SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Amendment No. 1
[X] Quarterly Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the Quarterly Period Ended September 30, 2005 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 Registrant as Specified in its Charter)
Delaware 52-2258371
---------------------------------------- ---------------------------------
(State of Incorporation) (IRS Employer Identification No.)
1650 W. Jackson Ozark, Missouri 65721
---------------------------------------- --------------------------------
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (417) 883-4549
----------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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 requirements for the past 90 days. 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 ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act
subsequent to the distribution of securities under a plan confirmed by a court.
N/A Yes [ ] No [X]
On November 7, 2005, 46,283,310 shares of our common stock were outstanding.
SLS INTERNATIONAL, INC.
EXPLANATORY NOTE
SLS International, Inc. is filing this Amendment No. 1 to our Quarterly
Report on Form 10-Q for the quarter ended September 30, 2005, as filed with the
U.S. Securities and Exchange Commission on November 14, 2005, to properly record
certain stock transactions by our CEO, which for accounting and tax purposes are
deemed to have been made by the company. This re-classification has resulted in
the following changes to our financial statements:
Our CEO granted shares and options to various consultants in the second
quarter of 2005, but the transactions were not previously recorded in the 10-Q
for the nine months ended September 30, 2005. The recording of this expense
results in an increase in general and administrative expense by $1,123,600 and
corresponding changes in "common stock paid in capital" and "retained earnings"
on the balance sheet. Prior versions of the 10-Q recorded $475,000 in
compensation expense for shares transferred to employees by our CEO during the
nine months ended September 30, 2005. These transfers were voided during 2005,
which eliminates the entry for both tax and accounting purposes. This change
results in a $475,000 reduction in general and administrative expense and
corresponding changes in "common stock paid in capital" and "retained earnings"
on the balance sheet.
These two changes resulted in a net increase of $648,600 in our net loss for the
nine months ended September 30, 2005.
This Amendment No. 1 affects the original financial statements and the
footnotes as originally filed, only to the extent described above. We have also
made revisions to Management's Discussion and Analysis of Financial Condition
and Results of Operations to reflect these changes in our financial statements.
This Amendment No. 1 does not reflect events that have occurred after
the original filing of the Quarterly Report on Form 10-Q filed on November 14,
2005 and does not modify or update the disclosures in the Quarterly Report on
Form 10-Q as filed in any way except with regard to the specific modifications
described in this Explanatory Note. This Amendment No. 1 should be read in
conjunction with the original filing of our Quarterly Report on Form 10-Q and
our other filings made with the Securities and Exchange Commission subsequent to
the filing of the original Quarterly Report on Form 10-Q.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheet 3
Condensed Consolidated Statements of Operations 5
Condensed Consolidated Statement of Cash Flows 7
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 17
PART II. OTHER INFORMATION
Item 6. Exhibits 18
Signatures 21
2
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, December 31,
2005 2004
------------- ------------
(unaudited) (audited)
Assets
Current assets:
Cash $ 301,705 $ 10,712,858
Certificates of Deposits 2,000,000 --
Accounts receivable, less allowance for doubtful accounts of
$45,000 for September 30, 2005 and December 31, 2004 365,633 271,429
Inventory 4,674,498 1,908,588
Deposits - inventory 58,000 50,000
Deposits - Merger -- 100,000
Prepaid expenses and other current assets 573,188 192,817
------------ ------------
Total current assets 7,973,024 13,235,692
------------ ------------
Fixed assets:
Construction in Progress
Building 4,161,230 --
Vehicles 283,233 51,949
Equipment 620,165 234,805
Leasehold improvements 4,370 245,681
------------ ------------
5,068,998 532,435
Less accumulated depreciation 219,111 105,131
------------ ------------
Net fixed assets 4,849,887 427,304
------------ ------------
Prepaid Expense 87,914 --
------------ ------------
Total assets $ 12,910,825 $ 13,662,996
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Current maturities of long-term debt and notes payable $ 760 $ 29,101
Accounts payable 704,665 346,980
Customer Deposits 76,377 --
Accrued liabilities 866 630,503
------------ ------------
Total current liabilities 782,668 1,006,584
------------ ------------
Notes payable, less current maturities 7,293 10,951
Accrued Liabilities Class D Warrants 12,804 --
------------ ------------
Total Long term liabilities 20,097 10,951
------------ ------------
Total liabilities 802,765 1,017,535
Commitments and contingencies:
Temporary Equity:
Preferred Stock, Series A, $.001 par,
2,000,000 shares authorized; 76,000 and 346,873 shares
issued as of September 30, 2005 and December 31, 2004 76 347
Contributed Capital - preferred 396,225 1,707,367
Common Stock, $.001 par; 75,000,000 shares authorized;
2,568,400 shares and 2,568,400 shares issued
as of September 30, 2005 and December 31, 2004 2,568 2,568
Contributed Capital - common 1,338,132 1,338,132
Shareholders' equity:
Preferred stock, Series B, $.001 par, 1,000,000 shares authorized;
97,200 shares issued as of September 30, 2005 and 196,050 shares
issued as of December 31, 2004 97 196
Preferred stock, Series C, $.001 par 25,000 shares authorized;
14,450 and no shares issued as of September 30, 2005
and December 31, 2004 14 --
Deposits on Preferred stock, series C -- 8,849,420
Contributed capital - preferred 16,981,107 5,069,298
Common stock, $.001 par; 75,000,000 shares authorized;
43,539,910 shares and 39,184,000 shares issued
at September 30, 2005 and December 31, 2004 43,540 39,184
Common stock not issued but owed to buyers; 1,428,071 shares
and 183,000 shares at September 30, 2005 and December 31, 2004 1,428 300
Contributed capital - common 30,506,100 20,543,959
Unamortized cost of stock issued for services (1,482,266) (1,363,973)
Unamortized cost of stock issued for compensation (2,217,971) --
Retained deficit (33,460,990) (23,541,337)
------------ ------------
Total shareholders' equity 12,108,060 12,645,461
------------ ------------
$ 12,910,825 $ 13,662,996
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For The Nine Months
Ended September 30,
------------------------------
2005 2004
------------ ------------
(unaudited)
Revenue $ 2,889,149 $ 1,502,559
Cost of sales 1,966,665 814,230
------------ ------------
Gross profit 922,484 688,328
General and administrative expenses 8,981,827 7,438,310
------------ ------------
Loss from operations (8,059,343) (6,749,980)
Other income (expense):
Interest expense (445) (1,469)
Interest and miscellaneous, net 136,232 28,198
Gain (loss) on disposal of fixed assets (234,158) --
Gain (loss) on valuation of D warrants 1,493,308 --
------------ ------------
1,394,937 26,729
------------ ------------
Loss before income tax (6,664,406) (6,723,252)
Income tax provision -- --
------------ ------------
Net loss (6,664,406) (6,723,252)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock (3,253,790) (3,874,061)
Premium - preferred series C (7,678) --
------------ ------------
Net loss available to common shareholders $ (9,925,874) $(10,597,313)
============ ============
Basic and diluted earnings per share $ (0.22) $ (0.34)
============ ============
Weighted average shares outstanding 44,526,987 30,995,380
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For The Three Months
Ended September 30,
------------------------------
2005 2004
------------ ------------
(unaudited)
Revenue $ 1,209,076 $ 576,336
Cost of sales 847,787 333,048
------------ ------------
Gross profit 361,289 243,288
General and administrative expenses 3,313,312 1,569,381
------------ ------------
Loss from operations (2,952,023) (1,326,093)
Other income (expense):
Interest expense (8) (451)
Interest and miscellaneous, net 69,893 8,495
Gain (loss) on valuation of D warrants 224,858 --
------------ ------------
294,744 8,044
------------ ------------
Loss before income tax (2,657,280) (1,318,048)
Income tax provision -- --
------------ ------------
Net loss (2,657,280) (1,318,048)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock -- (1,164,676)
Premium - preferred series C -- --
------------ ------------
Net loss available to common shareholders $ (2,657,280) $ (2,482,724)
============ ============
Basic and diluted earnings per share $ (0.06) $ (0.07)
============ ============
Weighted average shares outstanding 46,839,714 34,851,513
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For The Nine Months
Ended September 30,
------------------------------
2005 2004
------------ ------------
(unaudited)
Operating activities:
Net loss $ (6,664,406) $ (6,723,252)
Adjustments to reconcile net income to cash flows
from operating activities:
Depreciation and amortization 125,502 38,400
Amortization of cost of stock issued for services 398,012 210,012
Expense of stock options granted for services 1,395,790 2,719,977
Compensation expense for stock sold to employees 475,000 --
Loss (gain) on disposal of fixed assets 234,158 (3,000)
Gain on valuation of D warrants (1,493,308) --
Goodwill impairment charge -- 1,148,502
Change in assets and liabilities-
Accounts receivable, less allowance for doubtful accounts (94,204) (87,287)
Inventory (2,765,910) (1,116,130)
Deposits - Inventory (8,000) (321,016)
Deposits - merger 100,000 --
Prepaid expenses and other current assets (468,285) (108,333)
Accounts payable 357,685 101,766
Customer deposits 76,377 --
Accrued liabilities (616,833) 1,845
------------ ------------
Cash used in operating activities (8,948,422) (4,138,517)
------------ ------------
Investing activities:
Investment in certificates of deposits (2,000,000) --
Proceeds from disposal of fixed assets -- 3,000
Additions of fixed assets (4,777,874) (158,294)
------------ ------------
Cash used in investing activities (6,777,874) (155,294)
------------ ------------
Financing activities:
Sale of stock, net of expenses 4,515,988 5,291,950
Acquisition of subsidiary -- (400,000)
Repayments of notes payable (31,998) (1,326)
------------ ------------
Cash provided by financing activities 4,483,990 4,890,624
------------ ------------
Increase in cash (10,411,153) 596,812
Cash, beginning of period 10,712,858 1,482,786
------------ ------------
Cash, end of period $ 301,705 $ 2,079,598
============ ============
Supplemental cash flow information:
Interest paid $ 8,388 $ --
Income taxes paid (refunded) -- --
Change in temporary equity 1,311,413 5,713,592
Non-cash investing activities:
Stock issued and options granted for services $ 1,395,790 $ 2,719,977
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
SLS INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
at September 30, 2005 have been prepared in accordance with U.S.
generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and reflect all
adjustments which, in the opinion of management, are necessary for a
fair presentation of financial position as of September 30, 2005 and
results of operations and cash flows for the nine months ended
September 30, 2005. 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 2004 financial statements have been reclassified to
conform to the 2005 presentations. The statements should be read in
conjunction with the financial statements and footnotes there to
included in our Form 10-KSB for the year ended December 31, 2004.
NOTE 2 - NOTES PAYABLE
At December 31, 2004 there is a note payable to an individual in the
amount of $25,000. This note was paid in the quarter ended June 30,
2005. There is also a note payable for equipment in the amount of
$15,052 and $8,058 as of December 31, 2004 and September 30, 2005,
respectively. This note bears interest of 5.16% and matures in
September of 2008. Interest expense for the year ended December 31,
2004 and the nine months ended September 30, 2005 was $1,907 and $438
respectively.
NOTE 3 - STOCK TRANSACTIONS
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 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 was recorded over the two-year period of
the agreement beginning July 31, 2003 and ended June 30, 2005. Expense
was 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. Factors used in
the Black-Scholes pricing model included: risk-free interest rates of
3.65% to 3.73%; strike price of $0.25; market prices of $2.04 to $2.26;
volatility rate of 22.13%; and a yield rate of 0.00%. Consulting
expense relating to this agreement was $110,600 for the nine months
ended September 30, 2005. As of September 30, 2005 all of the 1,100,000
options have been earned and expensed. There will be no further expense
incurred in 2005.
In November 2003, an agreement was signed with William Fischbach for
consulting services to be performed November 10, 2003 to November 2006.
As compensation for consulting services we issued 400,000 shares of
common stock on November 11, 2003. Using the market value on 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, 2005. On September 30, 2005 there was $288,671 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 of each year based
on the previous year's performance levels. No options were issued on
January 1, 2004 or 2005 under this agreement. As of September 30, 2005,
Mr. Fischbach had earned no options based on his performance in the
nine months ended September 30, 2005. 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, 2005, Mr. Fischbach had earned no cash fee in the nine
months ended September 30, 2005.
In March 2004, we issued an option to purchase 100,000 shares of our
common stock at $2.98 per share as part of an employment agreement
signed with Joel Butler for consulting services. Using the market value
on the date the agreement was signed, the shares were valued at
$118,000 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 two-year period of the agreement. Consulting expense
relating to this agreement was $88,500 for the nine months ended
September 30, 2005. On September 30, 2005 there was $29,500 remaining
in unamortized stock issued for services for this agreement.
In December 2004, an agreement was signed with W. Curtis Hargis Co.
Hargis) for consulting services. As compensation for consulting
services we agreed to issue 100,000 options upon reaching an agreement
with a retailer introduced to us by Hargis. This occurred on March 21,
7
2005. We also agreed to issue Hargis an option to purchase one share of
common stock for every $100 in sales from the retailer provided that
Hargis shall not be entitled to receive in excess of 500,000 options.
The options have a term of three years and have a strike price equal to
the average price of the Company's common stock for the five trading
days immediately prior to the day the options are earned. Through
September 30, 2005, Hargis had earned 101,529 options to purchase
common stock. Using the Black-Scholes pricing method, the options were
valued at $62,886 and recorded as consulting expense in the nine months
ended September 30, 2005. Factors used in the Black-Scholes pricing
model included: risk-free interest rate of 3.93%; strike price of
$2.11; market price of $2.30; volatility rate of 25.87%; and a yield
rate of 0.00%. The agreement also calls for additional compensation to
Hargis in the form of a cash fee of 2% based on payment received from
the retailer. Through September 30, 2005, Hargis had earned $1,608
based on the value provided to us in the nine months ended September
30, 2005.
In February of 2005, an agreement was signed with 3CD Consulting, LLC
for consulting services to be performed November 18, 2004 to November
17, 2007. As compensation for consulting services the Company issued
1,000,000 options for shares of common stock. The options have a term
of 3 years and a strike price of $2. Using the Black-Scholes pricing
model, the options were valued at $814,781 and recorded as a debit in
the equity section of the balance sheet as unamortized cost of stock
issued for services. Factors used in the Black-Scholes pricing model
included: risk-free interest rate of 3.08%; strike price of $2.00;
market price of $2.45; volatility rate of 29.73%; and a yield rate of
0.00%. The expense is amortized over the three-year period of the
agreement. Consulting expense relating to this agreement was $203,694
for the nine months ended September 30, 2005. On September 30, 2005,
there was $579,091 remaining in unamortized cost of stock issued for
services for this agreement.
In January of 2005, an agreement was signed with New AV Ventures, LLC
(AV) for consulting services to be performed January 31, 2005 to
January 31, 2010. As compensation for consulting services the Company
issued 300,000 shares of common stock. Using the market value on the
date the agreement was signed, the shares were valued at $720,000 and
recorded as a debit in the equity section of the balance sheet as
unamortized cost of stock issued for services. The cost will be
amortized over the five-year period of the agreement. Consulting
expense relating to this agreement was $108,000 for the nine months
ended September 30, 2005. On September 30, 2005 there was $612,000
remaining in unamortized stock issued for services for this agreement.
The Company also agreed to give AV a percentage of future sales to
certain vendors and one option to purchase one share of common stock
for each $100 of sales to vendors generated by AV provided that AV
shall not be entitled to receive in excess of 700,000 options. The
options will have a term of five years and have a strike price equal to
the average price of the Company's common stock for the five trading
days immediately prior to January 1 of the following year. Through
September 30, 2005, New AV Ventures, LLC has earned no cash fee or
options under this agreement.
In January of 2005, the Company completed a private placement of 15,000
shares of its Series C Preferred Stock for an aggregate purchase price
of $15,000,000. The proceeds were $13,340,408, net of expenses.
Expenses associated with the offering are legal costs of $132,558 and
expenses related to a finder's fee. The finder was compensated with
$900,000 plus 600,000 warrants, which were valued at $627,034 using the
Black-Scholes pricing model. Factors used in the Black-Scholes pricing
model included: risk-free interest rate of 3.64%; strike price of
$2.50; market price of $2.79; volatility rate of 29.73%; and a yield
rate of 0.00%.
The Series C Preferred Stock contains a beneficial conversion feature.
The feature allows the holder to convert each share of preferred to 400
shares of common stock and accrues a 6% premium to the stated face
value of the shares of preferred stock, which would be convertible into
additional shares of common stock. A discount on preferred shares of
$3,246,112 relating to the beneficial conversion feature was recorded.
As of September 30, 2005, the full discount had been amortized to
retained earnings.
The 6% premium accrues to the face value of the preferred stock and
compounds quarterly. As of September 30, 2005, the face value of the
14,450 outstanding shares is $15,098,371, of which $648,371 is premium.
The face value of the preferred stock is convertible into common stock
at $2.50 per share. As a result, on September 30, 2005, the 14,450
outstanding shares of preferred stock were convertible into 6,039,348
shares of common stock.
Attached to each Series C Preferred share are 400 Class D warrants.
Each Class D warrant has a term of five years and provides the right to
purchase one share of our common stock at $6.00 per share, subject to
certain adjustments. The Company may redeem the warrants and may
require the holders to convert the preferred stock to common stock if
certain conditions are met. Using the Black-Scholes model for pricing,
the Class D warrants were valued at $1,506,112. Factors used in the
Black-Scholes pricing model included: risk-free interest rate of 3.64%;
strike price of $6.00; market price of $2.79; volatility rate of
29.73%; and a yield rate of 0.00%.
The provisions of the agreement pertaining to the Class D warrants
provide for penalties if we fail to keep the registration statement
effective for the resale of the common stock issuable upon exercise of
the warrants. Since these provisions provide a settlement alternative
that would be avoided by the company under other settlement
alternatives, we are required by EITF 00-19 to record a liability in an
amount equal to the market value of the Class D warrants. The initial
8
amount of this liability is the fair market value as determined by the
Black-Scholes pricing model amounting to $1,506,112. Subsequent changes
in the Black-Scholes based market value are to be reported in our
statement of operations. As of September 30, 2005, using the
Black-Scholes pricing model produced a value of $12,804. Factors used
in the Black-Scholes pricing model included: risk-free interest rate of
3.64% - 4.18%; strike price of $6.00; market price of $$1.91 - $2.79;
volatility rate of 18.54% - 29.73%%; and a yield rate of 0.00%.
Consequently the decrease in the original liability of $1,506,112 to
the September 30, 2005 value of $12,804 resulted in recognition of a
gain amounting to $1,493,308.
In the nine months ended September 30, 2005, 274,873 shares of
preferred stock, series A, were converted to 2,748,730 shares of common
stock. There are 76,000 shares of series A preferred stock outstanding
as of September 30, 2005.
In the nine months ended September 30, 2005, 98,850 shares of preferred
stock, series B, were converted to 988,500 shares of common stock.
There are 97,200 shares of series B preferred stock outstanding as of
September 30, 2005.
In the nine months ended September 30, 2005, 550 shares of preferred
stock, series C, were converted into 220,000 shares of common stock.
There are 14,450 shares of series C preferred stock outstanding as of
September 30, 2005. The premium on these converted shares was $7,678
and is recorded in these financial statements as a stock dividend. The
premium converted at $2.50 per share into an additional 3,071 shares of
common stock. These shares were not issued as of September 30, 2005 and
are therefore shown in these financial statements as stock not issued
but owed.
In the nine months ended September 30, 2005, 90,000 options were
granted from time to time to Ryan Schinmann for consulting services.
The options have strike prices equal to the market price on their
respective grant dates, ranging from $2.04 to $2.51. Using the
Black-Scholes pricing model, the options were valued at $86,269 and
recorded as consulting expense. Factors used in the Black-Scholes
pricing model included: risk-free interest rates of 3.94% to 4.50%;
strike prices of $2.04 to $2.51; market prices of $2.04 to $2.51;
volatility rate of 25.87%; and a yield rate of 0.00%. 10,000 additional
options are to be granted every month until the contract is terminated,
and the contract is terminable by the Company at will.
In the nine months ended September 30, 2005, 930,000 options were
granted to directors of the Company. Using the Black-Scholes pricing
model, the options were valued at $686,868 and recorded as compensation
expense. Factors used in the Black-Scholes pricing model included:
risk-free interest rates of 3.71% to 4.06%; strike prices of $2.27 to
$2.50; market prices of $2.27 to $2.38; volatility rate of 22.13%; and
a yield rate of 0.00%. In the second quarter of 2005, 730,000 options
issued in the first quarter automatically expired upon resignation of
two directors. Therefore, compensation expense for the nine months
ended September 30, 2005 was reduced by $490,868 in credits from the
expiration of such options, resulting in a net expense of $196,000 for
the nine months ended September 30, 2005.
In June of 2005, an agreement was signed with JMBP, Inc. and Mark
Burnett for consulting services. As compensation for consulting
services the Company agreed to issue 1,000,000 options for shares of
common stock and 1,000,000 warrants for shares of common stock. The
options have a term of five years and a strike price of $2.05. The
warrants have a term of five years and a strike price of $6.50. 400,000
options and 400,000 warrants vested on the date the agreement was
signed. The remaining options and warrants vest upon various events as
set forth in the agreement. Through September 30, 2005, 100,000
additional warrants and 100,000 additional options vested. Using the
Black-Scholes pricing model, these options and warrants were valued at
$283,740 and recorded as consulting expense for the nine months ended
September 30, 2005. Factors used in the Black-Scholes pricing model
included: risk-free interest rate of 3.61% - 3.89%; strike price of
$2.05 - $2.51 for the options and $6.50 for the warrants; market price
of $1.91 - $2.05; volatility rate of 19.36% - 22.13%; and a yield rate
of 0.00%. Expenses to be recorded in future quarters are unknown at
this time because the value of the vesting options and warrants will be
partly based on the market price on the date the vesting events take
place.
In June of 2005, we entered into employment agreements with Michael
Maples, Steven Lamar, and John Gott. Each agreement has a term of three
years. In the agreements we agreed to pay an aggregate of $150,000 in
signing bonuses, agreed to issue an aggregate of 1,125,000 shares of
common stock, and agreed to issue an aggregate of 1,250,000 options.
The signing bonuses were paid and capitalized as a prepaid expense,
which will be amortized monthly over the three-year term of each
agreement. In the nine months ended September 30, 2005, $14,132 was
recorded in compensation expense. There is $135,868 remaining in
prepaid expense as of September 30, 2005. The 1,125,000 shares of
common stock are required to be issued in January 2006 and are
therefore shown in these financial statements as "stock not issued but
owed". The shares were valued at $2,418,750, using the market price on
the date the agreement was signed, and recorded as unamortized cost of
stock issued for compensation in the equity section of these financial
statements. The cost will be amortized over the three-year term of the
agreements. For the nine months ended September 30, 2005, $230,279 was
amortized into compensation expense. Unamortized cost of stock issued
for compensation was $2,188,471 as of September 30, 2005. The 1,250,000
options will be earned evenly over the three-year term of each
agreement. Each option is convertible into one share of common stock at
a strike price of $2.50 and is exercisable for a period of ten years.
Expense associated with the options will be recorded over the
three-year period of the agreement at fair market value, using the
Black-Scholes pricing model. Compensation expense relating to options
earned for the nine months ended September 30, 2005 was $116,038.
Factors used in the Black-Scholes pricing model included; risk-free
9
interest rates of 3.75% - 4.09%; strike price of $2.50; market prices
of $1.91 - $2.15; volatility rates of 22.13% - 26.73%; and a yield rate
of 0.00%. Through September 30, 2005, 49,562 of the 1,250,000 options
have been earned and expensed. Expenses to be recorded in future
quarters are unknown at this time because the value of the earned
options will be partly based on the month-end market price.
In the quarter ended June 30, 2005, the company's CEO transferred
55,000 shares of his personal common stock to various individuals for
consulting services. For accounting and tax purposes, these transfers
are deemed to have been made by the Company. The shares were valued
using the market price at the date the stock was transferred. The stock
price ranged from $2.15 - $2.40. The shares were valued at $128,250 and
recorded as consulting expense for the nine months ended September 30,
2005.
In the quarter ended June 30, 2005, the company's CEO granted 500,000
options to a consultant from his own personal stock. For accounting and
tax purposes, these transfers are deemed to have been made by the
Company. Using the Black-Scholes pricing model included: risk free
interest rate of 3.19%; strike price of $.05; market price of $2.04;
volatility rate of 22.13%; and a yield rate of 0%. The options were
recorded as consulting expense for the nine months ended September 30,
2005.
NOTE 4 - UNAMORTIZED COST OF STOCK ISSUED FOR SERVICES AND COMPENSATION
As detailed in Note 3, we have issued or agreed to issue shares of
common stock and options as part of various consulting agreements. The
costs of these issuances are 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,
2005, $1,145,202 was amortized into consulting expense. Unamortized
cost of stock issued for services was $1,482,266 as of September 30,
2005.
As detailed in Note 3, we have agreed to issue common stock as part of
various employment agreements. The costs of these issuances are
recorded as a debit in the equity section of the balance sheet as
unamortized cost of stock issued for compensation. The balance is
amortized into compensation expense over the three-year lives of the
employment agreements. For the nine months ended September 30, 2005,
$230,279 was amortized into compensation expense. Unamortized cost of
stock issued for compensation was $2,217,971 as of September 30, 2005.
NOTE 5 - CONSULTING, PROMOTIONAL AND INVESTOR RELATIONS SERVICES
Consulting and investor relation services expense was $2,199,234 for
the nine months ended September 30, 2005. Consulting and investor
relation expenses incurred are detailed below:
Consulting expenses relating to stock issued for services were $398,012
(See Note 4) in the nine months ended September 30, 2005. Consulting
expenses relating to options issued for services was $747,190 (See Note
3) for the nine months ended September 30, 2005.
Various individuals and corporations performed consulting services and
investor relation services for us during the nine months ended
September 30, 2005 and were paid $1,054,032 in cash.
NOTE 6 - BUILDING AND RELATED PARTY TRANSACTIONS
We paid rent of $18,750 for January of 2005 to a company 50% owned by
John Gott, our Chief Executive Officer.
In February of 2005, we exercised an option to purchase a building from
a company 50% owned by John Gott, our Chief Executive Officer. The
purchase price was $3,500,000.
NOTE 7 - TEMPORARY EQUITY - RESCISSION OFFERS
The Company intends to make a rescission offer to all warrant holders
who exercised warrants during the period from May 1, 2002 through May
10, 2004. During such period, the registration statement that the
Company 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 the
Company's most recent audited financial statements. As a result, the
former warrant holders may be entitled to rescind their purchases and
the Company has decided to make the rescission offer. Once made, the
rescission offer is open for 30 days. The rescission offer would
require the Company to repurchase shares of common stock issued upon
exercise of 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. 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, 2004 or the nine
months ended September 30, 2005 has been made for 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 issued in the 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. If all warrant holders accepted the rescission offer,
the Company 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
10
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 on these financial statements.
From 2001 to 2003, we sold shares of our Convertible Preferred Stock,
which is reflected in these financial statements as our Series A
Preferred Stock. The Company discovered that the certificate of
designation for the Convertible Preferred Stock had not been filed, and
the Company made such filing in December of 2004. The delay in filing
the certificate of designation may have resulted in the shares of
Convertible Preferred Stock not being validly issued. We intend to make
a rescission offer during 2005 to the holders of all outstanding shares
of Convertible Preferred Stock, but we do not intend to offer
rescission to holders who have converted their Convertible Preferred
Stock to common stock. If all holders of the 76,000 shares of
Convertible Preferred Stock remaining outstanding on September 30, 2005
elected rescission at their original purchase price of $2.50 per share,
the Company would be required to pay an aggregate of $190,000 plus
interest. Because the current stock price is well above the conversion
price, no adjustments to these financial statements have been recorded.
Pending the completion of the rescission offer, the right of
shareholders to seek rescission and receive the rescission amount is
not completely within the control of the Company. As a result, the
shares subject to rescission rights are considered and treated as
temporary common and preferred stock for financial accounting purposes
until such time as the rescission rights lapse or are exercised.
Therefore the rescission amount and related shares were removed from
the Shareholder Equity and are currently classified as Temporary
Equity. The restatement was made solely to reflect this
reclassification and did not affect the Company's previously reported
net income, net income per share, assets or liabilities.
NOTE 8 - SUBSEQUENT EVENTS
From October 1, 2005 through November 7, 2005, 10,000 shares of
preferred stock, series A, were converted to 100,000 shares of common
stock.
From October 1, 2005 through November 7, 2005, 7,500 shares of
preferred stock, series B, were converted to 75,000 shares of common
stock.
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 for the cinema and movie theater market.
From the early 1990'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 June 1999, due to the favorable
customer acceptance of our 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.
We began selling loudspeakers in June 2000 when we introduced our Professional
Line. We introduced our other lines of speakers in subsequent years, with the
most recent being the Cinema line, which we started selling in 2004. Our
products are primarily sold through a network of sales representatives and our
own internal sales force, for our following lines: Pro, Cinema, Home Theatre,
Studio, Universal Series, RLA and the PRD series. Recently we have consolidated
all our foreign distribution with one sales representative organization who will
work between the Company and all foreign distributors. We have also begun
selling products directly through a corporate sales department that targets
major "big box" retailers.
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.
RESULTS OF OPERATIONS
Quarter ended September 30, 2005
as compared to the quarter ended September 30, 2004.
----------------------------------------------------
For the quarter ended September 30, 2005, revenue increased to $1,209,076 from
$576,336 in the 2004 period, a 110% increase, resulting primarily from the
positive results of a marketing program we started in January 2004 and our
increased production capabilities resulting from facility expansions completed
11
in 2004 and 2005. Compared to the same quarter of 2004, the most significant
sales increases have occurred in our "core" Pro products which accounted for 44%
of our sales in the quarter ended September 30, 2005. Sales to the Cinema
industry, a new line for 2005, have been very strong exceeding $280,000 for the
third quarter of 2005. During September of 2005 we shipped our new "home theater
in a box, the Q Line Silver to a Fortune 50 Retailer. While we believe this
channel exposure will be significant to our future sales growth, the initial
order was for 400 units to be distributed to 100 test stores throughout the US.
Our quarterly gross profit percentage decreased to approximately 30% in the 2005
period from margins of approximately 42% in the 2004 period, primarily due to
unusually high profit margins in the 2004 period.
General and administrative expenses for the 2005 third quarter increased to
$3,313,312 from $1,569,381 in the 2004 third quarter, an increase of $1,743,931.
As shown in the table below, the increase resulted primarily from non-cash
charges for options and stock transactions of the new directors and executives
and continuing increased cash costs to support our new facility, new management
structure, and advertising programs. Advertising and promotion expense increased
in the 2005 period due to image and branding programs directed at the retail
market in connection with planned product launches in retail outlets in late
2005 and early 2006 (approximately $429,000 in the 2005 period) and demo and
promotional equipment costs ($237,000 in the 2005 period). Other cash G&A
expense include increases in labor and related costs (approximately $321,000),
trade show and travel ($101,000), and increased operating costs at our new
facility ($78,000).
Three Months Ended
----------------------------
September 30, September 30,
2005 2004
------------- -------------
NON-CASH G&A EXPENSE ITEMS:
Charges for stock and options issued
for consulting and investor relation services $ 246,661 $ 373,412
Charges for options and stock issued and
sold to directors/employees 394,229 --
---------- ----------
Total non-cash G&A expense 640,890 373,412
---------- ----------
CASH G&A EXPENSE ITEMS:
Consulting and investor relation services 866,549 574,481
Advertising and promotion 796,625 120,268
Other cash G&A expenses 1,009,248 501,220
---------- ----------
Total cash G&A expense 2,672,422 1,195,969
---------- ----------
Total G&A expense $3,313,312 $1,569,381
========== ==========
Other income (expense) increased to a net income of $294,744 in the 2005 third
quarter as compared to net other income of $8,044 in the 2004 third quarter,
primarily due to $69,893 in interest earned on cash and certificates of deposit
related to cash received from our private placement of Series C Convertible
Preferred Stock and a $224,858 non-cash gain on the change in valuation of the
"D warrants" as explained further in Note 3 to the financial statements.
Due principally to the increase in general and administrative expense, offset to
a small degree by an increase in gross profit, and the other income items above,
our net loss increased to $2,657,280 in the third quarter of 2005 as compared to
a net loss of $1,318,048 in the comparable quarter of 2004.
Nine months ended September 30, 2005
as compared to the nine months ended September 30, 2004.
--------------------------------------------------------
Revenue increased to $2,889,149 from $1,502,559 in the first nine months of
2005, a 92% increase, resulting primarily from the positive results of a new
marketing program we started in January 2004 and our increased production
capabilities resulting from facility expansions completed in 2004 and 2005. Most
significant sales increases have occurred in our "core" Pro and RLA products
which accounted for over 50% of our sales in the nine months ended September 30,
2004 and 2005. Sales to the Cinema industry, a new line for 2005, have been
strong, exceeding $500,000 for the first nine months of 2005. During September
of 2005 we shipped our new "home theater in a box, the Q Line Silver to a
Fortune 50 Retailer. Our gross profit percentage decreased to approximately 32%
in the 2005 period from approximately 46% in the 2004 period, primarily due to
unusually high profit margins in the 2004 period.
12
General and administrative expenses for the first nine months of 2005 increased
to $8,981,827 from $7,438,310 in the 2004 period. The increase resulted
primarily from increased advertising expenses as well as increases in costs to
support our new facility and new management structure. The costs for the nine
months of 2004 includes a one-time impairment charge of $1,148,502 recognized in
the first half of 2004 related to the Evenstar, Inc. acquisition.
Nine Months Ended
----------------------------
September 30, September 30,
2005 2004
------------- -------------
NON-CASH G&A EXPENSE ITEMS:
Charges for stock and options issued for
consulting and investor relation services $2,268,802 $3,153,453
Charges for options and stock issued and
sold to directors/employees 630,817 87,786
Impairment charge - Evenstar, Inc. -- 848,502
---------- ----------
Total non-cash G&A expense 2,899,619 4,089,741
---------- ----------
CASH G&A EXPENSE ITEMS:
Consulting and investor relation services 1,053,871 912,476
Advertising and promotion 1,466,379 226,396
Acquisitions - SA Sound -- 109,165
Acquisitions - BG deal expired 100,000 --
Impairment charge - Evenstar, Inc. -- 300,000
Other cash G&A expenses 3,461,958 1,800,532
---------- ----------
Total cash G&A expense 6,082,208 3,348,569
---------- ----------
Total G&A expense $8,981,827 $7,438,310
========== ==========
As shown in the preceding table, our non-cash G&A expenses have decreased
$1,190,122. Cash G&A costs increased significantly due to a number of branding
and advertising programs, increased promotional costs, and consulting costs due
to infrastructure development and compliance issues. The increased advertising
costs included expenses for image and branding programs directed at the retail
market in connection with planned product launches in retail outlets in late
2005 and early 2006 (approximately $523,000 in the 2005 period), demo and
promotional equipment costs ($237,000 in the 2005 period), and preparation and
videos and collateral materials explaining our technology ($100,000 in the 2005
period). The increase in other cash G&A costs include increased labor and
related costs (approximately $592,000), trade shows and travel ($397,000), and
increased operating costs at our new facility ($487,000).
The combined factors of increased revenue offset by the increase in general and
administrative costs resulted in a Loss from Operations for the nine months
ended September of 2005 amounting to $8,059,343 compared to $6,749,980 loss for
the same period of 2004.
Other income (expense) amounted to $1,394,937 of income for the nine months of
2005 compared to $26,729 other income for the same period during 2004. Major
components of the 2005 other income amount are a loss of $234,158 due to the
disposal of leasehold improvements made to our previous office and factory
facility, a gain of $136,232 from interest income resulting from the proceeds
for our Series C Preferred stock offering, and a non-cash gain of $1,493,308
from the change in valuation of our D warrants that were issued as part of the
Series C Preferred offering.
The increase in other income and gross profit more than offset the increase in
our general and administrative costs to result in a net loss for the nine months
of 2005 amounting to a $6,015,806 loss compared to a loss of $6,723,252 for the
same period of 2004.
FINANCIAL CONDITION
On September 30, 2005, our current assets exceeded current liabilities by
$7,190,356 compared to an excess of $12,229,108, on December 31, 2004. Total
assets exceeded total liabilities by $12,108,060, compared to an excess of total
13
assets over total liabilities of $12,645,461 on December 31, 2004. The changes
in working capital, total assets, and total liabilities were principally due to
the receipt of $13,340,408 in net proceeds from the closing of our January 2005
private placement ($8,849,420 of which had been received prior to December 31,
2004) and the purchase of our new headquarters and manufacturing facility for
$3,500,000. In the first nine months of 2005, we also invested $231,284 for new
vehicles, $661,230 for improvements to the new headquarters and manufacturing
facility, and $385,360 for new equipment.
Our operations used cash of $10,411,153 for the first nine months of 2005 which
was primarily attributable to the net loss of $6,664,406 recognized during the
period; an increase in inventory of $2,765,910; a reduction of accrued
liabilities by $616,833, as we paid a $600,000 liability accrued at December 31,
2004 for a finder's fee in connection with the January 2005 private placement;
and an increase in prepaid expenses and other current assets of $468,285
primarily related to prepaid advertising associated with our national branding
campaign, deposits and prepaid insurance. We wrote off the $100,000 paid to
Bohlender-Graebener Corporation upon expiration of our agreement. On September
30,2005, we had a backlog of orders of approximately $108,698 compared to a
backlog of $200,000 at this same time last year.
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.
On June 17, 2005, we entered into employment agreements with John M. Gott, our
Chairman and Chief Executive Officer; Steven M. Lamar, our newly hired
President; and Michael L. Maples, our newly hired Chief Operating Officer and
Chief Financial Officer. Each employment agreement has a term of three years and
severance payments equal to six months of base salary following a termination by
us without "cause" or a termination by the executive for "good reason." Mr.
Gott's agreement provides for an annual salary of $180,000, an increase from his
previous salary of $96,000; a grant of options to purchase up to 500,000 shares
of our common stock at $2.50 per share; and an agreement to grant 500,000 shares
of our common stock to Mr. Gott in January 2006.
Mr. Lamar's agreement provides for an annual salary of $120,000, a signing bonus
of $100,000, a grant of options to purchase up to 500,000 shares of our common
stock at $2.50 per share, and an agreement to grant 500,000 shares of our common
stock to Mr. Lamar in January 2006.
Mr. Maples' agreement provides for an annual salary of $250,000, a signing bonus
of $50,000, a grant of options to purchase up to 250,000 shares of our common
stock at $2.50 per share, and an agreement to grant 125,000 shares of our common
stock to Mr. Maples in January 2006.
Each of the options described above were granted on June 21, 2005 and have a
term of ten years. The options vest in one-third increments on each of the
first, second and third anniversaries of the date of the option grant. The
options vest in full upon a "change of control" or termination of the
executive's employment by us without "cause."
On June 14, 2005, we entered into a Promotion Agreement with JMBP, Inc. and Mark
Burnett. In connection with the Promotion Agreement, we entered into an Option
Agreement and Warrant Certificate on June 14, 2005 with Mr. Burnett. Under the
Option Agreement, SLS granted Mr. Burnett 1,000,000 options for shares of our
common stock at an exercise price of $2.05 per share, subject to certain
adjustments specified in the Option Agreement. Under the Warrant Certificate, we
granted to Mr. Burnett warrants to purchase 1,000,000 shares of our common stock
at an exercise price of $6.50 per share, subject to certain adjustments
specified in the Warrant Certificate. Forty percent of the options and warrants
vested as of June 14, 2005 and the remainder of the options and warrants vest,
if at all, incrementally based on the achievement of specified milestones. The
vested options and warrants are exercisable at any time, and from time to time,
during the term beginning on June 14, 2005 and ending on June 14, 2010. SLS
issued the options and warrants as part of the consideration for the consulting
and other services SLS is entitled to receive under the Promotion Agreement.
Through September 30, 2005, 100,000 additional options and 100,000 additional
warrants vested based on performance under our agreement.
In order to continue operations, we have been dependent on raising additional
funds, and as discussed above, on January 4, 2005, we completed a private
placement of 15,000 shares of our Series C Convertible Preferred Stock for an
aggregate purchase price of $15 million (net proceeds of $13,340,408). The
investors also received five-year warrants to purchase an aggregate of 6,000,000
shares of our common stock at an exercise price of $6.00 per share, subject to
certain adjustments. The preferred stock is initially convertible, at the
holder's option, into an aggregate of 6,000,000 shares of our common stock, at a
conversion price of $2.50 per share, subject to certain adjustments, and accrues
a 6% premium to the stated value of the shares of preferred stock, which would
be convertible into additional shares of common stock. We may redeem the
warrants (or require the holders to exercise them) and may require holders to
convert the preferred stock to common stock if certain conditions are met.
Through September 30, 2005, holders had converted 550 shares of the Series C
Preferred Stock into common stock, leaving 14,450 shares of Series C Preferred
Stock outstanding.
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
14
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 was for one year and could 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 was required to work with us, diligently and in good faith, to
consummate a merger. During the first six months of the agreement, BG was not
permitted to solicit any offer to purchase BG, and was not permitted to respond
to any unsolicited offer. In addition to the above, BG granted us exclusive
sales and marketing rights to certain BG products and we committed to purchase
certain minimum quantities of various BG products at agreed-upon prices. Those
purchase commitments were 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. We satisfied all of these purchase commitments. In the event no agreement
to merge the companies on mutually acceptable terms could be reached before
termination of the agreement, BG would 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 additional 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. We are currently in negotiations with BG to extend the agreement.
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
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, 2005, we had $301,705 in
cash, and a certificate of deposit for $2,000,000 maturing on December 10, 2005.
With more than $5 million in receivables and inventory free of any debt we have
entered into discussions with commercial banking sources for a stand by line of
credit based on those assets.
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. We
expect that we will need to obtain some amount of additional financing before
the end of the first quarter of 2006 or earlier. However, we cannot be certain
that we will be able to successfully obtain such financing. If we fail to do so,
we may be unable to continue as a viable business, or we may be unable to
proceed with our initiatives to increase our retail sales and our other
initiatives.
CRITICAL ACCOUNTING POLICIES
Our discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting policies that require management to make judgments and estimates that
are subject to varying degrees of uncertainty. We believe that investors need to
be aware of these policies and how they impact our financial reporting to gain a
more complete understanding of our financial statements as a whole, as well as
our related discussion and analysis presented herein. While we believe that
these accounting policies are grounded on sound measurement criteria, actual
future events can and often do result in outcomes that can be materially
different from these estimates or judgments. The accounting policies and related
risks described in the notes to our financial statements for the year ended
December 31, 2004 are those that depend most heavily on these judgments and
estimates.
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.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our only current borrowing is a note payable on equipment in the principal
amount of $7,293 at September 30, 2005, which bears interest at a fixed rate of
5.16% and matures in September 2008.
We have invested $2,000,000 of current excess cash in one $2,000,000 certificate
of deposit. The CD earns interest at 3.34% per annum and matures on December 10,
2005. The selection of this investment was made with the primary goal of
preservation of principal, while obtaining a fixed yield. On October 14, 2005,
we cashed the CD prior to maturity. We have no other investments that are
subject to market risk.
ITEM 4. CONTROLS AND PROCEDURES.
As of September 30, 2005, our Chief Executive Officer and our 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 each concluded that our disclosure
controls and procedures were effective as of September 30, 2005.
In recent years, we have been required to make restatements and
reclassifications of our financial statements. Such restatements and
reclassifications call into question the effectiveness of our disclosure
controls and procedures. In 2004, we hired a consultant to examine and consider
enhancements to such controls and procedures. The consultant's work will
continue throughout 2005. In 2005, we have hired three new personnel - a Chief
Financial Officer, a Controller, and an Information Technology Director - whose
functions will include improving our controls and procedures.
We have made no changes in our internal control over financial reporting during
the quarter ended September 30, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
16
PART II - OTHER INFORMATION
Item 6. Exhibits.
The following are being filed as exhibits to this Report:
Exhibit No. Description of Exhibit
----------- -----------------------------------------------------------
31.1 Rule 13a-14(a) / 15d-14(a) Certifications of
Chief Executive Officer
31.2 Rule 13a-14(a) / 15d-14(a) Certifications of
Chief Financial Officer
32 Section 1350 Certifications
17
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: September 20, 2006 By: /s/ Michael L. Maples
-----------------------------
Michael L. Maples
Chief Financial Officer
(Principal Financial Officer)
18