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 June 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 August 1, 2004, 31,785,380 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 Balance Sheet 3
Condensed Statements of Operations 4
Condensed Statement of Cash Flows 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Controls and Procedures 18
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 20
Item 6. Exhibits and Reports on Form 8-K 21
Signature 22
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
June 30, December 31,
2004 2003
------------ ------------
(unaudited) (audited)
Assets
Current assets:
Cash $ 3,374,662 $ 1,482,786
Accounts receivable, less allowance for doubtful accounts of
$45,000 for June 30, 2004 and December 31, 2003 355,640 277,665
Inventory 1,018,266 590,297
Deposits - inventory 220,457 --
Deposits - Merger 100,000 --
Prepaid expenses and other current assets 19,349 6,850
------------ ------------
Total current assets 5,088,374 2,357,598
------------ ------------
Fixed assets:
Vehicles 78,949 73,376
Equipment 233,587 159,212
Leasehold improvements 240,105 175,621
------------ ------------
552,641 408,209
Less accumulated depreciation 109,299 88,016
------------ ------------
Net fixed assets 443,342 320,193
------------ ------------
$ 5,531,716 $ 2,677,791
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Current maturities of long-term debt and notes payable $ 28,871 $ 28,946
Accounts payable 256,157 357,287
Accrued liabilities 42,576 26,138
------------ ------------
Total current liabilities 327,604 412,371
------------ ------------
Notes payable, less current maturities 13,899 15,931
------------ ------------
Commitments and contingencies:
Shareholders' equity:
Preferred stock, Series A, $.001 par, 2,000,000 shares authorized;
1,495,533 issued as of June 30, 2004 and
1,545,300 issued as of December 31, 2003 1,496 1,545
Preferred stock, Series B, $.001 par, 1,000,000 shares
authorized; 219,600 shares issued as of June 30, 2004
and no shares issued as of December 31, 2003 219 --
Preferred stock, Series B, not issued but owed to buyers;
37,500 shares at June 30, 2004 38 --
Discount on preferred stock (1,285,341) (1,886,576)
Contributed capital - preferred 13,815,952 7,411,585
Common stock, $.001 par; 75,000,000 shares authorized;
29,333,780 shares and 28,230,180 shares issued at
June 30, 2004 and December 31, 2003 29,335 28,231
Common stock not issued but owed to buyers; no shares and
183,000 shares at June 30, 2004 and December 31, 2003 -- 183
Contributed capital - common 12,227,860 8,319,286
Unamortized cost of stock issued for services (641,196) (781,204)
Retained deficit (18,958,150) (10,843,561)
------------ ------------
Total shareholders' equity 5,190,213 2,249,489
------------ ------------
$ 5,531,716 $ 2,677,791
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SLS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For The Six Months
Ended June 30,
------------------------------
2004 2003
------------ ------------
(unaudited)
Revenue $ 926,222 $ 382,021
Cost of sales 481,182 155,561
------------ ------------
Gross profit 445,041 226,460
General and administrative expenses 5,868,928 1,108,535
------------ ------------
Loss from operations (5,423,887) (882,075)
Other income (expense):
Interest expense (1,019) (14,578)
Interest and miscellaneous, net 19,703 40,938
------------ ------------
18,684 26,360
------------ ------------
Loss before income tax (5,405,203) (855,715)
Income tax provision -- --
------------ ------------
Net loss (5,405,203) (855,715)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock (2,709,385) (212,558)
------------ ------------
Net loss availiable to common shareholders $ (8,114,588) $ (1,068,273)
============ ============
Basic and diluted earnings per share $ (0.28) $ (0.04)
============ ============
Weighted average shares outstanding 29,067,313 23,885,528
============ ============
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 June 30,
------------------------------
2004 2003
------------ ------------
(unaudited)
Revenue $ 505,306 $ 277,244
Cost of sales 228,266 98,125
------------ ------------
Gross profit 277,041 179,119
General and administrative expenses 2,912,239 606,386
------------ ------------
Loss from operations (2,635,199) (427,267)
Other income (expense):
Interest expense (514) (6,941)
Interest and miscellaneous, net 14,327 32,938
------------ ------------
13,813 25,997
------------ ------------
Loss before income tax (2,621,385) (401,270)
Income tax provision -- --
------------ ------------
Net loss (2,621,385) (401,270)
------------ ------------
Deemed dividend associated with
beneficial conversion of preferred stock (1,737,908) (79,280)
------------ ------------
Net loss availiable to common shareholders $ (4,359,293) $ (480,550)
============ ============
Basic and diluted earnings per share $ (0.15) $ (0.02)
============ ============
Weighted average shares outstanding 29,280,447 24,535,528
============ ============
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 Six Months
Ended June 30,
----------------------------
2004 2003
----------- -----------
(unaudited)
Operating activities:
Net loss $(5,405,203) $ (855,716)
Adjustments to reconcile net income to cash flows
from operating activities:
Depreciation and amortization 25,309 5,407
Amortization of cost of stock issued for services 140,008 443,536
Expense of stock options granted for services 2,416,569 23,134
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 (77,975) 91,889
Inventory (427,969) (169,452)
Deposits - Inventory (220,457) --
Prepaid expenses and other current assets -- 3,079
Accounts payable (101,130) 77,280
Due to shareholders -- (519)
Accrued liabilities 16,437 22,826
----------- -----------
Cash used in operating activities (2,488,909) (358,536)
----------- -----------
Investing activities:
Proceeds from disposal of fixed assets 3,000 --
Additions of fixed assets (148,458) --
----------- -----------
Cash used in investing activities (145,458) --
----------- -----------
Financing activities:
Sale of stock, net of expenses 4,928,350 371,600
Acquisition of subsidiary (400,000) --
Borrowings of notes payable -- 102,000
Repayments of notes payable (2,107) (13,948)
----------- -----------
Cash provided by financing activities 4,526,243 459,652
----------- -----------
Increase in cash 1,891,876 101,116
Cash, beginning of period 1,482,786 4,240
----------- -----------
Cash, end of period $ 3,374,662 $ 105,356
=========== ===========
Supplemental cash flow information:
Interest paid $ -- $ 6,027
Income taxes paid (refunded) -- --
Noncash investing activities:
Stock issued and options granted for services $ 2,416,569 $ 93,000
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 June 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 June 30, 2004 and results of operations and
cash flows for the six months ended June 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 June 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 six
months ended June 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 June 30, 2004, there is a note payable to an
individual in the amount of $25,000. This note bears interest of 7% and
is past due. There is also a note payable for equipment in the amount
of $19,877 and $17,770 as of December 31, 2003 and June 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 six months ended June 30, 2004 was $5,763 and $1,019,
respectively.
7
NOTE 4 - STOCK TRANSACTIONS
In the six months ended June 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 $790,842 for the six
months ended June 30, 2004. As of June 30, 2004 approximately 908,000
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 $130,000 for the six months ended June
30, 2004. On June 30, 2004 there was $613,671 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 June 30, 2004, Mr. Fischbach had earned no
options based on his performance in the six months ended June 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 June 30, 2004, Mr. Fischbach had earned
no cash fee based on the value provided to us in the six months ended
June 30, 2004.
In June 2004, we entered into a promotion 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.
8
Pursuant to the agreement, we granted options to purchase 1,000,000
shares of our common stock in exchange for various consulting services.
The option has a strike price of $2.00 per share 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 $1,492,291 for the six months ended June
30, 2004. As of June 30, 2004 approximately 705,000 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 six months ended June 30, 2004, 195,200 Class A warrants were
exercised for 195,200 shares of common stock for a total of $97,600.
555,200 Class A warrants are outstanding as of June 30, 2004. The
expiration date of the Class A warrants has been extended to August 5,
2004.
In the six months ended June 30, 2004, 6,000 Class B warrants were
exercised for 6,000 shares of common stock for a total of $18,000.
3,977,400 Class B warrants are outstanding as of June 30, 2004. The
expiration date of the Class B warrants has been extended to August 5,
2004.
In the six months ended June 30, 2004, we commenced an offering of
Series B preferred stock and sold 257,100 shares of preferred stock,
series B, for $4,815,750, net of expenses. As of June 30, 2004, 37,500
of these shares had not been issued and are, therefore, listed on these
financial statements as "not issued but owed to buyers". These shares
were issued in July of 2004. 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 are ten 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. If the
average closing market price for our common stock is equal to or
9
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 $2,108,150 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. On July 28, 2004, the offering was closed.
In the six months ended June 30, 2004, $2,709,385 of the unamortized
discount on preferred shares, series A and B, has been amortized to
retained earnings. At June 30, 2004, the unamortized discount on
preferred shares, series A and B, was $1,285,342.
In the six months ended June 30, 2004, 51,940 shares of preferred
stock, series A, were converted to 519,400 shares of common stock.
In the six months ended June 30, 2004, 100,000 options were granted for
consulting services. The options have a strike price equal to the
market price on their grant date, ranging from $2.73 to $3.10. Using
the Black-Scholes pricing model, the options were valued at $161,900
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 six months ended
June 30, 2004, $140,008 was amortized into consulting expense.
Unamortized cost of stock issued for services was $641,196 as of June
30, 2004.
NOTE 6 - CONSULTING, PROMOTIONAL AND INVESTOR RELATIONS SERVICES
Consulting and investor relation services expense was $3,118,036 for
the six months ended June 30, 2004. Consulting and investor relation
expenses incurred are detailed below:
Consulting expenses relating to stock issued for consulting agreements
was $140,008 (See Note 5) in the six months ended June 30, 2004.
Consulting expenses relating to options issued for services was
$2,575,033 (See Note 4) for the six months ended June 30, 2004.
10
In the six months ended June 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 six months ended June 30, 2004.
Various individuals and corporations performed consulting services and
investor relation services for us during the six months ended June 30,
2004 and were paid $152,995.
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 six months ended June 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
11
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.
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 six
months ended June 30, 2004. The options have a strike price of $2.21,
expire in 10 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 six
months ended June 30, 2004.
NOTE 9 - SUBSEQUENT EVENTS
From July 1 to July 28, 2004, we sold 15,000 shares of preferred stock,
series B, for $300,000. On July 28, 2004 the private placement offering
was closed.
On July 1, 2004, we issued 37,500 shares of preferred stock, series B
that were owed to buyers as of June 30, 2004.
From July 1 to July 29, 2004, 240,860 shares of preferred stock, series
A, were converted to 2,408,600 shares 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. 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
12
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 six months ended June 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.
13
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, and a line of in-wall,
in-ceiling and outdoor loudspeakers.
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 June 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 June 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 September 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 June 2001, we introduced a Commercial Line of loudspeakers that use
our PRD500 Ribbon Driver and, in September 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.
14
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2004 AS COMPARED TO THE QUARTER ENDED JUNE 30,
2003. For the quarter ended June 30, 2004, revenue increased to $505,306 from
$277,244 in the 2003 period, an 82% increase, resulting primarily from the
positive results of a new 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 55% in the 2004 period from approximately 65% 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, as well as the unusually
high historical gross profit percentage in the 2003 period.
General and administrative expenses for the 2004 second quarter
increased to $2,912,239 from $606,386 in the 2003 second quarter, an increase of
$2,305,853. The increase resulted primarily from $2,102,093 in consulting and
investor relation services expenses (as further described in Note 6 to the
financial statements), $1,680,698 of which were non-cash charges for the
amortization of stock and options issued under consulting agreements; $87,786 in
compensation expense for the non-cash charge for issuances of stock options (as
further described in Note 8 to the financial statements); and a cash payment of
$250,000 pursuant to a promotion agreement with the recording artist Quincy
Jones through Global Drumz, Inc.
Due to the increase in general and administrative expenses, partially
offset by the revenue increase, our net loss increased to $2,621,385 in the
second quarter of 2004 as compared to a net loss of $401,270 in the comparable
quarter of 2003.
Other income (expense) decreased to net other income of $13,813 in the
2004 second quarter as compared to net other income of $25,997 in the 2003
second quarter, primarily due to other income recognized in the 2003 period from
the write-off of accounts payable.
SIX MONTHS ENDED JUNE 30, 2004 AS COMPARED TO THE SIX MONTHS ENDED JUNE
30, 2003. For the first six months of 2004, revenue increased to $926,222 from
$382,021 in the first six months of 2003, a 142% increase, resulting primarily
from the positive results of a new 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 48% in the 2004 period from approximately 59% 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, as well as the unusually
high historical gross profit percentage in the 2003 period. 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 $5,405,203
in the first half of 2004 as compared to a net loss of $855,715 in the first
half of 2003.
General and administrative expenses for the first six months of 2004
increased to $5,868,928 from $1,108,535 in the 2003 period, primarily as a
result of consulting and investor relations services expenses of $3,118,036 in
the 2004 period ($2,335,041 of which were non-cash charges), compared to
$511,027 in the 2003 period.
15
Other income decreased to net other income of $18,684 in the 2004
period as compared to net other income of $26,360 in the 2003 period, primarily
due to other income recognized in the 2003 period from the write-off of accounts
payable.
FINANCIAL CONDITION
On June 30, 2004, our current assets exceeded current liabilities by
$4,760,770, compared to an excess of $1,945,227, on December 31, 2003. Total
assets exceeded total liabilities by $5,190,213, 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 257,100 shares of Series B
Preferred Stock for net proceeds of $4,815,750 in the first half of 2004. In
addition to funding operations, the proceeds from such sales of stock allowed us
to increase cash by $1,891,876, increase inventory by $427,969, increase net
fixed assets by $123,149, decrease accounts payable by $101,130, increase
accounts receivable by $77,975, and pay deposits totaling $320,457 for inventory
and a potential merger. On June 30, 2004, we had a backlog of orders of
approximately $125,000.
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 substantial 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. As
discussed above, through June 30, 2004, we sold 257,100 shares of Series B
Preferred Stock for net proceeds of $4,815,750. 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 half of 2004, we also received an aggregate of $115,600 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
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days. 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 has been
granted and is expected to be issued in the near future. 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.
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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 June 30, 2004, we
had $3,374,662 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 June 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 June 30, 2004.
18
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
are currently considering enhancements to such controls and procedures.
We have made no changes in our internal control over financial
reporting during the quarter ended June 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 June 30, 2004, the Company sold 113,600 shares of
Series B Preferred Stock for $2,251,500 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 second 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.
In June 2004, we entered into an endorsement / consulting agreement
with the recording artist Quincy Jones through Global Drumz, Inc., pursuant to
which we granted options to purchase 1,000,000 shares of common stock, at an
exercise price of $2.00 per share, in exchange for future endorsements of our
products and various other consulting services. Each option is exercisable for a
period of five years. Pursuant to the agreement, 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. The options automatically vest as to 50% of the
options upon the effective date of the agreement and as to one-sixth of the
remaining options monthly thereafter. The issuances to Global Drumz were made in
reliance on Section 4(2) of the Securities Act of 1933, as amended.
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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
----------- ----------------------
4.1 Certificate of Designations for Series B Preferred
Stock
4.2 Form of Class C Warrant
10.1 Promotion Agreement, dated June 2, 2004, between SLS
International, Inc. and Global Drumz, Inc.
10.2 Option Agreement, dated June 2, 2004, between SLS
International, Inc. and Global Drumz, Inc.
10.3 Redeemable Warrant, dated June 2, 2004, issued by SLS
International, Inc. in favor of Global Drumz, Inc.
10.4 Redeemable Warrant, dated March 23, 2004, issued by
SLS International, Inc. in favor of Kenny Securities
Corp.
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/A on May
20, 2004 to file financial statements and pro forma financial
information relating to our acquisition of Evenstar, Inc.
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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: August 6, 2004 By /s/ John Gott
-----------------------
John Gott
President and
Chief Financial Officer
(Principal Financial Officer)
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