SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the Quarterly Period Ended September 30, 2004
Or
| | Transition Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the Transition Period from _________ to ___________
Commission File Number: 333-43770
SLS INTERNATIONAL, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 52-2258371
(State of Incorporation) (IRS Employer Identification No.)
3119 South Scenic
Springfield, Missouri 65807
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (417) 883-4549
N/A
-------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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. N/A
Yes |_| No |_|
On November 4, 2004, 40,046,080 shares of SLS International, Inc.
common stock were outstanding.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [x]
SLS INTERNATIONAL, INC.
INDEX
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements
Condensed Consolidated Balance Sheet 1
Condensed Consolidated Statements of Operations 2
Condensed Consolidated Statement of Cash Flows 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Controls and Procedures 16
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 18
Item 6. Exhibits and Reports on Form 8-K 18
Signature 19
PART I- FINANCIAL INFORMATION
Item 1. Financial Statements
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, December 31,
2004 2003
------------ ------------
(unaudited) (audited)
Assets
Current assets:
Cash $ 2,079,599 $ 1,482,786
Accounts receivable, less allowance for doubtful accounts of
$45,000 for September 30, 2004 and December 31, 2003 364,952 277,665
Inventory 1,706,427 590,297
Deposits - inventory 321,016 --
Deposits - Merger 100,000 --
Prepaid expenses and other current assets 115,183 6,850
------------ ------------
Total current assets 4,687,177 2,357,598
------------ ------------
Fixed assets:
Vehicles 78,949 73,376
Equipment 237,847 159,212
Leasehold improvements 245,681 175,621
------------ ------------
562,477 408,209
Less accumulated depreciation 122,390 88,016
------------ ------------
Net fixed assets 440,087 320,193
------------ ------------
$ 5,127,264 $ 2,677,791
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Current maturities of long-term debt and notes payable $ 4,101 $ 28,946
Accounts payable 459,053 357,287
Accrued liabilities 27,985 26,138
------------ ------------
Total current liabilities 491,139 412,371
------------ ------------
Notes payable, less current maturities 37,450 15,931
------------ ------------
Commitments and contingencies:
Shareholders' equity:
Preferred stock, Series A, $.001 par, 2,000,000 shares
authorized; 766,873 issued as of September 30, 2004 and
1,545,300 issued as of December 31, 2003 767 1,545
Preferred stock, Series B, $.001 par, 1,000,000 shares
authorized; 255,600 shares issued as of September 30, 2004
and no shares issued as of December 31, 2003 256 --
Discount on preferred stock (223,816) (1,886,576)
Contributed capital - preferred 10,295,177 7,411,585
Common stock, $.001 par; 75,000,000 shares authorized;
36,912,580 shares and 28,230,180 shares issued at
September 30, 2004 and December 31, 2003 36,914 28,231
Common stock not issued but owed to buyers; no shares and
183,000 shares at September 30, 2004 and December 31, 2003 -- 183
Contributed capital - common 16,501,443 8,319,286
Unamortized cost of stock issued for services (571,192) (781,204)
Retained deficit (21,440,875) (10,843,561)
------------ ------------
Total shareholders' equity 4,598,675 2,249,489
------------ ------------
$ 5,127,264 $ 2,677,791
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements
1
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For The Nine Months
Ended September 30,
------------------------------
2004 2003
------------ ------------
(unaudited)
Revenue $ 1,502,559 $ 650,044
Cost of sales 814,230 324,362
------------ ------------
Gross profit 688,328 325,682
General and administrative expenses 7,438,310 3,232,220
------------ ------------
Loss from operations (6,749,980) (2,906,538)
Other income (expense):
Interest expense (1,469) (218)
Interest and miscellaneous, net 28,198 99,272
------------ ------------
26,729 99,054
------------ ------------
Loss before income tax (6,723,252) (2,807,484)
Income tax provision -- --
------------ ------------
Net loss (6,723,252) (2,807,484)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock (3,874,061) (1,089,927)
------------ ------------
Net loss availiable to common shareholders $(10,597,313) $ (3,897,411)
============ ============
Basic and diluted earnings per share $ (0.34) $ (0.16)
============ ============
Weighted average shares outstanding 30,995,380 24,720,928
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For The Three Months
Ended September 30,
------------------------------
2004 2003
------------ ------------
(unaudited)
Revenue $ 576,336 $ 268,023
Cost of sales 333,048 168,801
------------ ------------
Gross profit 243,288 99,222
General and administrative expenses 1,569,381 2,123,685
------------ ------------
Loss from operations (1,326,093) (2,024,463)
Other income (expense):
Interest expense (451) 14,360
Interest and miscellaneous, net 8,495 58,334
------------ ------------
8,044 72,694
------------ ------------
Loss before income tax (1,318,048) (1,951,769)
Income tax provision -- --
------------ ------------
Net loss (1,318,048) (1,951,769)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock (1,164,676) (877,369)
------------ ------------
Net loss availiable to common shareholders $ (2,482,724) $ (2,829,138)
============ ============
Basic and diluted earnings per share $ (0.07) $ (0.11)
============ ============
Weighted average shares outstanding 34,851,513 26,391,728
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For The Nine Months
Ended September 30,
----------------------------
2004 2003
----------- -----------
(unaudited)
Operating activities:
Net loss $(6,723,252) $(2,807,484)
Adjustments to reconcile net income to cash flows
from operating activities:
Depreciation and amortization 38,400 11,618
Amortization of cost of stock issued for services 210,012 779,103
Expense of stock options granted for services 2,719,977 552,739
Gain on disposal of fixed assets (3,000) --
Goodwill impairment charge 1,148,502 --
Change in assets and liabilities-
Accounts receivable, less allowance for doubtful accounts (87,287) 25,718
Inventory (1,116,130) (337,713)
Deposits - Inventory (321,016) --
Prepaid expenses and other current assets (108,333) 4,619
Accounts payable 101,766 (63,340)
Due to shareholders -- (20,519)
Accrued liabilities 1,845 (145,119)
----------- -----------
Cash used in operating activities (4,138,518) (2,000,378)
----------- -----------
Investing activities:
Proceeds from disposal of fixed assets 3,000 --
Additions of fixed assets (158,294) (46,771)
----------- -----------
Cash used in investing activities (155,294) (46,771)
----------- -----------
Financing activities:
Sale of stock, net of expenses 5,291,950 4,480,750
Acquisition of subsidiary (400,000) --
Borrowings of notes payable -- 102,000
Repayments of notes payable (1,326) (491,560)
----------- -----------
Cash provided by financing activities 4,890,624 4,091,190
----------- -----------
Increase in cash 596,812 2,044,041
Cash, beginning of period 1,482,786 4,240
----------- -----------
Cash, end of period $ 2,079,598 $ 2,048,281
=========== ===========
Supplemental cash flow information:
Interest paid $ -- $ 43,345
Income taxes paid (refunded) -- --
Noncash investing activities:
Stock issued and options granted for services $ 2,719,977 $ 822,605
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SLS INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
at September 30, 2004 have been prepared in accordance with U.S.
generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB and reflect all
adjustments which, in the opinion of management, are necessary for a
fair presentation of financial position as of September 30, 2004 and
results of operations and cash flows for the nine months ended
September 30, 2004. All such adjustments are of a normal recurring
nature. The results of operations for the interim period are not
necessarily indicative of the results expected for a full year. Certain
amounts in the 2003 financial statements have been reclassified to
conform to the 2004 presentations. The statements should be read in
conjunction with the financial statements and footnotes thereto
included in our Form 10-KSB for the year ended December 31, 2003.
NOTE 2 - COMMITMENTS AND CONTINGENCIES
Going Concern
The accompanying unaudited condensed consolidated financial statements
at September 30, 2004 have been prepared in conformity with U.S.
generally accepted accounting principles which contemplate our
continuance as a going concern. We have suffered losses from operations
during the nine months ended September 30, 2004 and the years ended
December 31, 2003, 2002, and 2001. Our cash position may be inadequate
to pay all of the costs associated with establishing a market for sales
of our loudspeakers. We intend to use borrowings and security sales to
improve our cash position, however no assurance can be given that debt
or equity financing , if and when required, will be available. The
unaudited condensed consolidated financial statements do not include
any adjustments relating to the recoverability and classification of
recorded assets and classification of liabilities that might be
necessary if we are unable to continue in existence.
NOTE 3 - NOTES PAYABLE
At December 31, 2003 and September 30, 2004, there is a note payable to
an individual in the amount of $25,000. This note bears interest of 7%
and matures in September of 2005. There is also a note payable for
equipment in the amount of $19,877 and $16,936 as of December 31, 2003
and September 30, 2004, respectively. This note bears interest of 5.16%
and matures in September of 2008. Interest expense for the year ended
December 31, 2003 and the nine months ended September 30, 2004 was
$39,170 and $1,469, respectively.
5
NOTE 4 - STOCK TRANSACTIONS
In the nine months ended September 30, 2004, 183,000 shares shown at
December 31, 2003 as "stock not issued but owed to buyers" were issued.
In July 2003, we entered into an endorsement agreement with the
recording artist Sting through Steerpike Ltd. The agreement grants
1,100,000 options in exchange for future endorsements of our products.
Each option is convertible into one share of common stock at a strike
price of $0.25 and is exercisable for a period of five years. Expense
associated with the options will be recorded over the two-year period
of the agreement beginning July 31, 2003 and ending July 31, 2005.
Expense will be recorded at fair market value, using the Black-Scholes
pricing model, on an accelerated method, thereby recording a larger
portion of the costs in the earlier months of the two year period.
Consulting expense relating to this agreement was $922,897 for the nine
months ended September 30, 2004. As of September 30, 2004 approximately
990,000 of the 1,100,000 options have been earned and expensed.
Expenses to be recorded in the remaining quarters of the year ended
December 31, 2004 and 2005 are unknown at this time because they are
partly based on the market price over those periods.
In November 2003, an agreement was signed with William Fischbach for
consulting services to be performed November 10, 2003 to November 10,
2006. As compensation for the consulting services we issued 400,000
shares of common stock on November 11, 2003. Using the market value of
the date the agreement was signed, the shares were valued at $780,000
and recorded as a debit in the equity section of the balance sheet as
unamortized cost of stock issued for services. The cost is amortized
over the three-year period of the agreement. Consulting expense
relating to this agreement was $195,000 for the nine months ended
September 30, 2004. On September 30, 2004 there was $548,671 remaining
in unamortized stock issued for services for this agreement. The
agreement also calls for the issuance of options, not to exceed an
aggregate of 800,000, to Mr. Fischbach on January 1 or each year based
on the previous year's performance levels. No options were issued on
January 1, 2004 under this agreement. As of September 30, 2004, Mr.
Fischbach had earned no options based on his performance in the nine
months ended September 30, 2004. The agreement also calls for
additional compensation to Mr. Fischbach in the form of a cash fee of
2% of the dollar amount of value provided in a merger, acquisition, or
other transaction resulting directly from Mr. Fischbach's services. As
of September 30, 2004, Mr. Fischbach had earned no cash fee based on
the value provided to us in the nine months ended September 30, 2004.
6
In June 2004, we entered into an endorsement / consulting agreement
with the recording artist Quincy Jones through Global Drumz, Inc. We
made a cash payment of $250,000 to Global Drumz, Inc. on the date of
the agreement. Pursuant to the agreement, we granted options to
purchase 1,000,000 shares of our common stock in exchange for future
endorsements of our products and various other consulting services. The
option has a strike price of $2.00 and is exercisable for a period of
five years. We also issued a warrant, with a five-year term, for
1,000,000 additional shares of common stock at an exercise price of
$7.00 per share. In the event that the closing price of our common
stock does not exceed $7.00 per share for a period of five consecutive
business days during the period commencing on June 2, 2004 and ending
on the expiration of the term of the options, we shall pay additional
compensation of $250,000. Expense associated with the options will be
recorded over the one-year vesting period of the agreement beginning
June 2, 2004 and ending June 2, 2005. The options and warrants
automatically vest as to 50% of the stock covered thereby upon the
effective date of the agreement and as to one-sixth of the remaining
stock covered thereby monthly thereafter. Expense will be recorded at
fair market value, using the Black-Scholes pricing model, on an
accelerated method, thereby recording a larger portion of the costs in
the earlier months of the one-year period. Consulting expense relating
to this agreement was $1,637,444 for the nine months ended September
30, 2004. As of September 30, 2004 approximately 956,000 of the
1,000,000 options have been earned and expensed. Expenses to be
recorded in the remaining quarters of the year ended December 31, 2004
and 2005 are unknown at this time because they are partly based on the
market price over those periods.
In the nine months ended September 30, 2004, 322,400 Class A warrants
were exercised for 322,400 shares of common stock for a total of
$161,200. The remaining Class A warrants expired in the third quarter
of 2004.
In the nine months ended September 30, 2004, 6,000 Class B warrants
were exercised for 6,000 shares of common stock for a total of $18,000.
The remaining Class B warrants expired in the third quarter of 2004.
In the nine months ended September 30, 2004, we commenced an offering
of Series B preferred stock and sold 272,100 shares of preferred stock,
series B, for $5,102,250, net of expenses. This preferred stock
contains a beneficial conversion feature. The feature allows the holder
to convert the preferred to 10 shares of common stock six months after
buying the shares. Attached to each preferred share is ten Class C
warrants. Each Class C warFrant has a term of three years and provides
the right to purchase one share of our common stock at $7.00 per share.
If the average closing market price for our common stock is equal to or
greater than $10.50 for a period of 30 days, then such warrants are
capable of being repurchased with a 30-day notice, at a price of $.001
per warrant. A discount on preferred shares of $2,211,300 relating to
the beneficial conversion feature was recorded and will be amortized
over the six month period beginning with the date the shareholders
purchased their shares.
7
In the nine months ended September 30, 2004, $3,874,061 of the
unamortized discount on preferred shares, series A and B, has been
amortized to retained earnings. At September 30, 2004, the unamortized
discount on preferred shares, series A and B, was $223,816.
In the nine months ended September 30, 2004, 780,600 shares of
preferred stock, series A, were converted to 7,806,000 shares of common
stock.
In the nine months ended September 30, 2004, 16,500 shares of preferred
stock, series B, were converted to 165,000 shares of common stock.
In the nine months ended September 30, 2004, 130,000 options were
granted for consulting services. The options have a strike price equal
to the market price on their grant date, ranging from $1.45 to $3.10.
Using the Black-Scholes pricing model, the options were valued at
$188,100 and recorded as consulting expense.
NOTE 5 - UNAMORTIZED COST OF STOCK ISSUED FOR SERVICES
During the years ended December 31, 2003 and 2002, we issued or agreed
to issue 3,215,452 shares of common stock, granted 500,000 options for
common stock, and 100,000 options for preferred stock, series A, as
part of consulting agreements. The value of stock issued and options
granted totaled $913,036 and $1,599,213 for the years ended December
31, 2003 and 2002. This cost is recorded as a debit in the equity
section of the balance sheet as unamortized cost of stock issued for
services. The balance is amortized into consulting expense over the
lives of the various consulting agreements. For the nine months ended
September 30, 2004, $210,012 was amortized into consulting expense.
Unamortized cost of stock issued for services was $571,192 as of
September 30, 2004.
NOTE 6 - CONSULTING, PROMOTIONAL AND INVESTOR RELATIONS SERVICES
Consulting and investor relation services expense was $4,065,929 for
the nine months ended September 30, 2004. Consulting and investor
relation expenses incurred are detailed below:
Consulting expenses relating to stock issued for consulting agreements
was $210,012 (See Note 5) in the nine months ended September 30, 2004.
Consulting expenses relating to options issued for services was
$2,943,441 (See Note 4) for the nine months ended September 30, 2004.
In the nine months ended September 30, 2004, we settled a lawsuit
brought by a former consultant. The former consultant returned 100,000
shares of common stock for cancellation in exchange for $250,000 paid
in March and April of 2004. This settlement was expensed as consulting
expense in the nine months ended September 30, 2004.
8
Various individuals and corporations performed consulting services and
investor relation services for us during the nine months ended
September 30, 2004 and were paid $662,476.
NOTE 7 - ACQUISITIONS
We entered into an agreement with the owners of SA Sound B.V. and SA
Sound USA, Inc. giving us an option to acquire said companies at any
time prior to February 27, 2004 for a purchase price of 370,000 euros,
approximately $467,000. We paid 50,000 euros, approximately $63,000 for
this option. The option agreement entitled us to a refund of the option
price if the due diligence performed disclosed any material adverse
facts. After completion of the due diligence, we determined not to
exercise the option to purchase and we have asserted a right to a
refund of the option price. The sellers have challenged the return of
the option fee. $109,165 has been recorded as acquisitions expense in
the nine months ended September 30, 2004 in relation to the option
price and related legal fees for this acquisition attempt.
On March 12, 2004, we acquired Evenstar, Inc., by a merger with and
into our newly formed, wholly owned subsidiary, Evenstar Mergersub,
Inc. (Mergersub). In consideration for Evenstar, Inc., we paid $300,000
in cash and issued 300,000 shares of common stock to the stockholders
of Evenstar, Inc. Using the market value of the common stock on the day
of the acquisition and the amount of cash given, the total acquisition
price was $1,161,000. An asset was recorded on these financial
statements in the amount of $12,498 for a patent acquired in the
merger. Evenstar had no other assets or liabilities, therefore, the
remaining $1,148,502 was recorded as goodwill on these financial
statements.
On March 12, 2004 we performed an impairment test on the goodwill
recorded in the merger with Evenstar, Inc. We determined that the
goodwill was impaired and an impairment charge of $1,148,502 was
recorded. This charge is shown on the condensed consolidated statement
of operations in the general and administrative expenses.
On April 2, 2004, we entered into a strategic alliance agreement with
Bohlender-Graebener Corporation ( BG ). We paid BG $100,000 on April 2,
2004 for this agreement. The agreement term is for one year and can be
extended for any length of time after the first year by mutual
agreement between BG and us. During the term of the agreement BG is
required to work with us, diligently and in good faith, to consummate a
merger. During the first six months of the agreement, BG is not
permitted to solicit any offer to purchase BG, and is not permitted to
respond to any unsolicited offer. In addition to the above, BG will
9
grant us exclusive sales and marketing rights to certain BG products
and we have committed to purchase certain minimum quantities of various
BG products at agreed upon prices. Those purchase commitments are as
follows; $175,000 in the third quarter of 2004, $175,000 in the fourth
quarter of 2004, and $200,000 in the first quarter of 2005. In the
event no agreement to merge the Companies on mutually acceptable terms
can be reached before termination of the agreement, BG will be entitled
to keep the $100,000 cash payment as consideration for its performance
under the agreement. In October of 2004, we agreed to pay BG an
additional $100,000 to extend certain terms of the agreement by six
months (See Subsequent Events footnote).
NOTE 8 - EMPLOYEE STOCK OPTIONS
During the second quarter of 2003, the Company adopted the fair value
recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, effective as of the beginning of the year.
There were no previous granting of options to employees prior to the
second quarter of 2003 and therefore this adoption has no effect on
previous financial statements. No method of reporting the change in
accounting principle has been used.
The board of directors approved 75,000 options for directors in the
nine months ended September 30, 2004. The options have a strike price
of $2.21, expire in ten years, and vest immediately. 25,000 options
were approved for each of three board members for their roles as
directors of the company. Using the Black-Scholes pricing model, in
accordance with the fair value recognition provision of FASB Statement
No. 123, the options were valued at $87,786 and recorded as
compensation expense in the nine months ended September 30, 2004.
NOTE 9 - SUBSEQUENT EVENTS
From October 1 to November 4, 2004, 284,000 shares of preferred stock,
series A, were converted to 2,840,000 shares of common stock.
From October 1 to November 4, 2004, 25,050 shares of preferred stock,
series B, were converted to 250,500 shares of common stock.
In October of 2004, we agreed to pay Bohlender-Graebener Corporation
(BG) an additional $100,000 to extend certain terms of the strategic
alliance agreement discussed in Note 7 above. In addition to the
$100,000 we also agreed to purchase 500 units of product. In return BG
agreed to extend exclusive merger negotiations by six months, provide
exclusivity of one of its products to the Company, and provide $100,000
in discounts against future product purchases.
10
We intend to make a rescission offer to all warrant holders who
exercised warrants during the period from May 1, 2002 through May 10,
2004. We are doing this because the registration statement filed with
the US Securities and Exchange Commission to register the common stock
issuable upon exercise of the warrants may not have been "current"
because it had not been amended to include our most recent audited
financial statements. The former warrant holders will be entitled to
rescind their purchases. Once made, the rescission offer is open for 30
days. The rescission offer would require us to purchase warrants back
at their original exercise price, $.50 for the Class A warrants and
$3.00 for the Class B warrants, at each warrant holder's option. The
current market price is well above the $.50 exercise price of the Class
A warrants so no adjustment to the financial statements for the year
ended December 31, 2003 and the nine months ended September 30, 2004
have been made for the rescission offer. The current market price is
below the $3.00 exercise price of the Class B warrants. 22,600 Class B
warrants were exercised during the rescission offer period, so the
rescission offer would not have a material liability effect on these
financial statements. Therefore, no adjustment has been made. If all
warrant holders accepted the rescission offer, we would be required to
pay $1,340,700 plus interest, which amount would be reduced to the
extent of the proceeds from any sales of the underlying common stock by
the former warrant holders. Acceptance of the rescission offer by all
former warrant holders could have a material adverse effect of these
financial statements.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
We manufacture premium-quality loudspeakers and sell them through our
dealer networks. The speakers use our proprietary ribbon-driver technology and
are generally recognized in the industry as high-quality systems. We sell a
Professional Line of loudspeakers; a Commercial Line of loudspeakers; Home
Theatre systems; a line for recording and broadcast studios; a line for
contractor installations and touring companies; a line of in-wall, in-ceiling
and outdoor loudspeakers; and a line of Cinema speakers.
From the early 1970's through 1999 we derived substantially all of our
revenue from marketing, renting, selling and installing sound and lighting
systems under the name Sound and Lighting Specialist Inc. In 1999, due to the
favorable customer acceptance of our new custom-designed loudspeaker systems, we
ceased these historical operations and began focusing all efforts towards
becoming a loudspeaker manufacturer and selling to dealers and contractors on a
wholesale basis. As a result, we have been essentially in a development stage,
as we are bringing to market products that we introduced in 2000 and 2001 and
designing and bringing to market additional products.
In 2000, we asked dealers and distributors to sell our Professional
Line of products. These dealers and distributors started to form our current
network of approximately 50 dealers and 7 foreign distributors and we began
shipping to them. However, most of the Professional Line required new ribbon
drivers that we completed and implemented into the product line in early 2001.
In 2000, we introduced our Home Theatre systems, and sales for those
systems began immediately. From September through December 2000, we added 20 new
Home Theatre dealers in the US and began marketing efforts to establish
distributors and dealers outside the US.
In 2001, we introduced a Commercial Line of loudspeakers that use our
PRD500 Ribbon Driver and, in 2001, we finished the development of our PRD1000
Ribbon Driver and began implementing it into our Professional Line. Our PRD
drivers, which we manufacture, upgraded the previous drivers that we purchased
from third-party manufacturers; and our cost is approximately one-sixth of the
price that we had been paying for the previous drivers.
The information in this section should be read together with the
financial statements, the accompanying notes to the financial statements and
other sections included in this report.
12
RESULTS OF OPERATIONS
Quarter ended September 30, 2004 as compared to the quarter ended
September 30, 2003. For the quarter ended September 30, 2004, revenue increased
to $576,336 from $268,023 in the 2003 period, a 115% increase, resulting
primarily from the positive results of a marketing program we started in January
2004 and our increased production capabilities resulting from a facilities
expansion completed in December 2003. Our gross profit percentage increased to
approximately 42% in the 2004 period from approximately 37% in the 2003 period,
primarily as a result of the introduction of new proprietary products,
manufacturing efficiencies in our new facility, and reduced materials cost by
purchasing in volume.
General and administrative expenses for the 2004 third quarter
decreased to $1,569,381 ($373,412 of which were non-cash charges) from
$2,123,685 ($865,172 of which were non-cash charges) in the 2003 third quarter,
a decrease of $554,304. The decrease resulted primarily from lower cash and
non-cash charges for consulting and investor relation services. The following
table compares categories of our general and administrative expenses in the
third quarter of 2004 to the third quarter of 2003:
Three Months Ended Three Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
Non-cash G&A expense items:
--------------------------
Charges for stock and options issued for
consulting and investor relation services $ 373,412 $ 865,172
---------- ----------
Total non-cash G&A expenses 373,412 865,172
Cash G&A expense items:
-----------------------
Consulting and investor relation services 574,481 823,583
Acquisitions - SA Sound -- --
Impairment charge - Evenstar, Inc. -- --
Other cash G&A expenses 621,488 434,930
---------- ----------
Total cash G&A expenses 1,195,969 1,258,513
---------- ----------
Total G&A expenses $1,569,381 $2,123,685
========== ==========
Due to the decrease in general and administrative expenses, as well as
the revenue increase and gross profit increase, our net loss decreased to
$1,318,048 in the third quarter of 2004 as compared to a net loss of $1,951,769
in the comparable quarter of 2003.
Other income (expense) decreased to net other income of $8,044 in the
2004 third quarter as compared to net other income of $72,694 in the 2003 third
quarter, primarily due to other income recognized in the 2003 period from the
write-off of accounts payable.
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Nine months ended September 30, 2004 as compared to the nine months
ended September 30, 2003. For the first nine months of 2004, revenue increased
to $1,502,559 from $650,044 in the first nine months of 2003, a 131% increase,
resulting primarily from the positive results of a marketing program we started
in January 2004 and our increased production capabilities resulting from a
facilities expansion completed in December 2003. Our gross profit percentage
decreased to approximately 46% in the 2004 period from approximately 50% in the
2003 period, primarily as a result of new personnel that were in training and
sales of several large systems at a high promotional discount. Due primarily to
the increase in general and administrative expenses, as discussed below, and
partially offset by the revenue increase, our net loss increased to $6,723,252
in the first nine months of 2004 as compared to a net loss of $2,807,484 in the
first nine months of 2003.
General and administrative expenses for the first nine months of 2004
increased to $7,438,310 ($4,089,741 of which were non-cash charges) from
$3,232,220 ($1,131,842 of which were non-cash charges) in the 2003 period,
primarily as a result of consulting and investor relation services expenses of
$4,065,929 in the 2004 period ($3,153,453 of which were non-cash charges,
including charges related to a promotional agreement with Quincy Jones),
compared to $2,199,782 in the 2003 period. In addition, we incurred increased
expenses for accounting, information technology, internal control upgrades and
facilities expansion. The following table compares categories of our general and
administrative expenses in the first nine months of 2004 to the first nine
months of 2003:
Nine Months Ended Nine Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
Non-cash G&A expense items:
--------------------------
Charges for stock and options issued for
consulting and investor relation services $3,153,453 $1,108,708
Charges for options issued to directors and
officers 87,786 23,134
Impairment charge - Evenstar, Inc. 848,502 --
---------- ----------
Total non-cash G&A expenses 4,089,741 1,131,842
Cash G&A expense items:
Consulting and investor relation services 912,476 1,091,074
Acquisitions - SA Sound 109,165 --
Impairment charge - Evenstar, Inc. 300,000 --
Other cash G&A expenses 2,026,928 1,009,304
---------- ----------
Total cash G&A expenses 3,348,569 2,100,378
---------- ----------
Total G&A expenses $7,438,310 $3,232,220
========== ==========
Other income decreased to net other income of $26,729 in the 2004
period as compared to net other income of $99,272 in the 2003 period, primarily
due to other income recognized in the 2003 period from the write-off of accounts
payable.
FINANCIAL CONDITION
On September 30, 2004, our current assets exceeded current liabilities
by $4,196,038, compared to an excess of $1,945,227, on December 31, 2003. Total
assets exceeded total liabilities by $4,598,675, compared to an excess of total
assets over total liabilities of $2,249,489 on December 31, 2003. The increased
working capital was primarily due to the sale of 272,100 shares of Series B
Preferred Stock for net proceeds of $5,102,250 in the first nine months of 2004.
In addition to funding operations, the proceeds from such sales of stock allowed
us to increase inventory by $1,116,130, increase cash by $596,813, increase net
fixed assets by $119,894, increase accounts receivable by $87,287, and pay
deposits totaling $421,016 for inventory and a potential merger. On September
30, 2004, we had a backlog of orders of approximately $200,000.
We have experienced operating losses and negative cash flows from
operating activities in all recent years. The losses have been incurred due to
the development time and costs in bringing our products through engineering and
to the marketplace. The report of our accountants contains an explanatory
paragraph indicating that these factors raise doubt about our ability to
continue as a going concern.
In order to continue operations, we have been dependent on raising
additional funds, and as discussed above, we commenced a new private placement
of Series B Preferred Stock in the first quarter of 2004 to raise capital.
Through September 30, 2004, we sold 272,100 shares of Series B Preferred Stock
for net proceeds of $5,102,250. Each share is convertible into ten shares of our
common stock six months after purchase. Prior to conversion, the shares have no
voting rights. Attached to each preferred share are ten of our class C warrants.
Each class C warrant has a term of three years and provides the right to
purchase one share of our common stock at $7.00 per share. The class C warrants
are immediately exercisable and detachable from the preferred share. If the
average closing market price for our common stock is equal to or greater than
$10.50 per share for a period of 30 days, then we are entitled to repurchase
such warrants, with 30 days notice, at a price of $.001 per warrant.
In the first nine months of 2004, we also received an aggregate of
$179,200 in cash in payment of the exercise price for the exercise of
outstanding warrants. The shares of common stock were issued pursuant to a
registration statement declared effective by the U.S. Securities and Exchange
Commission in 2001, registration statement number 333-43770. However, since May
1, 2002, such registration statement may not have been "current" because the
registration statement had not been amended to include our most recent audited
financial statements. As a result, the former warrant holders may be entitled to
demand a rescission of their previous exercises of common stock. We intend to
make a rescission offer to all warrant holders who exercised warrants during the
period from May 1, 2002 through May 10, 2004 (the date that an amendment to the
registration statement was declared effective, making the registration statement
"current"). Once made, the rescission offer is expected to remain open for 30
days.
14
The rescission offer would require us to repurchase the shares of common
stock issued upon exercise of the warrants at their original exercise price,
$.50 for the Class A warrants and $3.00 for the Class B warrants, at each
warrant holder's option. If all warrant holders accepted the rescission offer,
we would be required to pay $1,340,700 plus interest, which amount would be
reduced to the extent of the proceeds from any sales of the underlying common
stock by the former warrant holders. Acceptance of the rescission offer by all
former warrant holders could have a material adverse effect. The current market
price is over the $.50 exercise price of the Class A warrants, and if that
remains true, we would expect no former holders of Class A Warrants to accept
the rescission offer. The current market price is below the $3.00 exercise price
of the Class B warrants. Only 22,600 Class B warrants were exercised during the
rescission offer period, making our potential rescission liability to the former
Class B warrant holders equal to $67,800 plus interest, which amount would be
reduced to the extent of any sales of the underlying common stock by the former
warrant holders.
In the 2004 first quarter, we entered into an agreement with the owners
of SA Sound B.V. and SA Sound USA, Inc. giving us an option to acquire said
companies at any time prior to February 27, 2004 for a purchase price of 370,000
euros, or approximately $467,000. We paid approximately $63,000 for this option.
The option agreement entitled us to a refund of the option price if the due
diligence performed disclosed any material adverse facts. After completion of
the due diligence, we determined not to exercise the option to purchase and we
have asserted a right to a refund of the option price. The sellers have
challenged the return of the option fee.
On March 12, 2004, we acquired Evenstar, Inc., by a merger with and
into our newly formed, wholly owned subsidiary, Evenstar Mergersub, Inc.
Evenstar is the owner of one issued patent and a second patent that was issued
in September 2004. The patents are for Evenstar's digital amplification
technology, which provides for substantially reduced production costs compared
to amplifiers of comparable quality. In consideration for Evenstar, we paid
$300,000 in cash and issued 300,000 shares of common stock to the stockholders
of Evenstar. In connection with the acquisition, we hired the former president
of Evenstar as the head of our new electronics division, with responsibility for
designing and developing new electronics products. Our ability to integrate
Evenstar into our operations will have a substantial effect on our future
performance.
On April 2, 2004, we entered into a strategic alliance agreement with
Bohlender-Graebener Corporation ("BG"). We paid BG $100,000 on April 2, 2004 for
this agreement. The agreement term is for one year and can be extended for any
length of time after the first year by mutual agreement between BG and us.
During the term of the agreement BG is required to work with us, diligently and
in good faith, to consummate a merger. During the first six months of the
agreement, BG is not permitted to solicit any offer to purchase BG, and is not
permitted to respond to any unsolicited offer. In addition to the above, BG has
granted us exclusive sales and marketing rights to certain BG products and we
have committed to purchase certain minimum quantities of various BG products at
agreed-upon prices. Those purchase commitments are as follows; $175,000 in the
third quarter of 2004, $175,000 in the fourth quarter of 2004, and $200,000 in
the first quarter of 2005. In the event no agreement to merge the companies on
mutually acceptable terms can be reached before termination of the agreement, BG
will be entitled to keep the $100,000 cash payment as consideration for its
performance under the agreement. In October 2004, we agreed to pay BG an
additional $100,000 to extend certain terms of the strategic alliance agreement.
In addition to the $100,000 payment, we also agreed to purchase 500 units of
product. In return BG agreed to extend exclusive merger negotiations by six
months, provide exclusivity for one of its products to us, and provide $100,000
in discounts against future product purchases.
15
There is intense competition in the speaker business with other
companies that are much larger and national in scope and have greater financial
resources than we have. We will require additional capital to continue our
growth in the wholesale speaker market. We are relying upon our ability to
obtain the necessary financing through the issuance of equity and upon our
relationships with our lenders to sustain our viability. On September 30, 2004,
we had $2,079,599 in cash. We believe this cash is more than sufficient to fund
our planned operations for at least the next twelve months.
In the past, we have been able to privately borrow money from
individuals by the issuance of notes, and we have been able to raise money by
the issuance of preferred stock and common stock. We intend to continue to do so
as needed. However, we cannot be certain that we will continue to be able to
successfully obtain such financing. If we fail to do so, we may be unable to
continue as a viable business.
FORWARD-LOOKING INFORMATION
This report, as well as our other reports filed with the SEC and our
press releases and other communications, contain forward-looking statements made
pursuant to the safe harbor provisions of the Securities Litigation Reform Act
of 1995. Forward-looking statements include all statements regarding our
expected financial position, results of operations, cash flows, dividends,
financing plans, strategy, budgets, capital and other expenditures, competitive
positions, growth opportunities, benefits from new technology, plans and
objectives of management, and markets for stock. These forward-looking
statements are based largely on our expectations and, like any other business,
are subject to a number of risks and uncertainties, many of which are beyond our
control. The risks include those stated in the "Risk Factors" section of our
Annual Report on Form 10-KSB and economic, competitive and other factors
affecting our operations, markets, products and services, expansion strategies
and other factors discussed elsewhere in this report, our Annual Report on Form
10-KSB and the other documents we have filed with the Securities and Exchange
Commission. In light of these risks and uncertainties, there can be no assurance
that the forward-looking information contained in this report will in fact prove
accurate, and our actual results may differ materially from the forward-looking
statements.
ITEM 3. CONTROLS AND PROCEDURES.
As of September 30, 2004, our Chief Executive Officer and Chief
Financial Officer evaluated the effectiveness of the design and operation of our
disclosure controls and procedures. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective as of September 30, 2004.
16
As a result of the audit of our financial statements for the year ended
December 31, 2002, we were required to make restatements and reclassifications
of our unaudited financial statements filed for the quarters ended March 31,
June 30 and September 30, 2002. Such restatements and reclassifications call
into question the effectiveness of our disclosure controls and procedures. We
recently hired a consultant to examine and consider enhancements to such
controls and procedures.
We have made no changes in our internal control over financial
reporting during the quarter ended September 30, 2004 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
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PART II - OTHER INFORMATION
Item 2. Changes in Securities.
In the quarter ended September 30, 2004, the Company sold 15,000 shares
of Series B Preferred Stock for $286,500 in net cash proceeds. All sales were
made to accredited investors. Each share of preferred stock is convertible into
ten shares of common stock after six months. Attached to each preferred share
are ten of our class C warrants. Each class C warrant has a term of three years
and provides the right to purchase one share of our common stock at $7.00 per
share. The sales were made in reliance on Section 4(2) of the Securities Act of
1933, as amended.
The net proceeds from the sale of preferred stock in the third quarter
of 2004 are to be used for sales, marketing and advertising expenses, increases
in inventory, and working capital purposes. All of the foregoing uses of
proceeds were direct or indirect payments to nonaffiliates.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. The following are being filed as exhibits to this
Report:
Exhibit No. Description of Exhibit
10.1 Strategic Alliance Agreement Addendum,
dated October 19, 2004, between
Bohlender-Graebener Corporation and
SLS International, Inc.
31 Rule 13a-14(a) / 15d-14(a) Certifications
32 Section 1350 Certifications
(b) Reports on Form 8-K.
We filed a Report on Form 8-K on July 23, 2004 relating to our
financial results in the quarter and six months ended June 30,
2004.
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SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SLS INTERNATIONAL, INC.
(Registrant)
Date: November 15, 2004 By /s/ John Gott
---------------------------
John Gott
President and
Chief Financial Officer
(Principal Financial Officer)
19