary in Hong Kong. Sales by these operations made on a FOB China or Hong Kong basis are dominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars, thereby creating exposure to changes in exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. We do not believe that near-term changes in the exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows, and therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of the Hong Kong dollar. ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation (the "Evaluation") of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-15(c) under the Securities Exchange Act of 1934, within 90 days of the filing date of this report (the "Evaluation Date"). Based on this 27 Evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From July 2003 through August 2003, eight securities class action lawsuits were filed against The Singing Machine and certain of its officers and directors in the United States District Court for the Southern District of Florida on behalf of all persons who purchased The Singing Machine's securities during the various class action periods specified in the complaints. These complaints have all been consolidated into one action styled Bielansky, et al. v. Salberg & Co., et al., Case No. 03-80596-ZLOCH (the Shareholder Action). The complaints in the Shareholder Action allege violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5 promulgated there under. These complaints seek compensatory damages, attorney's fees and injunctive relief. While the specific factual allegations vary slightly in each case, the complaints generally allege that defendants falsely represented the Company's financial results for the years ended March 31, 2002 and 2001. In July 2003, a shareholder filed a derivative action against the Company, its board of directors and senior management purporting to pursue the action on behalf of the Company and for its benefit. No pre-lawsuit demand was made on the board of directors for them to investigate the allegations or to bring action. The Company is named as a nominal defendant in this case. This case has been consolidated into the Shareholder Action identified above. The derivative complaint alleges claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. The complaint alleges that the individual defendants breached their fiduciary duties and engaged in gross mismanagement by allegedly ignoring indicators of the lack of control over the Company's accounting and management practices, allowing the Company to engage in improper conduct and otherwise failing to carry out their duties and obligations to the Company. The plaintiff's seek damages for breach of fiduciary duties, punitive and compensatory damages, restitution, and bonuses or other incentive-based or equity based compensation received by the CEO and CFO under the Sarbanes-Oxley Act of 2002. The court in the Shareholder Action has directed plaintiffs' counsel to file one amended consolidated complaint no later than November 14, 2003. The Company intends to vigorously defend the Shareholder Action. As the outcome of litigation is difficult to predict, significant changes in the estimated exposures could occur which could have a material affect on the Company's operations. A second shareholder derivative suit was filed in October 2003, which makes generally the same allegations. The second derivative suit has not been served on the Company or on any of its current or former officers and directors. This suit has been transferred to the same judge to whom the Shareholder Action has been assigned and has likewise been consolidated into the Shareholder Action. In August 2003, we were advised that the Securities and Exchange Commission had commenced an informal inquiry of our company. We are cooperating fully with the SEC staff. It appears that the investigation is focused on the restatement of our audited financial statements for fiscal 2002 and 2001. We have been advised that an informal inquiry should not be regarded as an indication by the SEC or its staff that any violations of law have occurred or as a reflection upon any person or entity that may have been involved in those transactions. We are also involved in certain routine litigation matters incidental to our business and operations, which we do not believe are material to our business. In September 2003, we had a disagreement with AG Edwards & Sons, Inc.("AG Edwards") regarding the compensation that was payable to them under our investment banking agreement with them. We have entered into a settlement agreement with AG Edwards, whereby we agreed to pay $181,067 over a six month period and to issue them 40,151 shares of stock. These shares will be registered by the form S-1 currently under amendment. 28 ITEM 2. CHANGES IN SECURITIES (a) Not Applicable. (b) Not Applicable. (c) On December 19, 2003, we issued an aggregate of 221,920 options to our employees, as consideration for services they had rendered to us. We issued these options to our employees in reliance upon Section 4(2) of the Securities Act, because our employees were knowledgeable, sophisticated and had access to comprehensive information about us. NAME NUMBER OF OPTIONS EXERCISE PRICE ---- ----------------- -------------- Frank Abell 1,320 $ 1.97 Josef Bauer 2,740 $ 1.97 Dan Becherer 4,910 $ 1.97 Almina Brady-Dykes 1,320 $ 1.97 Pam Broyles 500 $ 1.97 Elizabeth Canela 660 $ 1.97 Yi Ping Chan 52,800 $ 1.97 Belinda Cheung 110 $ 1.97 Jeffrey Chiu 220 $ 1.97 Brian Cino 660 $ 1.97 John Dahl 50,000 $ 1.97 April Green 4,380 $ 1.97 Alicia Haskamp 24,600 $ 1.97 Jeff Ho 5,000 $ 1.97 Michelle Ho 5,660 $ 1.97 Wilson Ho 220 $ 1.97 Irene Ko 660 $ 1.97 Rose Labadessa 5,000 $ 1.97 Bill Lau 5,990 $ 1.97 Doral Lee 5,660 $ 1.97 Nataly Lessard 1,320 $ 1.97 Marian McElligott 3,290 $ 1.97 Alyssa Malamud 1,000 $ 1.97 Bernardo Melo 4,000 $ 1.97 Rick Ng 110 $ 1.97 Dennis Norden 8,000 $ 1.97 Cathy Novello 880 $ 1.97 Jennifer O'Kuhn 440 $ 1.97 Jorge Otaegui 440 $ 1.97 John Petko 1,500 $ 1.97 Terri Phillips 660 $ 1.97 Melody Rawski 1,100 $ 1.97 Evelyn Romero 500 $ 1.97 Kristi Ronyak 1,000 $ 1.97 Rafael Ros 1,200 $ 1.97 Stacy Sethman 1,100 $ 1.97 Edward Steele 10,000 $ 1.97 John Steele 12,200 $ 1.97 Nicolas Venegas 440 $ 1.97 Ho Man Yeung 110 $ 1.97 Yen Yu 220 $ 1.97 On November 20, 2003, 40,151 shares of stock were issued to AG Edwards in settlement of a disagreement on the terms of an investment banking agreement. This stock was valued at $89,354, its market price on the date of grant. We issued these shares to the AG Edwards & Sons, Inc. in reliance upon Section 4(2) of the Securities Act, because it was knowledgeable, sophisticated and had access to comprehensive information about us. (d) Not applicable. 29 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS EXHIBIT NO. DESCRIPTION - ----------- -------------------------------------------------------------------- 10.1 Factoring Agreement dated February 9, 2004 between Milberg Factors, Inc. and the Company.* 10.2 Security Agreement for Goods and Chattels dated February 9, 2004 between Milberg Factors, Inc. and the Company.* 10.3 Security Agreement for Inventory dated February 9, 2004 between Milberg Factors, Inc. and the Company.* 10.4 Second Amendment to the Transaction Documents dated February 9, 2004 between Omicron Master Trust, SF Capital Partners, Ltd, Bristol Investment Fund, Ltd., Ascend Offshore Fund, ltd., Ascend Partners, LP, Ascend Partners Sapient L.P. and the Company.* 10.5 Amendment to Domestic Licensing Agreement dated November 15, 2002 between the Company and MTV Networks, a division of Viacom International, Inc.* 10.6 Fifth Amendment to Domestic Licensing Agreement dated December 23, 2003 between the Company and MTV Networks, a division of Viacom International, Inc. (portions of this Exhibit 10.6 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission).* 10.7 Sales Agreement effective as of December 9, 2003 between the Company and CPP Belwin, Inc. and its affiliates (portions of this Exhibit 10.7 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission).* 31.1 Certification of Yi Ping Chan, Chief Executive Officer and Chief Operating Officer of The Singing Machine Company, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.* 31.2 Certification of April Green, Chief Financial Officer of The Singing Machine Company, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.* 32.1 Certification of Yi Ping Chan, Chief Executive Officer and Chief Operating Officer of The Singing Machine Company, Inc., Pursuant to 18 U.S.C. Section 1350.* 32.2 Certification of April Green, Chief Financial Officer of The Singing Machine Company, Inc., Pursuant to 18 U.S.C. Section 1350.* _________ *Filed herewith (B) REPORTS ON FORM 8-K During the three months ended December 31, 2003, we filed one Form 8-K. On November 7, 2003, we filed a Form 8-K announcing our financial results for the six months ended September 30, 2003. 30 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE SINGING MACHINE COMPANY, INC. DATED FEBRUARY 17, 2004 By: /s/ April J. Green ------------------------------------------- April J. Green Chief Financial Officer (On behalf of Registrant and Chief Accounting Officer) DATED FEBRUARY 17, 2004 By: /s/ Yi Ping Chan ------------------------------------------- Yi Ping Chan Chief Executive Officer (On behalf of Registrant and Principal Executive Officer) 31 EXHIBITS EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.1 Factoring Agreement dated February 9, 2004 between Milberg Factors, Inc. and the Company. 10.2 Security Agreement for Goods and Chattels dated February 9, 2004 between Milberg Factors, Inc. and the Company. 10.3 Security Agreement for Inventory dated February 9, 2004 between Milberg Factors, Inc. and the Company. 10.4 Second Amendment to the Transaction Documents dated February 9, 2004 between Omicron Master Trust, SF Capital Partners, Ltd, Bristol Investment Fund, Ltd., Ascend Offshore Fund, ltd., Ascend Partners, LP, Ascend Partners Sapient L.P. and the Company. 10.5 Amendment to Domestic Licensing Agreement dated November 15, 2002 between the Company and MTV Networks, a division of Viacom International, Inc. 10.6 Fifth Amendment to Domestic Licensing Agreement dated December 23, 2003 between the Company and MTV Networks, a division of Viacom International, Inc. (portions of this Exhibit 10.6 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 10.7 Sales Agreement effective as of December 9, 2003 between the Company and CPP Belwin, Inc. and its affiliates (portions of this Exhibit 10.7 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 31.1 Certification of Yi Ping Chan, Chief Executive Officer and Chief Operating Officer of The Singing Machine Company, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 31.2 Certification of April Green, Chief Financial Officer of The Singing Machine Company, Inc., Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. 32.1 Certification of Yi Ping Chan, Chief Executive Officer and Chief Operating Officer of The Singing Machine Company, Inc., Pursuant to 18 U.S.C. Section 1350. 32.2 Certification of April Green, Chief Financial Officer of The Singing Machine Company, Inc., Pursuant to 18 U.S.C. Section 1350. EX-10.1 3 factoringagreement.txt FACTORING AGREEMENT Exhibit 10.1 FACTORING AGREEMENT MILBERG FACTORS, INC. 99 Park Avenue New York, NY 10016 Gentlemen: We propose the following agreement with you, effective as of February 9, 2004 wherein we agree to retain you as our sole factor in accordance with the terms, provisions and conditions as hereinafter stated: 1. The undersigned, hereby sells, assigns, transfers and sets over to you as absolute owner and you hereby agree to purchase from the undersigned, without recourse to the undersigned to the extent expressly set forth below, all Receivables now or hereafter owned by us which are acceptable to you. You hereby agree to assume the risk of loss resulting from a customer's nonpayment of an approved Receivable due to the customer's financial inability at maturity to pay such Receivable (including financial inability to pay arising out of the filing of a bankruptcy or insolvency proceeding in respect of such customer). You shall not be responsible, however, for nonpayment due to any reason other than such inability to pay. The term "Receivables" means and includes all accounts, accounts receivable, notes, bills, acceptances and any and all other forms of obligations owing to us, whether secured or unsecured, all proceeds thereof and all of our rights to any merchandise which is represented thereby (delivered or undelivered), including all of our rights of stoppage in transit, replevin and reclamation as an unpaid vendor or lienor. You shall be privileged to enjoy all of the rights and remedies of the seller of such goods and shall be and become subrogated to all guaranties, collateral and other rights possessed by us or due to come into our hands, but you shall not be liable in any manner for exercising or refusing to exercise any rights thereby bestowed. From time to time we shall provide you with schedules describing all Receivables created or acquired by us and shall execute and deliver to you at your offices in the City of New York written assignments of such Receivables to you and shall furnish at the same time copies of customers' invoices or the equivalent, together with original shipping or delivery receipts for all merchandise sold and/or all notes, bills, acceptances or other evidences of customer indebtedness duly endorsed in blank by us, and any other information or documents you may call upon us from time to time to submit, all in form satisfactory to you. Receivables not approved by you as provided below in whole or in part (including any Receivables outstanding on the date hereof) shall bear the factoring charge described below, and are hereby assigned to you with full recourse to the undersigned to the extent and in the respects not so approved. 2. The amounts and terms of each sale to our customers shall be submitted to you for your credit approval in writing and no sales or deliveries shall be made without such written approval, which may be withdrawn at any time before delivery, but in no event shall you have any credit risk on any Receivable, whether or not approved by you, if the net face amount of such Receivable is less than $150.00, or the invoice evidences charges for samples supplied to our customer. Your factoring charge, due and payable at time of purchase, shall be eighty one hundredths of one percent (0.80%) of the gross amount of said Receivables, less any trade and cash discounts to customers (which shall be computed on the shortest terms where optional terms are given); but in no event shall your factoring charge on any invoice evidencing a Receivable purchased hereunder be less than five dollars. You agree, however, to reduce this minimum invoice charge to one dollar per invoice during any month in which we transmit substantially all factored invoices to you electronically. In the event that the terms of any of our sales exceeds 60 days, you shall receive as to such sales an additional 1/4 of one percent for each additional 30 days, or portion thereof, of extended terms or additional dating. In addition, with prior written notice to us, you may from time to time impose a surcharge with respect to Receivables from customers who are debtors-in-possession under the Federal Bankruptcy Code, other high-risk customers or customers located outside the United States. The purchase price of Receivables accepted by you is to be the net face amount thereof less your factoring charge. The term "net face amount" means the gross amount of Receivables, less trade and cash discounts 1 to customers (which shall be computed on the shortest terms where optional terms are given) and credits and allowances to customers of any nature. After purchase of Receivables by you, a discount, credit or allowance may be claimed solely by the customer and the customer and the undersigned will not issue or grant any discounts, credits or allowances to a customer without your prior consent. At the time of purchase of Receivables and periodically thereafter, you may in your sole and absolute discretion make advances to us and/or arrange for the issuance of letters of credit for our benefit which advances and letters of credit, in the aggregate and at anytime outstanding, will not exceed the lesser of (i) $3,500,000 (the "Maximum Revolving Amount"), or (ii) eighty percent (80%) of the purchase price, and you will credit to our account the balance of said purchase price less any monies remitted, paid or otherwise advanced by you for our account and less returns, trade and cash discounts, credits or allowances of any nature at anytime issued, owed, granted or outstanding, upon the respective collection of such Receivables, after adding thereto five (5) banking days to cover mailing time, delays in remittances and clearance of checks, or, in the case of approved Receivables, upon their respective uncollectability because of the customer's financial inability at maturity to pay same. Notwithstanding the foregoing, it is understood that you may, at our request, from time to time advance a sum that is more or less than the sum determined by the application of the above percentage of the purchase price and may, in fact, make advances in excess of the Maximum Revolving Amount but you are under no obligation to do so; all advances in excess of the aforesaid percentage, less all applicable deductions, charges, chargebacks and reserves, and all advances in excess of the Maximum Revolving Amount, are repayable on demand. Amounts taken by customers for anticipation shall be charged to our account by you. The minimum aggregate factoring charges payable under this Agreement for each contract year hereof shall be two hundred thousand dollars ($200,000), which, to the extent of any deficiency, shall be chargeable to our account with you on a monthly basis (i.e., to the extent the monthly factoring charge is less than $16,666.66, the deficiency shall be chargeable to our account). You shall be entitled to hold all sums and all property of the undersigned at any time to our credit or in your possession, or upon or in which you have a lien or security interest, as security for all of our obligations at any time owing to you and to each corporation which is at any time your parent, affiliate, subsidiary or a co-subsidiary of your parent. Such obligations shall include, without limitation, all obligations to you hereunder and all obligations for purchases made by the undersigned from any other client factored or financed by you or by any such parent, affiliate, subsidiary or co-subsidiary, whether under this agreement or otherwise, no matter how or when arising and whether due or to become due, and you shall have the right to charge to our account the amount of all such obligations and pay over such amounts to such parent, affiliate, subsidiary or co-subsidiary. Recourse to security shall not at any time be required, and we shall at all times remain liable to you and such parent, affiliate, subsidiary or co-subsidiary on demand for all loans and advances (including any advances in excess of the net face amount of Receivables) to or for our account and for all of our other obligations to you. You may at your option reserve an amount of past sales (the "Reserve"), and revise said Reserve from time to time, if in your sole judgment it is necessary to cover possible returns of merchandise, deductions or other claims or setoffs made by customers. 3. Subject to the provisions of this Agreement, upon our request, you shall remit (and at any time in your sole discretion you may remit) any money standing to our credit on your books in excess of the Reserve. You may charge to our account interest on any monies remitted or otherwise advanced by you or charged to our account hereunder (the "Advances") before the collection of Receivables or in the case of approved Receivables, before their respective uncollectability because of the customer's financial inability at maturity to pay same as above described, at a rate three-quarters of one percent (.75%) per annum above the highest publicly announced "reference", "prime" or "base" interest rate of JPMorgan Chase Bank or The Bank of New York (the "Prime Rate"), (which is now four percent (4%) per annum) computed on the basis of a 360 day year (the "Effective Rate"); provided, however, that interest on Advances which are in excess of eighty percent (80%) of the net face amount of outstanding Receivables purchased hereunder, less the Reserve, disputed accounts and unapproved Receivables will bear interest at a rate one percent (1%) per annum in excess of the Effective Rate. Said Effective Rate shall be increased or decreased effective the first day of the month following any month in which there is an increase or decrease in the Prime Rate, such increase or decrease to be in an amount equal to the increase or decrease in such Prime Rate; provided, however, that in no event shall such Effective Rate be decreased below the rate of four and three quarters percent (4.75%) per annum. Such interest is due and payable at the close of each month. You 2 will account to us monthly and each monthly accounting will be fully binding upon us unless we give you written notice of exceptions within sixty (60) days from its date. 4. We warrant and agree as to each such Receivable that at the time of the sale or assignment thereof to you hereunder and at all times thereafter: it will be a bona fide existing obligation created by the absolute sale and delivery of merchandise or the rendition of services to customers in the ordinary course of business and will be paid and performed according to the terms provided therein; all documents delivered to you in connection therewith are genuine; it will be enforceable against all parties thereto without credit, defense, offset or counterclaim, real or claimed, whether arising out of the transaction creating such Receivable or otherwise; and it will be free and clear of liens and encumbrances. We further warrant and agree as to each such Receivable that at the time of the sale or assignment thereof to you hereunder we will have good title thereto and good right to sell, assign, transfer and set over such Receivable to you. All invoices to customers shall state plainly on the face thereof that the accounts receivable represented by such invoices have been assigned and are payable only to you. You may prepare and mail all customers' invoices, and billings of such customers' invoices by whomsoever done shall constitute an assignment to you of the Receivables represented thereby whether or not the undersigned executes any other specific instrument of assignment. We hereby further warrant and agree that the customer in each instance has received and will accept the merchandise sold or the services rendered and the invoice therefor without dispute or claim in any respect whatsoever, including, without limitation, disputes as to price, terms or quality and defenses based on force majeure. We will notify you promptly of and shall at our own cost and expense settle all disputes and claims and will pay you promptly the amount of the Receivables affected thereby, as well as the amount of any unapproved Receivable if unpaid at its due date. If you so elect you are to have and are hereby granted the right and option at all times to settle, compromise, adjust or litigate all disputes or claims directly with the customer or other complainant upon such terms and conditions as you deem advisable, and also the right to take possession of and to sell or cause to be sold without notice any returned merchandise, at such prices, to such purchasers and upon such terms as you deem advisable, and in any case to charge the deficiencies, costs and expenses thereof (including attorneys' fees) to us. In addition to all other rights hereunder, you may charge against our account the full net face amount of any Receivable where there is such dispute, defense, offset, claim and/or counterclaim (regardless of the extent or nature thereof or whether arising out of the transaction creating such Receivable or otherwise) or where the customer fails or refuses to pay the amount due for any reason other than the customer's financial inability at maturity to pay, or if any unapproved Receivable is unpaid at its due date, but such chargeback shall not be deemed a re-assignment thereof, and title to such Receivable shall remain in you until such Receivable is fully paid, settled or discharged. If monies are due and owing from a customer for both credit-approved and non credit-approved Receivables, any payments or recoveries received on such Receivables will be applied first to any credit-approved Receivables. We hereby agree to indemnify and hold you harmless against and in respect of any and all liability, loss or expense (including attorneys' fees) arising out of or relating to any breach of warranty or covenant on our part. Any merchandise which is returned by customers or otherwise recovered shall be set aside, marked in your name and held by us as your trustee. We exonerate you from any liability for any loss, depreciation or other damage to Receivables unless caused by your willful and malicious act. We agree to execute such further instruments as may be required or permitted by any law relating to notices of or affidavits in connection with assignments of accounts receivable and to cooperate with you in the filing or recording and renewal thereof. As additional security for all of our obligations to you, as hereinabove defined, the undersigned hereby grants you a continuing security interest in all Accounts, General Intangibles and Contract Rights (as said terms are defined in Article 9 of the Uniform Commercial Code) now existing or hereafter acquired by us and all proceeds thereof. Each sale of Receivables hereunder shall constitute and be a transaction separate from and independent of each other, but all such transactions shall be subject to and governed by each and every of the terms, provisions and conditions of this agreement. During the term of this agreement we shall not sell, negotiate, pledge or assign or grant any security interest in any Receivables, Accounts, General Intangibles, Contract Rights or inventory to any one other than you without your prior consent, nor shall we grant or permit to exist without your prior consent any mortgage, pledge, security interest, encumbrance or lien of any kind upon any of our property, except liens for taxes not yet due, liens incidental to our business which were not incurred in connection with the borrowing of 3 money or obtaining of advances or credit and which do not in the aggregate materially detract from the value of our assets or impair the use thereof in the operation of our business. We authorize you to file such financing statements under the Uniform Commercial Code as you may deem necessary or advisable to perfect the security interests we have granted to you under or in connection with this Agreement or otherwise. We appoint Stephen R. Murphy or any other person whom you may designate as our attorney with power: to endorse our name on any checks, notes, acceptances, money orders, drafts or other forms of payment or security that may come in your possession; to sign our name on any invoice or bill of lading relating to any Receivable, on drafts against customers, on schedules of assignment of Receivables, on notices of assignment and public records, on verification of accounts and on notice to customers; to notify the post office authorities to change the address for delivery of our mail to an address designated by you; to receive, open and dispose of all mail addressed to us; to send requests for verification of accounts to customers; and to do all other things you deem necessary to carry out this Agreement. We hereby ratify and approve all acts of the attorney and neither you nor the attorney will be liable for any acts of commission or omission, nor for any error of judgment or mistake of fact or law. This power, being coupled with an interest, is irrevocable so long as any Receivable sold to you remains unpaid or any money remains due to you from us. We shall immediately place notations upon our books of account to disclose the assignment of all Receivables, accounts, general intangibles and contract rights to you. 5. The undersigned will repay upon demand all our obligations to you and in addition thereto all costs and expenses, including without limitation reasonable attorneys' fees, incurred to obtain or enforce payment of any obligation of the undersigned to you, or in the prosecution or defense of any action or proceeding either against you or us concerning any matter arising out of or relating to this Agreement, the Receivables, any collateral pledged in your favor and/or any of our obligations to you, including, without limitation, to defend successfully, in whole or in part, any and all actions or proceedings brought by the undersigned. In addition, we agree to reimburse you for the amount of all filing and search fees, reasonable attorneys' fees, costs and expenses incurred by you in connection with the negotiation, preparation, closing, administration and enforcement of this agreement and any ancillary documents issued in connection herewith and modifications and additions to any of them. We shall also pay your customary charges for all services performed by you for us at our request and all banking facility charges incurred in connection with the opening and operation of our account with you, and we shall also pay you your customary charges for any field examination, collateral analysis or other business analysis, the need for which is determined by you, plus all costs and disbursements incurred by you in the performance of such examinations or analysis. If any remittances are made directly to us, we shall hold the same as your property and immediately deliver them to you in their original form. We hereby waive presentment and protest of any instrument and notice thereof, notice of default and any other notices to which we might otherwise be entitled. All sales of Receivables to you by us shall be deemed to include all of our right, title and interest to all of our books, records, files and all other data and documents relating to each Receivable. If any tax by any governmental authority is imposed on any transaction between us, or in respect to sales or the merchandise affected by such sales, which you are or may be required to withhold or pay, we agree to indemnify and hold you harmless in respect of such taxes, and we will repay you the amount of any such taxes, which may be charged to our account. 6. We warrant that we are solvent and will so remain during the terms of this Agreement. We agree to furnish to you year-end financial statements certified by our regularly employed Certified Public Accountant, such unaudited financial statements and financial information as you shall reasonably request, copies of each filing made by us with the Securities and Exchange Commission (including, without limitation, Forms 10-Q, 10-K and 8-K, and all registration statements) and each press release issued by us, within two business days of such filing or issuance, and, on each anniversary hereof, a list of our 5% or greater shareholders, officers and directors. We hereby represent, warrant and covenant to you that: (a) the execution, delivery and performance of this Agreement, any supplements hereto and all related documents, the sale of Receivables hereunder, the borrowing of loans and advances hereunder and thereunder, if any, and the grants of security interests hereunder and thereunder, do not and will not (i) violate in any material respect the provisions of any applicable law, statute, rule, regulation, order or decree to which we are subject, (ii) conflict with, result in a breach of, or constitute a default under, our certificate of incorporation 4 or by-laws, or, in any material respect, any indenture, agreement or other instrument to which we are a party, or by which we or any of our property may be bound, or (iii) result in the creation or imposition of any security interest, mortgage, pledge or other lien upon any property now owned or hereafter acquired by us, other than the security interests granted to you hereunder; (b) the operation of our business is and will remain in compliance in all material respects with all applicable laws including all applicable environmental laws and regulations and all applicable state and federal laws and regulations; (c) based upon the Employee Retirement Income Security Act of 1974 ("ERISA") and the regulations and published interpretations thereunder (i) we have not engaged in any Prohibited Transactions as defined in Section 406 of ERISA and Section 4975 of the Internal Revenue Code, as amended, (ii) we have met all applicable minimum funding requirements under Section 302 of ERISA in respect of our plans, (iii) we have no knowledge of any event or occurrence which would cause the Pension Benefit Guaranty Corporation to institute proceedings under Title IV of ERISA to terminate any employee benefit plan(s), (iv) we have no fiduciary responsibility for investments with respect to any plan existing for the benefit of persons other than our employees and (v) we have not withdrawn, completely or partially, from any multiemployer pension plan so as to incur liability under the Multiemployer Pension Plan Amendments Act of 1980; (d) we are a corporation duly incorporated, validly existing and in good standing under the laws of the state of our incorporation and are and will remain duly licensed and qualified to do business and are in good standing in all other states wherein the nature of our business makes licensing or qualification as a foreign corporation necessary and wherein the failure to be so licensed or qualified could have a material adverse effect on our condition, business or operations; (e) except as disclosed on Schedule A hereto, there are no pending or threatened investigations, actions or proceedings before or by any court, governmental department, commission, board, bureau or administrative agency which if adversely determined would materially affect our condition, business or operations; (f) we own and have good and marketable title to all of the Receivables, goods and chattels and other assets real and personal in which a lien or security interest is given to you under your security agreements free and clear of all liens, charges and encumbrances; (g) except as disclosed on Schedule A hereto, we have filed all material tax returns and paid all material United States federal, state and local taxes, and non-U.S. taxes, other than taxes not yet due or which may hereafter be paid without penalty, and have no knowledge of any deficiency or additional assessment in connection therewith not provided for on our books, and will continue to do so during the term hereof; (h) we are (i) in compliance with, and (ii) have procured and are now in possession of, all material licenses or permits required by any applicable United States federal, state or local or non-U.S. law or regulation for the operation of our business in each jurisdiction wherein we are now conducting or propose to conduct business; (i) we are not in default in the payment of the principal of or interest on any indebtedness for borrowed money or, in any material respect, under any instrument or agreement under and subject to which any indebtedness for borrowed money has been issued and no event has occurred under the provisions of any such instrument or agreement which with or without the lapse of time or the giving of notice, or both, constitutes or would constitute an event of default thereunder; (j) we will promptly inform you of: (i) the commencement of all proceedings and investigations by or before any governmental or nongovernmental body and all actions and proceedings in any court or before any arbitrator against or in any way concerning any of our properties, assets or business, which might singly or in the aggregate, have a materially adverse effect on us, (ii) any amendment of our certificate of incorporation or by-laws, (iii) any change in our business, assets, liabilities, financial condition, results of operations or business prospects which has had or might have any materially adverse effect on us, (iv) any default or Event of Default hereunder or any event which with the passage of time or giving of notice or both would constitute a default or Event of Default, (v) any default or any event which with the passage of time or giving of notice or both would constitute a default under any agreement for the payment of money to which we are a party or by which we or any of our properties may be bound or which would have a material adverse effect on our business, operations, property or financial condition, (vi) any change in the location of our places of business, and (vii) any change in our corporate name; (k) all financial projections prepared by us or at our direction and delivered to you will represent, at the time of delivery to you, our best estimate of our future financial performance and will be based upon assumptions which are valid in light of the then current business conditions; (l) all balance sheet and income statements which have been delivered to you fairly, accurately and properly state our financial condition and there has been no material adverse change in our financial condition as reflected in such statements since the date of the latest thereof and such statements do not fail to disclose any fact or facts which might materially and 5 adversely affect our financial condition; (m) we will not hereafter incur indebtedness for borrowed money, except to you and except for indebtedness incurred by our Hong Kong subsidiary, International SMC (HK) Limited, in an aggregate amount not to exceed $5,000,000, provided that we shall not incur any liability in respect thereof, whether by guarantee or otherwise; (n) we will not guarantee or endorse the obligations of any person, firm or corporation, except in the ordinary course of business, enter into any merger or consolidation, or purchase or otherwise acquire the stock or any material obligations or assets of any person, firm, corporation or other enterprise; (o) Yi Ping Chan will not cease to be our Chief Operating Officer, and Josef A. Bauer will not cease to be a director and significant shareholder; (p) we will not pay any management fees or make any similar payments or declare any dividends, except dividends payable exclusively in our stock, or redeem any of our stock or make any other payments in respect of our stock that are the equivalent to dividends or stock redemption payments, to any shareholder or affiliate as long as any debts and obligations hereunder remain outstanding without your express prior written consent; and (q) we will not issue any guarantees of the obligations of any third person or entity as long as any debts and obligations hereunder remain outstanding, without your express prior written consent. 7. This Agreement shall be governed by and interpreted in accordance with the laws of the State of New York applicable to contracts to be performed wholly within the State of New York and shall have an initial term of two years from its effective date and thereafter shall be automatically renewed for successive periods of two years unless terminated by either you or us at the conclusion of its initial term or any renewal term by giving the other at least sixty (60) days prior written notice. If the aggregate purchase price of approved Receivables you credit to our account in any contract year as a result of their respective uncollectability because of the customer's financial inability at maturity to pay same (net of recoveries thereon) exceeds one-hundred percent (100%) of the aggregate factoring charges (i.e., commissions) posted to our account with respect to such contract year, then you shall have the option to extend the term of this Agreement for an additional one (1) year period beyond the expiration of the term during which such event occurs. As so extended, the renewal and termination provisions of this paragraph will continue to apply. You will endeavor to give us timely written notice of such extension, but your failure to do so will not constitute a breach of, or otherwise impair your ability to extend, this Agreement. The mailing of a registered or certified letter of notice addressed by one party to the other at its usual address shall constitute sufficient notice which shall be effective for the purposes set forth therein on the appropriate date specified in such letter. Notwithstanding the foregoing, you may terminate this Agreement, without notice, upon the occurrence of any one or more of the following events (an "Event of Default"): (a) default in the payment or performance, when due or payable, of any payment required under this Agreement or under any future agreement or supplement with you or under any agreement to which we are a party with third parties; (b) any warranty, representation, or other statement made or furnished to you by us or on our behalf or by any guarantor of our obligations hereunder or in connection herewith or in any instrument furnished in compliance with or in reference to this Agreement proves to have been false or misleading in any material respect when made or furnished or becomes false in any material respect; (c) we fail or neglect to perform, keep or observe any term, provision, condition, covenant, warranty or representation contained in this Agreement or in any other agreement between us or any rider or supplement which is required to be performed, kept or observed by us; (d) any statement, report, financial statement, or certificate made or delivered by us, or by any of our officers, employees or agents, to you or filed with the Securities and Exchange Commission is not true and correct in any material respect; (e) the imposition of a lien or encumbrance on any of our assets, including the Receivables, or the making of any levy, seizure, or attachment on all or any of our assets, including the Receivables; (f) any material adverse change in our financial condition or the financial condition of any guarantor of our obligations hereunder; (g) we or any guarantor of our obligations hereunder become insolvent, or unable to meet our debts as they mature, or fail, suspend or go out of business or a case is commenced under the Bankruptcy Code or an order for relief in a case under the Bankruptcy Code is entered with respect to us or any such guarantor, or a custodian or receiver (or other court designee performing the functions of a receiver) is appointed for or takes possession of either our or any such guarantor's assets or affairs; (h) we or any guarantor of our obligations hereunder cease to conduct our business as now conducted or are enjoined, restrained or in any 6 way prevented by court, governmental or administrative order from conducting all or any material part of our business affairs; (i) a notice of any lien, levy or assessment is filed of record with respect to all or any of our assets by the United States, or any department, agency or instrumentality thereof, or by any state, county, municipal or other governmental agency, including, without limitation, the Pension Benefit Guaranty Corporation, or if any taxes or debts owing at any time or times hereafter to any one of them becomes a lien or encumbrance upon any of the Receivables or any of our other assets and the same is not released within thirty (30) days after the same becomes a lien or encumbrance; (j) you shall in good faith deem yourself insecure or unsafe; (k) any guaranty given you with respect to our obligations is limited or terminated or otherwise deemed unenforceable or invalid; (1) death of a guarantor of our obligations hereunder or in connection herewith which guaranty is not replaced by a guarantor, acceptable to you in your sole discretion; (m) we shall fail to pay our taxes when due unless such taxes are being contested in good faith by appropriate proceeding and with respect to which adequate reserves have been provided on our books; (n) should there be a sale or transfer of all or substantially all of our assets or any material change in our shareholdings; (o) should our Tangible Net Worth (as customarily defined under GAAP) be less than $7,500,000; or (p) should our Working Capital (as customarily defined under GAAP) be less than $7,500,000. Upon the effective date of termination for whatever reason, all moneys chargeable to our account under this Agreement shall be immediately due and payable without further notice or demand. Notwithstanding termination, until all your rights and all our obligations hereunder (including without limitation the payment in full of all moneys chargeable to our account under this Agreement and the provision of an indemnity as provided in the last sentence of this Agreement) have been fully satisfied, (i) we shall continue to assign to you and grant you a security interest in all Receivables then existing or thereafter arising, shall not factor or assign Receivables, or grant a security interest therein, to any other person or entity, shall state on the face of all invoices that the Accounts Receivable represented by such invoices have been assigned and are payable only to you, and shall immediately deliver any remittances to you in their original form, (ii) all of our obligations and all of your rights and powers with respect to Receivables then existing or thereafter arising, with respect to other security then existing or thereafter arising or acquired, and with respect to transactions or events occurring prior to the effective date of such termination shall be unaffected and unimpaired by such termination, and (iii) all of our representations, warranties, covenants and agreements and all other provisions binding upon us contained herein shall survive and continue in full force and effect, and shall be fully operative. 8. Failure by you to exercise any right, remedy or option under this Agreement or delay by you in exercising the same will not operate as a waiver; no waiver or consent by you will be effective unless it is in writing and then only to the extent specifically stated. This Agreement cannot be changed or terminated other than by a writing signed by the party to be charged, is our entire contract, and is for the benefit of and binding upon the parties hereto and their respective successors and assigns, heirs, executors, administrators and personal representatives. Your rights and remedies under this agreement will be cumulative and not exclusive of any other right or remedy which you may have. Both parties agree that all actions and proceedings directly or indirectly relating to this Agreement will be litigated exclusively in the federal or state courts located in the County and State of New York and that such courts are convenient forums and both parties submit to the personal jurisdiction of such courts. BOTH YOU AND WE WAIVE ALL RIGHT TO A TRIAL BY JURY IN ANY LITIGATION RELATING TO TRANSACTIONS UNDER THIS AGREEMENT, SUPPLEMENTS HERETO AND ANY RELATED AGREEMENTS, AND WE AGREE NOT TO ASSERT ANY COUNTERCLAIM OF ANY NATURE IN SUCH LITIGATION. In the event that you cease to act as factor for us hereunder, we agree to furnish to you an indemnity satisfactory to you against any item which could be charged to us under the terms hereof which may in 7 your sole and absolute discretion include the retention of any property held by you or the holding by you without interest from the date of termination of any balance standing to our credit, as security for our obligations hereunder. Attest: Very truly yours, THE SINGING MACHINE COMPANY, INC. /s/ April Green By: /s/ Yi Ping Chan - ------------------------- ------------------------------ Yi Ping Chan, Interim CEO & COO (Seal) Date: February 9, 2004 Address: 6601 Lyons Road, Building A-7 Coconut Creek, FL 33073 Attest: Accepted at New York, N.Y. MILBERG FACTORS, INC. /s/ Stephen R. Murphy By: /s/ Daniel R. Milberg - ------------------------- ------------------------- Stephen R. Murphy, Daniel R. Milberg, Senior Vice President, Senior Vice President Secretary & Treasurer (Seal) 8 Schedule A ---------- Section 6(e) and 6(g) 9 EX-10.2 4 goodsandchattels.txt SECURITY AGREEMENT Exhibit 10.2 SECURITY AGREEMENT--GOODS AND CHATTELS To: MILBERG FACTORS, INC. 99 Park Avenue New York, NY 10016 Gentlemen: 1. To secure the payment of all debts, liabilities, obligations, covenants and duties owing by us to you under that certain Factoring Agreement bearing the effective date of February 9, 2004 as well as to secure the payment in full of the other Obligations referred to herein, we hereby grant to you a continuing security interest in all goods and general intangibles (as defined in Article 9 of the Uniform Commercial Code) whether now owned or hereafter acquired by us and wherever located, all replacements and substitutions therefor or accessions thereto and all proceeds thereof, including, without limitation, the machinery and equipment described in the annexed Schedule "A" (all herein referred to collectively as "Collateral"). Inventory is specifically excluded from the Collateral. 2. The term "Obligations" as used herein shall mean and include the indebtedness owing by us to you as hereinabove specifically set forth and also any and all other loans, advances, extensions of credit, endorsements, guaranties, benefits or financial accommodations heretofore or hereafter made, granted or extended by you to us or which you have or will become obligated to make, grant or extend to or for our account and any and all interest, commissions, obligations, liabilities, indebtedness, charges or expenses heretofore or hereafter chargeable against us or owing by us to you or upon which we may be or have become liable as endorser and guarantor and any and all renewals or extensions of any of the foregoing, no matter how or when arising, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether under any present or future agreement or instrument between us or otherwise and the amount due upon any notes or other obligations given to or received by you for or on account of any of the foregoing and the performance and fulfillment by us of all of the terms, conditions, promises, covenants, provisions and warranties contained in this Security Agreement and any note or notes secured hereby or in any present or future agreement or instrument between us. 3. Unless expressly limited by the provisions of paragraph "1", your security interest granted and created in the Collateral shall extend and attach to the entire Collateral whether the same constitutes personal property or fixtures, including, without limitation, to all dyes, jigs, tools, benches, tables, substitutions, accretions, component parts, replacements thereof and additions thereto, as well as to all accessories, motors, engines, auxiliary parts used in connection with or attached to the Collateral and any packing material in which the Collateral may be contained. We shall furnish you from time to time upon request with written statements and schedules identifying and describing the Collateral and any additions thereto and substitutions thereof in such detail as you may require. 4. We hereby warrant and covenant to you that: (a) the Collateral is presently located at 6601 Lyons Road, Building A-7, Coconut Creek, FL 33073 303 West Artesia Blvd., Compton, CA 90220 1975 Charles Willard Street, Rancho Dominguez, CA 90220 and we will notify you promptly of any new location where Collateral may be located; (b) we are the lawful owner of the Collateral free from any adverse lien, security or encumbrance whatsoever and have the sole right to grant a security interest therein and will defend the Collateral against all claims and demands of all persons; (c) we will keep the Collateral free and clear of all attachments, levies, taxes, liens, security interests and encumbrances of every kind and nature; 1 (d) we will at our own cost and expense keep the Collateral in good state of repair and will not waste or destroy the same or any part thereof; (e) we will not without your prior written consent, sell, exchange, lease or otherwise dispose of the Collateral or any of our rights therein or permit any lien or security interest to attach to same, except that created by this Agreement; (f) we will insure the Collateral in your name against loss or damage by fire, theft, burglary, pilferage, loss in transit and such other hazards as you shall specify in amounts and under policies by insurers acceptable to you and all premiums thereon shall be paid by us and the policies delivered to you. If we fail to do so, you may procure such insurance and charge the cost to our account; (g) we will not permit any Collateral to be removed from its present location without your prior written consent, and we will at all times allow you or your representatives free access to and the right of inspection of the Collateral; (h) we shall comply in all material respects with the terms and conditions of any leases covering the premises wherein the Collateral is located and any orders, ordinances, laws or statutes of any city, state, or governmental department having jurisdiction with respect to such premises or the conduct of business thereon, and, when requested by you, we will execute any written instruments and do any other acts necessary to effectuate more fully the purposes and provisions of this Agreement; (i) if any of the Collateral is or in your opinion may become part of any real estate, we will obtain and deliver to you a written waiver by the record owner and any mortgagees of said real estate of all interest in the Collateral and a written subordination by any person who has a lien on said real estate which is or may be superior to the security interest granted hereby; (j) we will not permit anything to be done that may impair or lessen in any material respect the value of any Collateral or the security intended to be afforded by this Agreement; (k) we will indemnify and save you harmless from all loss, costs, damage, liability or expense, including reasonable attorneys' fees, that you may sustain or incur to enforce payment, performance, or fulfillment of any of the debts or obligations secured hereby or in the enforcement of this Agreement and the priority thereof or in the prosecution or defense of any action or proceeding either against you or us concerning any matter growing out of or in connection with this Agreement and/or any of the Obligations secured hereby and/or any of the Collateral; and (1) the execution of this Agreement has been duly approved by the undersigned in any manner required by law. 5. We shall be in default under this Agreement upon the happening of any of the following events or conditions: (a) we shall fail to pay when due or punctually perform any of the Obligations; (b) any covenant, warranty, representation or statement made or furnished to you by us or on our behalf was false in any material respect when made or furnished; (c) the loss, theft, substantial damage, destruction, sale or encumbrance to or of any of the Collateral or the making of any levy, seizure or attachment thereof or thereon; (d) we shall become insolvent, cease operations, dissolve, terminate our business existence, make an assignment for the benefit of creditors, suffer the appointment of a receiver, trustee, liquidator or custodian of all or any part of our property; (e) any proceedings under any bankruptcy or insolvency law shall be commenced by or against us or any guarantor or endorser of the Obligations; or (f) any guarantor or endorser of the Obligations shall die, make an assignment for the benefit of creditors, or suffer the appointment of a receiver of any part of such guarantor's or endorser's property. 6. Upon any such default and at any time thereafter, you may declare all Obligations secured hereby immediately due and payable and you shall have the remedies of the secured party provided in the Uniform Commercial Code, and in addition, those provided by other provisions of law and in this Agreement. You will at all 2 times have the right to take possession of the Collateral and to maintain such possession on our premises or to remove the Collateral or any part thereof to such other premises as you may desire. Upon your request, we shall assemble the Collateral and make it available to you at a place designated by you. If any notification of intended disposition of any Collateral is required by law, such notification, if mailed, shall be deemed properly and reasonably given if mailed at least five days before such disposition, postage prepaid, addressed to us either at our address shown herein or at any address appearing on your records for us. Any proceeds of any disposition of any of the Collateral shall be applied by you to the payment of all expenses in connection with the sale of the Collateral, including reasonable attorneys' fees and other legal expenses and disbursements and the reasonable expense of retaking, holding, preparing for sale, sale, and the like, and any balance of such proceeds may be applied by you toward the payment of the Obligations secured hereby in such order of application as you may elect, and we shall be liable for any deficiency. 7. If we default in the performance or fulfillment of any of the terms, conditions, promises, covenants, provisions or warranties on our part to be performed or fulfilled under or pursuant to this Agreement, you may at your option without waiving your right to enforce this Agreement according to its terms, immediately or at any time thereafter and without notice to us, perform or fulfill the same or cause the performance or fulfillment of the same for our account and at our sole cost and expense, and the cost and expense thereof (including reasonable attorneys' fees) shall be added to the Obligations secured hereby and shall be payable on demand with interest thereon at the rate charged upon the Obligations secured hereby, but not in excess of that permitted by law. 8. No delay or failure on your part in exercising any right, privilege or option hereunder shall operate as a waiver of such or of any other right, privilege, remedy or option, and no waiver whatever shall be valid unless in writing, signed by you and then only to the extent therein set forth, and no waiver by you of any default shall operate as a waiver of any other default or of the same default on a future occasion. Your books and records containing entries with respect to the Obligations secured hereby shall be admissible in evidence in any action or proceeding, shall be binding upon us for the purpose of establishing the items therein set forth and shall constitute prima facie proof thereof. You shall have the right to enforce any one or more of the remedies available to you, successively, alternately or concurrently. We agree to join with you in executing financing statements or other instruments pursuant to the Uniform Commercial Code in form satisfactory to you and in executing such other documents or instruments as may be required or deemed necessary by you for purposes of affecting or continuing your security interest in the collateral. 9. This Agreement cannot be terminated orally. All of the rights, remedies, options, privileges and elections given to you hereunder shall enure to the benefit of your successors and assigns. The term "you" as herein used shall include your company, any parent of your company, any of your subsidiaries and any co-subsidiaries of your parent, whether now existing or hereafter created or acquired, and all of the terms, conditions, promises, covenants, provisions and warranties of this Agreement shall enure to the benefit of and shall bind the representatives, successors and assigns of each of us and them. Attest: Very truly yours, THE SINGING MACHINE COMPANY, INC. /s/ April Green By: /s/ Yi Ping Chan - ----------------------- ------------------------------ Yi Ping Chan, Interim CEO & COO (Seal) Dated: February 9, 2004 Accepted at New York, N.Y. Attest: on February 9, 2004 MILBERG FACTORS, INC. /s/ Stephen R. Murphy By: /s/ Daniel R. Milberg - ------------------------ ------------------------- Stephen R. Murphy, Daniel R. Milberg, Senior Vice President, Senior Vice President Secretary & Treasurer (Seal) 3 EX-10.3 5 securityinterestininventory.txt SECURITY INTEREST IN INVENTORY Exhibit 10.3 SECURITY INTEREST IN INVENTORY UNDER UNIFORM COMMERCIAL CODE SUPPLEMENT TO FINANCING OR FACTORING CONTRACT To: Milberg Factors, Inc. 99 Park Avenue New York, NY 10016 Gentlemen: This is a supplement to our Factoring Agreement with you bearing the effective date of February 9, 2004. It is hereby incorporated therein, shall have a term concurrent therewith and is deemed in all respects a part thereof. 1. In addition to your other security, we hereby grant you a continuing security interest under the Uniform Commercial Code in all Inventory now and hereafter owned by us. The term "Inventory" means and includes all merchandise intended for sale by us and all raw materials, goods in process, finished goods, materials and supplies of every nature used or useable in connection with the manufacture, packing, shipping, advertising or sale of such merchandise, all of which may be described generally (but without limitation) as: Karaoke machines, CD plus graphics, audiocassette tapes, recorded music and all products incidental to the manufacture and shipping thereof We warrant that all Inventory is and will be owned by us, free of all other liens, encumbrances and security interests. 2. Your security interests in the Inventory shall continue through all stages of manufacture and shall, without further act, attach to goods in process, to the finished goods, to the accounts receivable or other proceeds resulting from the sale or other disposition thereof and to all such Inventory as may be returned to us by customers. 3. The Inventory shall be security for all Advances made pursuant to the Factoring Agreement and/or loans and advances to the undersigned under the Factoring Agreement, as originally existing and as hereby and at any time heretofore or hereafter supplemented or amended as well as for all other loans and advances to us or for our account by you or your subsidiaries and for all commissions, obligations, indebtedness, interest, charges and expenses chargeable to our account or due from us from time to time, however arising, and whether or not evidenced by notes or other instruments. Until all such obligations have been paid in full, your security interest in the Inventory and all proceeds thereof, shall continue in full force and effect and you will at all times have the right to take possession of the Inventory and to maintain such possession on our premises or to remove the Inventory or any part thereof to such other places as you may desire. If you exercise your right to take possession of the Inventory, we shall, upon your demand, assemble the Inventory and make it available to you at a place reasonably convenient to you. In addition, with respect to all Inventory as well as all Receivables and other security, you shall be entitled to all of the rights and remedies set forth in the Factoring Agreement and all of the rights provided by the Uniform Commercial Code. 4. Upon our request, you may make Advances to us prior to our sale of Inventory. Any such Advances will be made at your sole discretion, will be charged by you to our account and will bear interest payable in the manner and at the rate specified in the Factoring Agreement. All such Advances shall be 1 payable by us on demand and recourse to the security therefor will not be required at any time. Their amounts and the relation thereof to the value of the Inventory will be determined by you alone. 5. Except for sales made in the regular course of our business, we shall not sell, encumber or dispose of or permit the sale, encumbrance or disposal of any Inventory without your prior written consent. As sales are made in the regular course of business, we shall, in accordance with the provisions of the Factoring Agreement, immediately execute and deliver to you schedules and assignments of all Receivables created thereby. If sales are made for cash, we shall immediately deliver to you the identical checks, cash or other forms of payment which we receive. All payments received by you on account of cash sales of Inventory as well as on account of Receivables will be credited to our account in accordance with the provisions of the Factoring Agreement. 6. We shall perform any and all steps requested by you to perfect your security interest in the Inventory, such as leasing warehouses to you, placing and maintaining signs, appointing custodians, executing and filing financing or continuation statements in form and substance satisfactory to you, maintaining stock records and transferring Inventory to warehouses. If any Inventory remains in the possession or control of any of our agents or processors, we shall notify such agents or processors of your security interest therein, and upon request, instruct them to hold all such Inventory for your account and subject to your instructions. A physical listing of all Inventory, wherever located, shall be taken by us at least annually, and a copy of each such physical listing shall be supplied to you. A perpetual inventory shall be maintained by us by location and product, and a copy of such perpetual inventory shall be supplied to you monthly and at such other times as you may request. You may examine and inspect the Inventory at any time. 7. We shall have the Inventory insured in your name against loss or damage by fire, theft, burglary, pilferage, loss in transportation and such other hazards as you shall specify, by insurers, in amounts and under policies acceptable to you, and all premiums thereon shall be paid by us and the policies delivered to you. If we fail to do so, you may procure such insurance and charge the cost to us. Attest: Very truly yours, THE SINGING MACHINE COMPANY, INC. /s/ April Green By: /s/ Yi Ping Chan - ------------------------ ------------------------------ Yi Ping Chan, Interim CEO & COO (Seal) Dated: February 9, 2004 Accepted at New York, N.Y. Attest: on February 9, 2004 MILBERG FACTORS, INC. /s/ Stephen R. Murphy By: /s/ Daniel R. Milberg - ------------------------ ------------------------- Stephen R. Murphy, Daniel R. Milberg, Senior Vice President, Senior Vice President Secretary & Treasurer (Seal) 2 EX-10.4 6 amend2-transaction104.txt SECOND AMENDMENT EXHIBIT 10.4 THE SINGING MACHINE COMPANY, INC. 6601 Lyons Road, Building A-7 Coconut Creek, Florida 33073 February 9, 2004 Omicron Master Trust SF Capital Partners, Ltd. Bristol Investment Fund, Ltd. Ascend Offshore Fund, Ltd. Ascend Partners LP Ascend Partners Sapient LP RE: SECOND AMENDMENT TO THE TRANSACTION DOCUMENTS ("AMENDMENT") ----------------------------------------------------------- Dear Sirs: Reference is made to that certain Securities Purchase Agreement ("Purchase Agreement") dated August 20, 2003 entered into by and among The Singing Machine Company, Inc. (the "Company") and each of Omicron Master Trust, SF Capital Partners, Ltd., Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend Partners LP and Ascend Partners Sapient LP (collectively referred to herein as the "Purchasers" and individually, as a "Purchaser"). ALL CAPITALIZED TERMS NOT DEFINED HEREIN SHALL HAVE THE SAME MEANING AS DEFINED TERMS IN THE PURCHASE AGREEMENT. The Company wishes to enter into a factoring agreement ("Factoring Agreement") with Milberg Factors, Inc. and Milberg has requested that each Purchaser sign certain subordination agreements ("Subordination Agreements") and agree to certain other changes in the Transaction Documents, set forth herein, as a condition to entering into the Factoring Agreement. In consideration for entering into the Subordination Agreements with Milberg Factors, Inc. and the granting of an aggregate of 30,000 warrants ("New Warrants") pro-rata to the Purchasers and increasing the interest rate of the Debentures from 8.0% per annum to 8.5% per annum, effective immediately, the Purchasers agree to the following: (i) they will waive any and all liquidated damages and other damages that have accrued under the Transaction Documents on or prior to the date of this Agreement and that they hereby waive their claim to any liquidated damages and other damages that may accrue between the date of this Amendment and July 1, 2004 (except those damages set forth in the next sentence), (ii) that the Transaction Documents are amended so that the total amount of liquidated damages and other damages that the Purchasers, as a group, will be able to collect under the Transaction Documents while the Factoring Agreement with Milberg Factors is in effect, which includes without limitation, the Registration Rights Agreement, the Debentures and the Warrants, is limited to $150,000 in the aggregate during a Company's fiscal year, provided that any and all liquidated damages or other damages exceeding the $150,000 pay-out allowed during each fiscal year will continue to accrue and will be immediately due and payable, in their entirety, after the Factoring Agreement is terminated. The limitation on the waiver of liquidated damages and other damages (a) set forth in subsection (ii) of the preceding sentence shall not apply to liquidated damages set forth in Section 4(b)(ii) and (iii) of the Debentures and Section 3(a) of the Warrant Agreements and (b) any damages arising because the stock certificates are not issued without restrictive legends, provided that such removal is permitted by applicable law. The New Warrants shall be in the form of the warrants issued pursuant to the Purchase Agreement and will have an exercise price equal to the lesser of the closing bid price on the date hereof and the closing bid price on their date of issuance, will be immediately exercisable and will expire on January __, 2007. The Registration Rights Agreement is hereby amended to include in the definition of Registrable Securities the shares issuable upon exercise of the New Warrants and the other changes set forth in the preceding paragraph. The increase in the interest rate from 8.0% to 8.5% shall be effective immediately without any other action required by the Company or such Purchaser. Each Debenture and Warrant shall be deemed to be automatically amended to reflect the changes set forth herein and no new Debentures will be issued to reflect such increase in the interest rate or other changes set forth herein. Except that, each such agreeing Purchaser shall have the right to exchange their existing Debenture for a new Debenture with the increase in interest rate and the other changes set forth herein hereunder reflected accordingly. Any other relevant Transaction Documents shall be amended to reflect the changes agreed to herein. The Company acknowledges and agrees that no consideration other than the consideration set forth herein has been or shall be offered or paid to any other person to obtain a Purchaser's agreement to enter into the Subordination Agreement. The first sentence of this paragraph is intended to treat for the Company the Purchasers as a class and shall not in any way be construed as the Purchasers acting in concert or as a group with respect to the purchase, disposition or voting of Securities or otherwise. For clarification purposes, each Purchaser's agreement to the terms hereunder constitutes a separate right granted to each Purchaser by the Company and negotiated separately by each Purchaser. Except as expressly amended hereby, the Purchase Agreement, the Debentures, the Warrants, the Registration Rights Agreement and any other Transaction Documents are ratified and confirmed by the parties hereto and remain in full force and effect in accordance with the terms hereof. Unless stated to the contrary herein, this Amendment shall be governed by the provisions contained in the Purchase Agreement and all amendments to the Purchase Agreement. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and, all of which taken together shall constitute one and the same Amendment. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature were the original thereof. Sincerely, THE SINGING MACHINE COMPANY, INC. By: /s/ Yi Ping Chan Yi Ping Chan Chief Operating Officer Agreed and accepted this 9th day of February 2004: Omicron Master Trust SF Capital Partners, Ltd. By: /s/ Bruce Bernstein By: /s/ Brian Davidson Name: Bruce Bernstein Name: Brian Davidson Title: Managing Partner Its: Authorized Signatory Bristol Investment Fund, Ltd. Ascend Offshore Fund, Ltd. By: /s/ Paul Kesslor By: /s/ Malcolm Fairbain Name: Paul Kesslor Name: Malcom Fairbain Title: Director Title: Managing Member Ascend Partners LP Ascend Partners Sapient LP By: /s/ Malcolm Fairbain By: /s/ Malcolm Fairbain Name:Malcolm Fairbain Name: Malcolm Fairbain Title: Managing Member Title: Managing Member 2 EX-10.5 7 mtv-amend3.txt AMENDED AGREEMENT Exhibit 10.5 MTV NETWORKS A VIACOM COMPANY November 15, 2002 Terry Marco Director of Marketing The Singing Machine Company 6601 Lyons Road, Bldg. A-7 Coconut Creek, FL 33073 Dear Ms. Marco: Reference is made to the Merchandise License Agreement dated November 1, 2000, as amended January 1, 2002, by and between MTV Networks, a division of Viacom International Inc. ("MTVN") and The Singing Machine Company, Inc. ("Licensee") with respect to the licensing of the MTV: Music Television name, trademark and logo in connection with certain song compilations for use in connection with a "Karaoke" machine (the "Agreement"). Capitalized terms used without definition herein shall have the respective definitions set forth in the Agreement. Notwithstanding anything to the contrary contained in the Agreement, MTVN and Licensee hereby agree that the "Basic Provisions" section of the Agreement shall be amended as follows, including the Additional Terms and Conditions section as indicated in Paragraph 3 below: 1. "Licensed Territory", add the following: Australia 2. "Guaranteed Minimum Royalty", add the following: In consideration for the additional rights granted hereunder to Licensee, Licensee shall pay to MTVN, an additional Guaranteed Minimum royalty of Five Thousand United States Dollars (US$5,000)(the "Australia Guaranteed Minimum Royalty") payable upon Licensee's execution of this Amendment. Licensee shall report sales of Licensed Products in Australia separately from those royalties earned in the United States, its territories and possessions, utilizing the attached Royalty Report form. In addition, it is understood and agreed that Licensee shall not have the right to cross collateralize royalties earned in respect of sale of the Licensed Products between territories (e.g. royalties earned in the United States, its territories and possessions may not be applied against royalties earned in Australia, and vice versa). The Australia Guaranteed Minimum Royalty is a one-time payment and the Licensee shall not have any obligation to make additional payments for the right to sell the Licensed Productu8s currently granted under the Agreement in Australia, other than royalties due MTVN in respect of sale of the Licensed Products in Australia. 3. Article 4, Quality Samples, Approvals, and Manufactures, subparagraph (d), add the following: With respect to Australia only, concurrently with the initial shipment of Licensed Product, Licensee shall send 4 product samples of Music Product (as defined in the Agreement) and 2 product samples of MTV Karaoke Machines (as defined in the Agreement) directly to Miriam Wermelt, Manager, International Consumer Products, 1515 Broadway, New York, NY 10036, 47th floor and 2 of each Licensed Product each subsequent year of the License Term. Nothing contained herein shall be deemed a waiver of any of MTVN's rights and remedies, with respect to the performance of the Agreement at law or equity, all of which are expressly reserved, nor shall anything contained herein relieve Licensee of its obligations set forth in the Agreement. Except as otherwise herein amended, the Agreement is hereby ratified and confirmed in all respects. Please indicate your acceptance of the foregoing by signing in the space provided below. Very truly yours, ACCEPTED AND AGREED TO: MTV NETWORKS, a division of The Singing Machine Company, Inc. Viacom International Inc. By: /s/ John Klecha By: /s/ Kathleen Hricik --------------------------- ----------------------------- Name: John Klecha Name: Kathleen Hnak Title: President & COO Title: EVP International Program Enterprises Date: 11/26/02 Date: Exhibit A MTV NETWORKS ROYALTY REPORT Licensee: _____________________ Property: _____________________ Reporting Period: _____________
- ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ Product Design # Retail Unit Quantity of Total Royalty Royalty Deductions Description Account Price Units Sold Sales Rate Due - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ - ------------- ----------- ---------- -------- ------------- --------- ---------- ----------- ------------ Totals: ------------ --------- -------- ------------
Total Royalty Due:_______________ Less Deductions: ________________ Less Advance Paid (or balance forward):____________ Balance Forward:_________________ or Amount Due:______________ I hereby certify that the above information is true and accurate: Signature:_______________________________ Print Name:______________________________ Title:___________________________________ EX-10.6 8 mtvn-amend5.txt AMENDMENT 5 TO MTVN Exhibit 10.6 [LOGO FOR MUSIC TELEVISION MTV] mtv: music television 1515 broadway / new york / ny / 10036-5797 January 7, 2004 Ms. Rose L. Labadessa Corporate Legal Manager & Music Licensing Coordinator The Singing Machine Company, Inc. Business & Legal Affairs 6601 Lyons Road Building A-7 Coconut Creek, FL 33073 Re: Fifth Amendment to MTVN Domestic Merchandise License Agreement. --------------------------------------------------------------- Dear Rose: Enclosed for your files is a fully executed copy of the above-mentioned amendment by and between The Singing Machine Company, Inc. and MTV Networks, a division of Viacom International Inc. Please feel free to contact me at the below number should you have any questions. Sincerely, /s/ Hillary Cohen Director MTV Business & Legal Affairs Phone: 212-846-6758 Fax: 212-8461922 Email-hillary.cohen@mtvstaff.com Via Express Mail. - ----------------- cc: G. Bolan, G. Cheeks, T. Connolly, H. Eskenazi, T. Hernandez, A. Green (Singing Machine), G. Legrand, B. Matthews, V.O'toole, L. Silfen, H. Reyes, P. White and M. Wermelt. Enclosure(1) As of December 23, 2003 Mr. Yi Ping Chan, Interim CEO and COO The Singing Machine Company, Inc. 6601 Lyons Road, Bldg. A-7 Coconut Creek, FL 33073 Re: Fifth Amendment to MTVN Domestic Merchandise License Agreement. - -------------------------------------------------------------------- Dear Mr. Chan: Reference is made to the agreement dated the 1 St day of November, 2000, as amended January 1, 2002; November 13, 2002, November 15, 2002 and February 26, 2003 by and between MTV Networks, a division of Viacom International Inc., ("MTVN") and The Singing Machine Company, Inc. ("Licensee") with respect to the "MTV: Music Television" name, trademark and logo (the "Licensed Property") (the "Agreement"). Capitalized terms used without definition herein shall have the respective definitions set forth in the Agreement. Effective as of the date hereof, MTVN and Licensee hereby agree that the Agreement shall be amended as follows: 1. The notices information for Licensee contained in Article 16 of the Additional Terms and Conditions of the Agreement shall be deleted in its entirety and replaced with the following: "If to Licensee: ---------------- The Singing Machine Company, Inc. Attention: Mr. Yi Ping Chan, Interim CEO & COO 6601 Lyons Road, Building A-7 Coconut Creek, FL 33073 Telephone: 954-596-1000 Telecopy: 954-596-2000" 2. Paragraph 2 of the Second Amendment to the MTVN Domestic Merchandise License Agreement dated November 13, 2002 shall be deleted in its entirety and replaced with the following: "2. (a) In addition to (and not in lieu of) the Guaranteed Minimum Royalty of $686,250 payable pursuant to the Agreement, receipt of which is hereby acknowledged, Licensee shall pay MTVN an additional Guaranteed Minimum Royalty of $1,300,000. (b) The Guaranteed Minimum Royalty, due MTVN pursuant to Section 2(a) above shall be payable as follows: (i) $500,000 on or before December 27, 2002, receipt of which is hereby acknowledged; (ii) $333,334 on or before June 1, 2003, receipt of which is hereby acknowledged; (iii)$333,333 on or before September 1, 2003, receipt of which is hereby acknowledged; and (iv) $133,333 on or before December i, 2003, receipt of which is hereby acknowledged. (c) It is acknowledged and agreed that the changes made in Section 2(a) and Section 2(b) above shall have no impact on the Australian Guaranteed Minimum Royalty of $5000 pursuant to the amendment dated November 15, 2002. 3. The definition of "Term" contained in the Basic Provisions of the Agreement is hereby deleted in its entirety and replaced with the following: "The 'INITIAL TERM' of this Agreement shall commence on November 1, 2000 and continue through December 31, 2003." 4. (a) The Initial Term of the Agreement shall be extended for a period of four months from January 1, 2004 through April 30, 2004 (the "First Renewal Term). (b) MTVN shall have two separate, independent options to renew the Term (as hereafter defined) of the Agreement, in its sole discretion (each a "Renewal Option") for: (i) a second four month term, from May 1, 2004 through August 31, 2004 (the "Second Renewal Term"); and (ii) a third four month term, from September 1, 2004 through December 31, 2004 (the "Third Renewal Term") (Section 4(b)(i) and Section 4(b)(ii) each, a "Renewal Term") (The Initial Term and the First Renewal Term and the Second Renewal Term, if any, and Third Renewal Term, if any, collectively, the "Term") A Renewal Option may be exercised by MTVN providing notice to Licensee not later than 15 days prior to the expiration of Term of the Agreement. 5. (a) In consideration of the First Renewal Term, Licensee shall pay MTVN an additional Guaranteed Minimum Royalty in the amount of $100,000 which shall be payable on January 5, 2004. Notwithstanding anything to the contrary contained in the Agreement, if Licensee fails to pay MTVN the $100,000 on January 5, 2004, MTVN shall have the right, in its sole discretion, to terminate the Agreement immediately upon notice to Licensee. (b) Provided that MTVN exercises its Renewal Option for either the Second Renewal Term or the Third Renewal Term, Licensee shall pay MTVN an additional Guaranteed Minimum Royalty in the amount of $100,000 for each such Renewal Term (for a maximum of $200,000), payable to MTVN on the first day of each such Renewal Term (i.e., $100,000 on May 1, 2004 for the Second Renewal Term and $100,000 on September 1, 2004 for the Third Renewal Term). Notwithstanding anything to the contrary contained in the Agreement, if Licensee fails to make payment of the $100,000 due on the first 2 day of a Renewal Term, MTVN shall have the right, in its sole discretion, to terminate the Agreement immediately upon notice to Licensee. 6. The following shall be added to the definition of "Royalty Rate" contained in the Basic Provisions of the Agreement: "The Royalty Rate on sales of all Licensed Products sold on or after January 1, 2004 shall be as follows: (a) *% of Net Sales (as defined in the Additional Terms and Conditions of the Agreement) for the Music Products and the Duet Microphones; and (b) *% of Net Sales (as defined in the Additional Terms and Conditions of the Agreement) for the MTV Karaoke Machines. 7. Royalties from the sale of Licensed Products sold during (a) the First Renewal Term (i. e., January 1, 2004 through April 30, 2004) and (b) the Second Renewal Term, if any, and the Third Renewal Term, if any, shall be recoupable solely against the Guaranteed Minimum Royalty payments due and paid on or after January 1, 2004 with no carryover of any unrecouped Guaranteed Minimum Royalty amounts paid through December 31, 2003. Any unearned sums from the $100,000 Guaranteed Minimum Royalty payable for the First Renewal Term shall carry over and be recoupable from sales of the Licensed Products made during the Second Renewal Term, if any. Additionally any unearned sums from the $200,000 Guaranteed Minimum Royalty payable from the First Renewal Term and the Second Renewal Term shall carry over and be recoupable from sales of the Licensed Products made during the Third Renewal Term, if any. 8. As of January 1, 2004, Licensee shall (a) have the right to manufacture, distribute, sell or advertise solely the MTV Karaoke Machines described (i) in Section 7 of the definition of "Licensed Products" contained in the Basic Provisions, the Model SMVG 600, and (ii) in Paragraph 9 below, the Model 988 Karaoke Machine and (b) solely have the right to sell off existing inventory of all other Licensed Products. 9. The following shall be added as an MTV Karaoke Machine in the definition of "Licensed Products" contained in the Basic Provisions of the Agreement: "One version of a Karaoke hardware machine branded with the Licensed Property which (a) enables the end-user to play the Music Products and the Sampler Music Products and participate in Karaoke activities, (b) includes a viewing monitor to view the lyrics of the songs, (c) has a front load, one CD&G changer, (d) includes a video camera feature that (i) is permanently attached to the top of the Karaoke machine and manufactured as part of the Karaoke machine hardware as a whole, (ii) needs to be manually adjusted by the end-user to record the end-user's performance, (iii) is not an individual piece of hardware separate and apart from the Karaoke machine and is not able to be detached from the Karaoke machine for use independent of the Karaoke machine and {iv} does not contain the technical functionality to allow it to operate as a stand alone video camera, and (e) includes a built-in speakersystem) (the "Model 988 Karaoke Machine"). __________ * The confidential portion has been so omitted pursuant to a request for confidential treatment and has been filed separately with the Securities and Exchange Commission. 3 The technical spec sheet for the Model 988 Karaoke Machine is attached hereto and incorporated into Attachment A of the Agreement. 10. Licensee acknowledges and agrees that the Model 988 Karaoke Machine as described herein and any Karaoke machine with a podium stand feature shall be exclusively branded with the Licensed Property. In no event shall Licensee produce and/or sell a Karaoke machine with said podium feature on behalf of itself (e.g., a Singing Machine branded Karaoke machine) or on behalf of any other third party licensor. For the avoidance of doubt, the right of exclusivity contained in this Paragraph 10 shall remain in full force and effect during the Term of the Agreement and shall be null and void upon termination or expiration of the Agreement. 11. The Presentation Date to Licensee's Retailers for the Model 988 Karaoke Machine shall be January 8, 2004 at the Consumer Electronics Show ("CES"). If the Model 988 Karaoke Machine does not receive a favorable response from customers at CES, and Licensee decides not to manufacture and sell the Model 988 Karaoke Machine, then Licensee shall have the right to present designs for the development of a new Karaoke machine to be branded with the Licensed Property for MTVN's approval, which approval may be withheld in MTVN's sole discretion. 12. The Initial Ship Date to Licensee's Retailer for the Model 988 Karaoke Machine shall be July 1, 2004 or such other date as mutually agreed upon by the MTVN and Licensee. 13. The first four lines of Section 13fc) of the Additional Terms and Conditions of the Agreement shall be deleted in their entirety and replaced with the following: "Upon the expiration of this Agreement, provided that Licensee is not in default at the time of expiration and provided further that MTVN has exercised a Renewal Option for the Third Renewal Term (i. e., the Term of the Agreement has been extended through December 31, 2004), Licensee may continue to sell the Licensed Products, previously manufactured and on hand, on a non-exclusive basis during a period of 90 days thereafter, subject to all of the terms and conditions contained in this Agreement; provided, however, that:". Except as otherwise herein amended, the Agreement is hereby ratified and confirmed in all respects. 4 Please indicate your acceptance of the foregoing by signing in the space provided below. Very truly yours, MTV Networks, a division of Viacom International Inc. By: /s/ Heidi Eskenazi -------------------------------- Name: Heidi Eskenazi Title: V.P. Licensing, Merchandising & Interactive, MTV ACCEPTED AND AGREED TO: THE SINGING MACHINE COMPANY, INC. BY: /s/ Yi Ping Chan ---------------------------- Name: Yi Ping Chan Title: Interim CEO & COO cc: G. Boland; T. Connolly; H.P. Eskenazi; T. Hernandez; A. Green (Singing Machine); G. Legrand; B. Matthews; V. O'toole; L. Silfen; M. Wermelt; and P. White 5 Attachment A Product Specification of STVG-988 Maestro EX-10.7 9 wbp-salesagrmnt.txt WBP SALES AGREEMENT EXHIBIT 10.7 SALES AGREEMENT This Sales Agreement (this "Agreement"), effective as of December 9, 2003 (the "Effective Date"), is made by and between The Singing Machine Inc., a Delaware corporation ("SMC"), and CPP Belwin, Inc., a Delaware Corporation and its Affiliates (collectively, "WPB"). WHEREAS, SMC has produced karaoke software, in compact disk ("CDG") format (such CDG's are collectively referred to as the "Catalogue" and individually as a "Title"); and WHEREAS, SMC has requested WBP to market the Titles; and WHEREAS, WBP is willing to market the Titles subject to the terms of this Agreement. NOW, THEREFORE, in consideration of the above premises SMC and WBP agree as follows: ARTICLE I - DEFINITIONS 1.1 In addition to those terms set forth above, the terms listed below shall have the following meanings for the purpose of this Agreement: "Advertising Allowance" means sums agreed upon by the parties to be used to promote the sale of Licensed Products including, but not limited to cooperative advertising costs and market development funds. "Affiliate" means a corporation, partnership (limited or general), limited liability company, joint venture, association, trust, or any other unincorporated organization or entity owned in whole or in part by or under common control with a party to this Agreement. "Change of Control" shall include any change of control directly or indirectly of WBP whether such change of control is by merger, consolidation, sale or transfer of assets or equity, assignment, transfer, combination, joint venture, management contract, assimilation, attribution or amalgamation of any kind whatsoever. "Claim" means any claim, action, suit, litigation, investigation, inquiry, review or proceeding. "Confidential Information" means all information furnished by a party (the "Providing Party") to the other party (the "Receiving Party") that is designated as confidential, whether or not a trade secret, including but not limited to any business plans, any information regarding the Providing Party's marketing, structural or strategic plans, or any other analyses, compilations, studies or other documents whether prepared for or given to the Receiving Party or prepared by or for directors, officers, employees, agents or representatives of the Providing Party or any affiliate thereof (including without limitation accountants, attorneys and financial advisors) (Representatives"). 1 "Copyright Office" means the Copyright Office of the Library of Congress of the United Stated of America. "CDG" means a compact disk with graphics containing the contents of a Title. "Distribution Fee" means that percentage of Net Sales Receipts set forth on Exhibit C. "Effective Date" means December 9, 2004. "Intellectual Property" means all patents, trademarks, trade names, logos, service marks, service names, copyrights, and applications therefore, and license or other rights in respect thereof used in connection with the Catalogue and any of the Titles and whether or not SMC's or any other Person's. "Judgment" means any judgment, decree, writ, injunction, ruling or order. "Legal Expenses" means any and all fees, costs and expenses of any kind reasonably incurred by a Person and its counsel in investigating, preparing for, defending against or providing evidence, producing documents or taking other action with respect to, any threatened or asserted Claim including but not limited to fees, costs and expenses of counsel at pre-trail, trail and appellate levels. "Licensed Products" means CDG's and Other Formats containing the contents of any of the Titles set forth on Exhibit A. "Licensed Property" means the Mark, the Logo and all Intellectual Property and Technology. "Logo" means those certain logos set forth on Exhibit B attached hereto and hereby made a part hereof and all other logos of SMC registered with the Copyright Office or non-U.S. registration authorities or used by SMC as common law marks or their equivalent. "Mark" means those certain trademarks and service marks set forth on Exhibit C attached hereto and hereby made a part hereof and all other marks of any type or nature of SMC registered with the Copyright Office or non-U.S. registration authorities or used by SMC as common law marks or their equivalent. "Net Proceeds" means Net Sales Receipts actually received by WBP, less the Distribution Fee, the Reserve Amount, the Advertising Allowance, is any, and less any other payments due to WBP hereunder. "Net Reserves" means the Reserve Amount retained by WBP for a particular month less the amount of money required to repay any Licensed Products returned by WBP Account and Non-WBP Account customers during that month and less any sums anticipated to be due WBP by reason of any indemnity obligations of SMC. "Net Reserve Month" means the third month prior to the month before the month in which the payment of Net Reserves are to be made. For example, on March 15, 2004, WBP will 2 be required to pay the amount of Net Reserves due to SMC for the month of December, 2003 (December being the third month before February, the month before the payment is being made). "Net Sales Receipts" means gross revenue from the sale of Licensed Products less sales tax, VAT (or its equivalent) and other taxes in the nature of sales taxes and freight costs, if any. "Non-WBP Accounts" means those accounts to which Licensed Products are sold directly by SMC. A true and complete list of Non-WBP Accounts is set forth on Exhibit D. "Other Formats" means any format other than CDG, whether now known or hereafter invented or discovered. "Person" means and includes an individual, corporation, partnership (limited or general), joint venture, association, trust, any other unincorporated organization or entity and a governmental entity or any department or agency thereto. "Remaining Inventory" means those Licensed Products that make up the inventory of WBP at the date of termination of this Agreement. "Reserve Amount" means a sum equal to twenty five (25%) percent of Net Sales Receipts reserved as set forth in Section 5.2 of this Agreement to cover the returns of Licensed Products and indemnity sums due or payable to WBP. "Security Interest" means any security interest, pledge, lien, charge, claim, option, equity, right, restriction on transfer or encumbrance of any nature whatsoever. "SMC Agreement" means any agreement between SMC and any Person including but not limited to all security agreements, pledges, other security instruments, agreements, contracts, leases, licenses, franchises, obligations, instruments or other commitments, arrangements or understandings of any kind, whether written or oral, binding or nonbonding, to which SMC is a party and which include in any part the Catalogue or by which SMC or any of the Catalogue may be bound or affected. "Tax" and "Taxes" means all taxes, fees, levies or other assessments, including but not limited to income, excise, property, sales, franchise, withholding, value added, social security and unemployment taxes imposed by the United States, any state, county, local or foreign government, or any subdivision or agency thereof or taxing authority therein, and any interest, penalties or additions to tax relating to such taxes, charges, fees, levies or other assessments. "Technology" means trade secrets, proprietary information, inventions, know-how, processes and procedures owned by SMC, licensed to WBP and used in connection with the Catalogue and any of the Titles. "Termination Date" means the date upon which this Agreement is scheduled to terminate, whether it is scheduled to terminate at the end of the initial term of this Agreement or at the end of any subsequent renewal term. 3 "Territory" means the United States of America and Canada and their respective territories and possessions as well as U.S. Military Exchanges throughout the entire world. "WBP Accounts" means those accounts to which Licensed Products are sold other than Non-WBP Accounts. "WBP Indemnified Parties" means WBP, its directors, officers, shareholders, employees and Affiliates and their respective directors, officers, shareholders and employees. ARTICLE II - LICENSE 2.1 Grant. SMC grants to WBP an exclusive right and license to: (i) promote, market and sell the Licensed Products within the Territory; and (ii) use the Licensed Property in or on any product container, product literature, product advertisement or other method that may be used to distribute, promote, advertise and sell the Licensed Products within the Territory. SMC will cooperate with WBP and use its best efforts to assist and facilitate the promotion, sale, distribution and marketing of Licensed Products, including without limitation, referring sales "leads" to WBP within the Territory. 2.2 Internet Rights Included. The rights licensed to WBP hereunder shall include and not be limited to anything that pertains to the Internet, INTERNIC, the World Wide Web, any web site, Domain name, Domain registration, or any other computer related or Internet related or derived source or system. To the extent that SMC maintains a web site, SMC shall maintain a link to a designated web site of WMP upon which the Licensed Products shall be available for sale. Such link shall be exclusive for products of similar character. 2.3 Sublicense Rights. WBP shall have the right to sublicense the rights licensed to it hereunder and to subcontract the sale, promotion, marketing and distribution of all or any portion of any of the Licensed Products. 2.4 Code Programs. Additional discount programs are offered on behalf of WBP to retail and wholesale customers otherwise known as "Code Programs". Code Programs may include additional discounts or dating for a specific period of time. SMC may elect, upon notice to WBP, to participate in WEA's Code Programs or any of them. WBP shall not offer Licensed Products under any Code Program without the prior consent of SMC. ARTICLE III - DUTIES OF THE PARTIES 3.1 SMC Obligations. SMC shall deliver, at its sole cost, risk and expense, Licensed Products in such quantities as EBP shall request and in all cases sufficient to meet market demand to WBP's warehouse, F.O.B. such warehouses. Each warehouse shall be delivered a complete range of all Licensed Products. SMC shall also provide SBP with a suggested retail price list for the Licensed Products as agreed upon by the parties. SMC shall provide promotional copies as requested by WBP but shall not be obligated to provide more than 200 4 copies of each Title. Each promotional copy shall be marked as such and shall not be sold by WBP. SMC shall consult with WBP and approve all advertising sufficiently in advance to permit WBP to carry out a marketing campaign in form and substance similar to other WBP and Affiliate marketing campaigns. SMC shall pay the cost of all advertising. With the prior written consent of WBP which may be withheld in the sold discretion of WBP, the cost of advertising may be paid from the Net Sales Receipts. To the extent that Advertising Allowances are paid from Net Sales Receipts, such Advertising Allowances shall be deducted from Net Sales Proceeds after the payment to WBP of Distribution Fees and SMC Serviced Account Distribution Fees. 3.2 Duties of WBP. WBP shall use reasonable commercial efforts to promote, market and sell the Licensed Products to WBP Accounts at a price agreed upon between WBP and SMC. WBP's marketing efforts shall include attendance at those trade shows and conventions it elects to attend, meetings with WBP Accounts, direct mail such as mailings to Licensed Product dealers, preparation and mailing of catalogues, and placement and promotion of the Licensed Products on www.songexpress.com and any business to business intranet site that it may maintain. WBP shall provide locations for the warehousing of Licensed Products in sufficient quantities to meet market demand. The present warehouse locations are 15800 N.W. 48th Avenue, Miami, Florida, and 948 Meridian Lake Dr., Bldg F, Aurora, Illinois. WBP may change the locations for warehousing the Licensed Products on twenty-one (21) days notice to SMC. WBP shall provide order fulfillment services from its warehouses. In addition, WBP shall provide (i) record keeping of all sales and returns and (ii) inventory control in accordance with industry standard practice. WBP shall also use reasonable commercial efforts to collect all sums due from sales of the Licensed Products. In the event that WBP engages outside collection agents, it shall advance such fees and any costs associated therewith and shall thereafter recover such costs and fees from Net Receipts prior to the payment of sums due to SMC. ARTICLE IV - TERM AND TERMINATION 4.1 Term. The term of this Agreement (the "Term") shall commence on the Effective Date and shall terminate two years from the Effective Date unless it is earlier terminated as provided in Sections 4.2 or 4.3 below. Any party may terminate this Agreement as of a Termination Date by notice to the other party received by the other party no later than 180 days prior to the Termination Date (the "Expiration Notice"). Upon notice from WBP no earlier than 180 days prior to the Termination Date and provided that SMC has not timely delivered to WBP an Expiration Notice, the term of this Agreement shall be extended for an additional period of two years upon the same terms and conditions as set forth herein. 4.2 Termination by SMC. This Agreement may be terminated prior to the Termination Date in the event of a default by EBP as more specifically set forth in Article IX below. 4.3 Termination by WBP. This Agreement may be terminated at any time prior to the Termination Date upon thirty (30) days prior written notice from WBP to SMC or in the event of a default by SMC as more specifically set forth in Article IX below. 5 4.4 Sales Post-Termination. Upon termination of this Agreement, WBP shall have the right to deliver Licensed Products to the WBP Accounts and the Non-WBP Accounts that have placed orders prior to such termination. 4.5 Post Termination Obligations. Termination of this Agreement shall not relieve any party of any obligation or liability accrued hereunder prior to such termination, not affect or impair the rights of any party arising under this Agreement prior to such termination, except as expressly provided herein. After the termination of this Agreement, subject to WBP's rights to deliver Licensed Products to WBP Accounts and Non-WBP Accounts, WBP shall deliver the Remaining Inventory to SMC, at the cost and expense of SMC. WBP shall also cease to use the Licensed Property and shall turn over to SMC all promotional materials that contain the Licensed Property. ARTILE V - PAYMENTS 5.1 Net Proceeds. WBP shall pay the Net Proceeds to SMC monthly beginning on January 15, 2004 and continuing each month thereafter on the 15th day following the end of each month, in arrears. With such payment, SBP shall provide a monthly repost detailing the sales, Reserve Amounts and Net Proceeds payable for the previous month (the "Monthly Report"). In the event that for any reason a payment is not due for any month, WBP shall nevertheless provide a Monthly Report for such month. 5.2 Reserve Amount. WBP shall retain the amount of twenty five (25%) percent of all Net Sales Receipts as the Reserve Amount. Beginning on March 15, 2004 and the fifteenth of each month thereafter, WBP shall pay to SMC, along with the Net Proceeds, the amount of Net Reserves due to SMC for the Net Reserve Month. On the 15th day of the third month following the month during which this Agreement terminates, WBP shall pay the final amount of Net Reserves to SMC. 5.3 Set Off. All sums payable to SMC shall be subject to set off by SBO for sums due to WBP as set forth in Articles X and XI below. 5.4 WBP Books of Account. WBP shall maintain and keep (at its principal place of business or such other place as shall be disclosed to SMC and its sole expense) accurate books of account and record covering all matters and transactions relating to this Agreement. SMC and its duly authorized representative(s) shall have the right at its sole expense, upon reasonable notice during WBP's regular business hours and in a manner reasonably calculated to avoid disruption of the business of WBP being carried on at such location, no more than twice in any calendar year, to examine and copy and otherwise audit said books of accounts, records with respect to this Agreement. WBP shall maintain and keep all such books of account and records available for at least two (2) years after expiration or earlier termination of this Agreement. 6 ARTICLE VI - REPRESENTATIONS OF SMC 6.1 SMC represents and warrants to WBP as follows: a. Organization and Good Standing. SMC is a corporation duly organized, validly existing an din good standing under the laws of the State of Florida and has the corporate power and authority to own the Licensed Property, the Catalogue and each Title contained within it, and to carry on its business as now being conducted. b. Authority, Approvals and Consents. SMC has the corporate power and authority to enter into this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized and approved by the Board of Directors of SMC and no other corporate proceedings on the part of SMC are necessary to authorize and approve this Agreement and the transactions contemplated hereby. This Agreement has been duly executed and delivered by, and constitutes a valid and binding obligation of, SMC, enforceable against SMC in accordance with its terms (except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally or by the principles governing the availability of equitable remedies). The execution, delivery and performance of this Agreement by SMC and the consummation of the transactions contemplated hereby do not and will not: (i) contravene any provisions of the Certificate of Incorporation of By-Laws of SMC; (ii) conflict with, result in a breach of any provision of, constitute a default under, result in the modification or cancellation of, or give rise to any right of termination or acceleration in respect of, any SMC Agreement or require any consent or waiver of, or release of Security Interest by, any Person; (iii) result in the creation of any Security Interest upon, or any Person obtaining any right to acquire, any properties, assets or rights or SMC. c. Absence of Liabilities. SMC has no liabilities of any nature whatsoever (whether known or unknown, due or to become due, accrued, absolute, contingent or otherwise) that would result in a Security Interest on all or any portion of the Catalogue including, without limitation, any liabilities for Taxes or liabilities for unpaid fees or royalties to any Person providing goods or services in connection with any of the Titles. d. Legal Matters. On the date of this Agreement, (i) there are no Claims pending against, or, to the best knowledge of SMC threatened against of affecting, SMC, or any of its properties or rights before or by any court, arbitrator, panel, agency or other governmental, administrative or judicial entity and (ii) SMC is not subject to any Judgment. 7 e. Ownership. SMC has good and marketable title to the Catalogue free and clear of all rights of other Persons. f. Intellectual Property; Technology. SMC owns or has valid, binding and enforceable rights to use all Intellectual Property and Technology, without any conflict with the rights of others and will at all times during the Term own or have valid, binding and enforceable rights to use all Intellectual Property and Technology, without any conflict with the rights of others. SMC is the sole and exclusive owner of or has the right to use the Licensed Property subject to no interference or other contest proceeding. SMC has not received any notice from any other person pertaining to or challenging the right of SMC to won or use, as applicable, any part of the Licensed Property. SMC has not granted any outstanding licenses or other rights, and has no obligations to grant licenses or other rights in or to, any of the Licensed Property. No Claims have been made by SMC of any violation or infringement by others of the rights of SMC with respect to any Licensed Property, and SMC knows of no basis for the making of any such claim. SMC has not violated or infringed any intellectual property or technology rights (including but not limited to trade secrets) of any other Person related to the Catalogue or any Title. g. Brokers. Neither SMC, nor any director, officer or employee thereof, has employed any broker or finder of has incurred or will incur any broker's, finder's or similar fees, commissions or expense, in each case in connection with the transactions contemplated by this Agreement. h. Disclosure. SMC has not made any material misrepresentation to WBP relating to this Agreement or the Catalogue nor has SMC omitted to state to WBP any material fact relating to this Agreement or the Catalogue which is necessary in order to make the information given by or on behalf of SMC to WBP not misleading or which, if disclosed, would reasonably affect the decision of a Person who is considering licensing the Catalogue or any Title. ARTICLE VII - REPRESENTATIONS OF WBP 7.1 WBP represents and warrants to SMC as follows: a. Organization and Good Standing. WBP is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Florida and has the corporate power and authority to license the Licensed Property and to carry on its business as not being conducted. b. Authority, Approvals and Consents. WBP has the corporate power and authority to enter into this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby have been duly authorizes and approved by all necessary corporate action. This Agreement has been duly executed and delivered by, and constitutes a valid and binding obligation of, WBP, enforceable against WBO in accordance with its terms (except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally or by the principles governing the availability of equitable remedies). 8 c. Brokers. Neither the WBP, not any manager, officer or employee thereof, has employed any broker or finder or has incurred or will incur any broker's, finder's or similar fees, commissions or expenses, in each case in connection with the transactions contemplated by this Agreement. ARTICLE VIII - CONFIDENTIALITY 8.1 Confidentiality. WBP and SMC agree that any Confidential Information disclosed by a Providing Party to the Receiving Party pursuant to this Agreement shall be maintained in strict confidence and each will use all reasonable diligence to prevent disclosure except to necessary personnel and to Affiliated and consultants who agree to be bound by this confidentiality provision. SMC further agrees that the Technology shall be maintained in strict confidence and that it will use all reasonable diligence to prevent disclosure except to necessary personnel, Affiliated and consultants, who agree to be bound by this confidentiality provision. WBP's and SMC's obligations under this confidentiality provision shall remain in effect for the Term and a period of one (1) year thereafter. WBP and SMC shall not have any obligation of confidentiality with respect to information that: a. is in the public domain by use and/or publication at the time of its receipt from the disclosing party; or b. is developed independently of information received from the disclosing party; or c. was already in the recipient's possession prior to receipt from disclosing party; or d. is properly obtained by recipient from a third party with a valid legal right to disclose such information and such third party is not under a confidentiality obligation to the disclosing party. Upon termination of this Agreement, all confidential information provided by each party (each, a "Disclosing Party") to the other (each, a "Receiving Party") shall be promptly returned by the Receiving Party to the Disclosing Party. ARTICLE IX - DEFAULT 9.1 WBP events of Default. Each of the following will constitute a "WBP Event of Default" under this License provided that SMC first gives written notice thereof to WBP: a. Failure to timely pay sums due to SMC within ten (10) business days following written notice of such failure; 9 b. Failure to perform any material term, covenant, provision, warranty, or undertaking in this Agreement unless WBP has promptly commenced and continues diligent efforts to remedy the default within thirty (30) days following written notice thereof. If the remedy requires additional time in excess of the 30 day cure period, WBP shall have such additional time as is reasonably necessary to cure same. c. If any representation of WBP under this Agreement is false when made or becomes false at any time during the Term. d. If WBP files a voluntary petition under any bankruptcy, reorganization, or insolvency law of any jurisdiction; e. If WBP consents to or applies for the appointment of a trustee, receiver, custodian, or similar official for itself or for all or substantially all its assets or a trustee, receiver, custodian, or similar official is appointed to take possession of all or substantially all of WBP's assets and the order of appointment is not dismissed or stayed within 60 days after appointment; f. If WBP makes any assignment for the benefit of creditors, or other arrangement or composition under any laws for the benefit of insolvent persons; an order for relief is entered against WBP under any bankruptcy, reorganization, or insolvency law of any jurisdiction and such order is not dismissed or stayed within 60 days after its entry; or any case, proceeding, or other action seeking such order remains undismissed for 60 days after its filing; or any writ of attachment, garnishment, or execution is levied against all of substantially all of WBP's asset; or all or substantially all of WBP's assets become subject to any attachment, garnishment, execution, or other judicial seizure, and the same is not satisfied, removed, released, or bonded within 60 days after the date the writ was levied or the date of the attachment, garnishment, execution, or other judicial seizure. 9.2 Remedies for WBP Event of Default. Upon a WBP Event of Default, SMC shall be entitled to the following remedies: a. If WBP is in default on any payment due under this Agreement, the amount in arrears will bear interest from the date of the default until the amount is paid in full, at a rate equal to the maximum rate allowed by Florida law. b. SMC may terminate this Agreement, and such termination will be without prejudice to any other rights or claims SMC may have against WBP. c. SMC may seek specific performance and injunctive relief, including, without limitations, temporary or preliminary injunctive relief. 9.3 SMC Events of Default. Each of the following will constitute a "SMC Event of Default" under this License provided that WBP first gives written notice thereof to SMC: a. Failure to perform any material term, covenant, provision, warranty, or undertaking in this Agreement unless SMC has promptly commenced and continues diligent efforts to remedy the default within thirty (30) days following written notice 10 thereof. If the remedy requires additional time in excess of the 30 day cure period, SMC shall have such additional time as is reasonably necessary to cure same. b. If any representation of SMC under this Agreement is false when made or becomes false at any time during the Term. c. If SMC files a voluntary petition under any bankruptcy, reorganization, or insolvency law of any jurisdiction; d. If SMC consents to or applies for appointment of a trustee, receiver, custodian, or similar official for itself or for all or substantially all its assets or a trustee, receiver, custodian, or similar official is appointed to take possession of all or substantially all of SMC's assets and the order of appointment is not dismisses or stayed within 60 days after appointment; e. If SMC makes any assignment for the benefit of creditors, or other arrangement or composition under any laws for the benefit of insolvent persons; an order for relief is entered against SMC under any bankruptcy, reorganization, or insolvency law of any jurisdiction and such order is not dismisses or stayed within 60 days after its entry; or any case, proceeding, or other action seeking such order remains undismissed for 60 days after its filing; or any writ of attachment, garnishment, or execution is levied against all or substantially all of SMC's assets; or all or substantially all of SMC's assets become subject to any attachment, garnishment, execution, or other judicial seizure, and the same is not satisfied, removed, released, or bonded within 60 days after the date the writ was levied or the date of the attachment, garnishment, execution, or other judicial seizure. 9.4 Remedies for SMC Event of Default. Upon a SMC Event to Default, WBP shall be entitled to the following remedies: a. If SMC is in default on any payment due under this Agreement, the amount in arrears will bear interest from the date of the default until the amount is paid in full, at a rate equal to the maximum rate allowed by Florida law. b. WBP may terminate this Agreement, and such termination will be without prejudice to any other rights or claims WBP may have against SMC. c. WBP may seek specific performance and injunctive relief, including, without limitation, temporary or preliminary injunctive relief. 9.5 Rights of WBP. In the event that a SMC Event of Default results from SMC's cessation of or failure to actively conduct its primary business operations, the liquidation or seizure of its assets, any bankruptcy or insolvency, an assignment for the benefit of creditors, or its failure to own or control the Licensed Property, then WBP shall have the right, in addition to all other remedies, to the ownership of the Licensed Property for no additional consideration. In such event, SMC shall execute such documents as shall be required to transfer to and fully vest the Licensed Property and the Catalogue in WBP. 11 ARTICLE X - INFRINGEMENT ACTIONS 10.1 Infringement Actions. If either party hereto learns of a possible infringement of the Licensed Property or asserted against either party as a result of the Licensed Property, such party shall inform the other party hereto promptly in writing of such possible infringement and provide the other party with any available evidence thereof, to the extent in such party's possession or control. 10.2 SMC Obligation to Protect the Licensed Property and the WBP Indemnified Parties. During the Term, SMC shall (i) prosecute any lawsuits, legal actions or other proceedings which, in the opinion of WBP, are necessary or advisable to protect the Licensed Property from infringements, and (ii) protect, indemnify and defend the WBP Indemnified Parties in the event that any claim, lawsuit, legal action or other proceeding is made or instituted against WBP as a result of its sales of Licensed Products. Notwithstanding the foregoing, SMC shall not be required to indemnify and defend the WBP Indemnified Parties in connection with the illegal or grossly negligent actions of the WBP Indemnified Parties. The cost and expense of defending and indemnifying the WBP Indemnified Parties and of prosecuting lawsuits, legal actions or other proceedings in connection with alleged infringements shall be paid by SMC. In furtherance of such right, WBP hereby agrees that SMC may include WBP as a party plaintiff in any such suit, without expense to WBP, and WBP undertakes to furnish any documentary evidence or evidentiary materials which SMC may reasonably require for the purpose of terminating such infringements. 10.3 WBP Right to Protect the Licensed Property and the WBP Indemnified Parties. If within six (6) months after having been notified of any alleged infringement of the Licensed Property, SMC shall have been unsuccessful in persuading the alleged infringer to desist and shall not have brought and shall not be diligently prosecuting an infringement action, or if SMC shall notify WBP at any time prior thereto of its intention not to bring suit against any alleged infringer, then, and in those events only, WBP shall have the right, but shall not be obligated, to prosecute at its own expense such infringement of the Licensed Property and WBP may, for such purposes, use the name of SMC as party plaintiff. SMC shall bear all costs and expenses of any such suit. If within ten (10) days of being notified of any claim or demand against any WBP Indemnified Party, SMC shall not have formally and actually undertaken the defense of such WBP Indemnified Party or if SMC shall at any time thereafter discontinue its defense of such WBP Indemnified Party, WBP shall have the right to defend the WBP Indemnified Party at the expense of SMC. 10.4 Cooperation. In any infringement suit to protect the Licensed Property or to indemnify any Person pursuant to this Agreement, WBP shall, at the request and expense of SMC, cooperate in all respects and, to the extent possible, have its employees testify when requested and make available relevant records, papers, information, samples, specimens, and the like. 10.5 Escrow of Funds. In the event that any suit is brought by any third party alleging that any of the Licensed Property infringes any Intellectual Property of any other Person, or if a 12 claim or demand is brought against any WBP Indemnified Party (collectively, an "Indemnifiable Matter"), at the option of WBP, the sums payable to SMC with respect to the sale of the Licensed Products (the "Escrowed Funds") may be held in escrow by WBP to the extent of the costs and expenses reasonably anticipated by WBP to be incurred including but not limited to Legal Expenses and potential damages for such Indemnifiable Matter. The expenses incurred by WBP in connection with the Indemnifiable Matter shall be paid to WBP on a monthly basis upon the submission of invoices for such expenses and the balance of the Escrowed Funds shall remain in escrow pending the outcome of the Indemnifiable Matter. Upon the conclusion of the Indemnifiable Matter, the applicable amount of Escrowed Funds shall be remitted first, to WBP to the extent of its remaining costs and expenses including but not limited to the Legal Expenses and then to the claimant if the claimant is awarded damages or if a settlement is agreed upon by SMC with the claimant that requires the payment of sums to the claimant. The balance of Escrowed Funds shall then be paid to SMC. The Escrowed Funds shall not bear interest and WBP shall have no obligation to invest the Escrowed Funds. In the event of a dispute over all or any portion of the Escrowed Funds, WBP may initiate an action in the nature of interpleader and deposit the portion of the Escrowed Funds that is in dispute with the court having jurisdiction over such interpleader action. In any action in which the Escrowed Funds are interpled, WBP, upon depositing the Escrowed Funds with a court, shall be released from further liability, but shall be entitled to assert all claims to which it may be entitled. WBP shall not be liable, except for its own gross negligence or willful misconduct in connection with the Escrowed Funds. WBP shall be entitle to rely upon any order, judgment, certification, demand, notice, instrument or other writing delivered to it hereunder without being required to determine the authenticity or the correctness of any fact stated therein or the propriety or validity or the service thereof. WBP may act in reliance upon any instrument or signature believed by it to be genuine and may assume that any person purporting to give receipt or advice or make any statement or execute any document in connection with the provisions hereof has been duly authorized to do so. 10.6 Additional Provisions. The provisions of Section 11.2 c. (i)-(iv) shall govern the defense and settlement of any Indemnifiable Matter. ARTICLE XI - SURVIVAL AN DINDEMNIFICATION 11.1 Survival. All representations and warranties of the parties shall survive the termination of this Agreement for a period of five years; provided, however, that (i) to the extent any breach of a representation or warranty involved any Tax matters, such representation and warranty and any related indemnity obligation shall survive until the expiration of the applicable statute of limitations relating to any such Tax matter. 11.2 Indemnification. The parties shall indemnify each other as set forth below: a. In addition to its indemnification obligations set forth in Article X, SMC shall (i) indemnify and hold harmless WBP from any and all losses, damages, liabilities and Claims arising out of, based upon or resulting from any inaccuracy as of the date hereof of any representation or warranty of SMC which is contained in or made 13 pursuant to this Agreement or any breach by SMC of any of its obligation contained in or made pursuant to this Agreement and (ii) reimburse WBP for any and all fees, costs and expenses of any kind related thereto (including, without limitation, any and all Legal Expenses). b. WBP shall (i) indemnify and hold harmless SMC from any and all losses, damages, liabilities and Claims arising out of, based upon or resulting from any inaccuracy as of the date hereof of any representation or warranty of WBP which is contained in or made pursuant to this Agreement or any breach by WBP of any of its obligations contained in or made pursuant to this Agreement and (ii) reimburse SMC for any and all fees, costs and expenses of any kind related thereto (including, without limitation, any and all Legal Expenses). c. Promptly after receipt by any person entitle to indemnification under this Section 11.2 (an "Indemnified Party") of notice of the commencement of any action in respect of which the Indemnified Party will seek indemnification hereunder, the Indemnified Party shall notify each person that is obligated to provide usch indemnification (an "Indemnified Party") thereof in writing, but any failure to so notify the Indemnifying Party shall not relieve it from any liability that it may have to the Indemnified Party other than under this Article XI. The Indemnifying Party shall be entitle to participate in the defense of such action and, provided that within 15 days after receipt of such written notice the Indemnifying Party confirms in writing its responsibility therefore and reasonably demonstrates that it will be able to pay the full amount of potential liability in connection with any such claim, to assume control of such defense with counsel reasonably satisfactory to such Indemnified Party; provided, however, that: (i) the Indemnified Party shall be entitle to participate in the defense of such claim and to employ counsel at its own expense to assist in the handling of such claim; (ii) the Indemnifying Party shall obtain the prior written approval of the Indemnified Party before entering into any settlement of such claim or ceasing to defend against such claim, if pursuant to or as a result of such settlement or cessation, injunctive or other equitable relief would be imposed against the Indemnified Party; (iii) no Indemnifying Party shall consent to the entry of any judgment or enter into any settlement that does not include as an unconditional term thereof the giving by each claimant or plaintiff to each Indemnified Party of a release from all liability in respect of such claim; and (iv) the Indemnifying Party shall not be entitled to control (but shall be entitle to participate at its own expense in the defense of), and the Indemnified Party shall be entitle to have sole control over, the defense or settlement of (A) any claim to the extent the claim seeks an order, injunction or other equitable relief against the Indemnified Party which, if successful, could materially interfere with the business, operations, assets, condition (financial or otherwise) or 14 otherwise, or prospects of the Indemnified Party or (B) any claim relating to Taxes. After written notice by the Indemnifying Party to the Indemnified Party of its election to assume control of the defense of any such action, the Indemnifying Party shall not be liable to such Indemnified Party hereunder for any Legal Expenses subsequently incurred by such Indemnified Party in connection with the defense thereof other than reasonable costs of investigation and of liaison counsel for the Indemnified Party. If the Indemnifying Party does not assume control of the defense of such claim as provided in this Section 11.2 (c), the Indemnified Party shall have the right to defend such claim in such manner as it may deem appropriate at the cost and expense of the Indemnifying Party, and the Indemnifying Party will promptly reimburse the Indemnified Party therefore in accordance with this Section 11.2. The reimbursement of fees, costs and expenses required by this Section 11.2 shall be made by periodic payments during the course of the investigation or defense, as and when bills are received or expense incurred. d. In the event that the Indemnifying Party shall be obligated to indemnify the Indemnified Party pursuant to this Article XI, the Indemnifying Party shall, upon payment of such indemnity in full, be subrogated to all rights of the Indemnified Party with respect to the claims to which such indemnification relates. e. Any claim by WBP for indemnification may be applied against any payment thereafter due to SMC under this Agreement, by means of setoff, reduction or otherwise. The rights of WBP under this subsection (e) are in addition to such other rights and remedies which WBP may have under this Agreement or otherwise. 11.3 Survival. SMC's obligations under Article X and this Article XI shall survive the termination of this Agreement. ARTICLE XII - GENERAL TERMS AND CONDITIONS 12.1 Notices. All notices or other communications required or permitted hereunder shall be in writing and shall be deemed to have been duly given (i) if physically delivered, (ii) if transmitted by fax or other similar means, with subsequent oral confirmation, or (iii) three (3) business days after having been transmitted to a third party providing delivery services in the ordinary course of business which guarantees delivery on the next business day after such transmittal (e.g., via Federal Express) all of which notices or other communications shall be addressed to the recipient as follows: 15 If to WBP: CPP Belwin, Inc. 15800 N.W. 48th Avenue Miami, Florida 33014 ATTN: Fred S. Anton, Chief Executive Officer Telecopy Number: (305) 621-1094 With a courtesy copy to: Carlton Fields P.A. 100 SE 2nd Street 40th Floor Miami, Florida 33131 ATTN: Andrew J. Markus, Esq. If to SMC: The Singing Machine, Inc. 6601 Lyons Road Building A-7 Coconut Creek, Florida 33073 ATTN: Rose L. Labadessa, Corporate Legal Manager Telecopy Number: (954) 596-2000 or such other addressees and telecopy numbers as either Party shall hereafter furnish to the other Party. 12.2 Modifications. This Agreement may not be amended, changed, modified or rescinded except in writing signed by a duly authorized representative of each party hereto. 12.3 Captions; Gender, Number. Section and other heading shave been inserted for convenience of reference only an dare not a part of nor intended to govern, limit or aid in the construction of any term or provision hereof. All words used in this Agreement will be construed to be of such gender or number as the circumstances require. Unless otherwise expressly provided, the word "including" does not limit the preceding words or terms. 12.4 Dispute Resolution and Arbitration. Any dispute, controversy or claim arising out of or relating to this Agreement shall be settled by binding arbitration conducted by the American Arbitration Association ("AAA") in accordance with AAA Commercial Arbitration Rule and Procedures (the "Rules"). The arbitration shall be heard by three arbitrators to be selected in accordance with the Rules, in Miami-Dade County, Florida. Judgment upon any award rendered may be entered in any court having jurisdiction thereof. Within 7 calendar days after appointment the arbitrators shall set the hearing date, which shall be within 90 days after the filing date of the demand for arbitration unless a later date is required for good cause shown and shall order a mutual exchange of what they determine to be relevant documents and the dates thereafter for the taking of up to a maximum of 5 depositions by each party to last no more than 2 days in aggregate for each party. Both SMC and WBP waive the right, if any, to obtain any award for exemplary or punitive damages or any other amount for the purpose of imposing a penalty from the other in any arbitration or judicial proceeding or other adjudication arising out of or with respect to this Agreement, or any breach hereof, including any claim that this 16 Agreement, or any part hereof, is invalid, illegal or otherwise voidable or void. In addition to all other relief, the arbitrator shall have the power to award reasonable attorneys' fees to the prevailing party. The arbitrators shall make their award no later than 7 calendar days after the close of evidence of the submission of final briefs, whichever occurs later. The obligations herein to arbitrate shall not prevent any party from seeking temporary restraining orders, preliminary injunctions or other procedures in a court of competent jurisdiction to obtain interim relief when deemed necessary by such party and court to preserve the status quo or prevent irreparable injury pending resolution by arbitration of the actual dispute or to seek a remedy specifically provided for in this Agreement. All parties hereto acknowledge and agree that the state and federal courts of the State of Florida are courts of competent jurisdiction for purposes of this paragraph and do hereby submit to the jurisdiction of the appropriate court in the State of Florida to which the matter is first submitted by a party for enforcement of any arbitration award or to obtain any such interim relief as herein provided. 12.5 Governing Law; Jurisdiction. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Florida without regard to its choice of law rules or similar principle which would refer to and apply the substantive laws of another jurisdiction, and applicable international conventions and treaties. 12.6 Waiver. The failure of either party to exercise any right or option arising out of a breach of this Agreement shall not be deemed a waiver of any right or option with respect to any subsequent or different breach, or a consent to the continuance of any existing breach. 12.7 Specific Performance. In addition to such other remedies as may be available under applicable law, the parties acknowledge that the remedies of specific performance and/or injunctive relief shall be available and proper in the event either party fails or refuses to perform its duties or fulfill its covenants hereunder. 12.8 Successors and Assignment. The rights and obligations under this Agreement may not be assigned or otherwise transferred by either party without the prior written consent of the other party, which consent shall not be unreasonably withheld or delayed.; provided, however, that WBP may make an assignment to an Affiliate without the consent of SMC (provided that WBP is not relieved of its liability hereunder). WBP agrees to provide SMC notice of any such assignment. Any attempted assignment or transfer in contravention of this provision will be null and void. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their successors and permitted assigns. 12.9 Change of Control. Notwithstanding Section 13.8 above, a Change of Control shall not be considered an assignment or transfer of any rights or obligations of WBP hereunder. In the event of a Change of Control, at the option of WBP or any successor to WBP, this Agreement may be terminated upon notice to SMC. 12.10 Entire Agreement. This Agreement (including the Exhibits and Schedules to this Agreement which are, by this reference, incorporated herein), constitutes the entire agreement and understanding of the parties with respect to the subject matter of this Agreement and supersedes all prior agreements and understandings of the parties with respect to the subject matter of this Agreement. 17 12.11 Counterparts. This Agreement may be executed in two or more counterparts, all of which will be considered one and the same agreement and each of which will be deemed an original. 12.12 Severability. If any one or more of the provisions of this Agreement is held to be invalid, illegal or unenforceable, the validity, legality or enforceability of the remaining provisions of this Agreement will not be affected thereby, and Sellers and Buyer will use their reasonable efforts to substitute one or more valid, legal and enforceable provisions which insofar as practicable implement the purposes and intent hereof. To the extent permitted by applicable law, each party waives any provision of law which renders any provision of this Agreement invalid, illegal, or unenforceable in any respect. 12.13 Beneficiaries. This Agreement shall not confer upon any other Person any rights or remedies hereunder. 12.14 Expenses. Each of the parties hereto shall pay its own fees and expenses (including the fees of any attorneys, accountants, investment bankers or others engaged by such party) in connection with this Agreement and the transactions contemplated hereby whether or not the transactions contemplated hereby are consummated. 12.15 Further Assurances. The parties agree (a) to furnish upon request to each other such further information, (b) to execute and deliver to each other such other documents, and (c) to do such other acts and all things as the other party may reasonably request for the purpose of carrying out the intent of this Agreement and the documents referred to this Agreement. 12.16 No Partnership. The parties hereby acknowledge that it is not their intention under this Agreement to create between themselves a partnership, joint venture, tenancy-in-common, joint tenancy, co-ownership, franchise, or agency relationship. Accordingly, notwithstanding any expressions or provisions contained herein, nothing in this Agreement shall be construed or deemed to create, or to express an intent to create, a partnership, joint venture, tenancy-in-common, joint tenancy, co-ownership, franchise, or agency relationship of any kind or nature whatsoever between the parties hereto. 12.17 No Presumption. The parties have participated jointly in the negotiation and drafting of this Agreement. In the event of any ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by both parties, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Agreement. 18 IN WITNESS WHEREOF, the parties have caused this Sale Agreement to be executed in their respective corporate names by their respective officers thereunto duly authorized. CPP Belwin, Inc., a Delaware corporation By: /s/ Fred S. Anton ----------------- Name: FRED S. ANTON --------------- Title: CEO --------------- The Singing Machine Inc., a Delaware corporation By: /s/ Yi Ping Chan ---------------- Name: Yi Ping Chan Title: Interim CEO and COO 19 EXHIBIT A --------- LOGO ---- (To be supplied by SMC) 20 EXHIBIT B --------- MARK ---- (To be supplied by SMC) 21 EXHIBIT C --------- DISTRIBUTION FEE ---------------- The Distribution Fee payable to WBP for all WBP Accounts shall be * (*%) percent of Net Sales Receipts. The Distribution Fee for Non-WBP Accounts shall be * (*%) percent of Net Sales Receipts (the "SMC Serviced Account Distribution Fee"). SMC Services Account Distribution Fee shall be applicable to all shipments of products of any type or description made on or after the Effective Date regardless of when the purchase order was entered. ___________ * The confidential portion has been so omitted pursuant to a request for confidential treatment and has been filed separately with the Securities and Exchange Commission. 22 EXHIBIT D --------- NON-WBP ACCOUNTS ---------------- The following are Non-WBP Accounts. * ___________ * The confidential portion has been so omitted pursuant to a request for confidential treatment and has been filed separately with the Securities and Exchange Commission. 23 EX-31.1 10 certification-311.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATIONS I, Yi Ping Chan, certify that: 1. I have reviewed this Form 10-Q of The Singing Machine Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Yi Ping Chan ------------------------------------------------- Yi Ping Chan Chief Executive Office and Chief Operating Officer (Principal Executive Officer) Date: February 17, 2004 EX-31.2 11 certification-312.txt CERTIFICATION EXHIBIT 31.2 CERTIFICATIONS I, April Green, certify that: 1. I have reviewed this Form 10-Q of The Singing Machine Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ April Green - ----------------------------- April Green Chief Financial Officer (Principal Financial Officer) Date: February 17, 2004 EX-32.1 12 certification-321.txt CERTIFICATION EXHIBIT 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of The Singing Machine Company, Inc. (the "Company") on Form 10-Q for the period ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Yi Ping Chan, Chief Executive Officer and Chief Operating Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: February 17, 2004 /s/ Yi Ping Chan ------------------------------- Yi Ping Chan Chief Executive Officer and Chief Operating Officer (Principal Executive Officer) EX-32.2 13 certification-322.txt CERTIFICATION EXHIBIT 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of The Singing Machine Company, Inc. (the "Company") on Form 10-Q for the period ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, April J Green, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: February 17, 2004 /s/ April J Green ------------------------------- April J Green Chief Financial Officer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----