-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GgSRiWoPkvoj5J5aT8HbSWwH6O2t0lMduHUJwnioN+WGzcPIAAbY79rofI2Mb44k tJZQipL4bdp+BHFEew+3Kw== 0001116502-06-000697.txt : 20060331 0001116502-06-000697.hdr.sgml : 20060331 20060331162839 ACCESSION NUMBER: 0001116502-06-000697 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060331 DATE AS OF CHANGE: 20060331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SLS INTERNATIONAL INC CENTRAL INDEX KEY: 0001121785 STANDARD INDUSTRIAL CLASSIFICATION: HOUSEHOLD AUDIO & VIDEO EQUIPMENT [3651] IRS NUMBER: 522258371 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-31323 FILM NUMBER: 06729278 BUSINESS ADDRESS: STREET 1: 3119 SOUTH SCENIC CITY: SPRINGFIELD STATE: MO ZIP: 65807 BUSINESS PHONE: 4178834549 10-K 1 sls-10k.txt ANNUAL REPORT ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 __________________ FORM 10-K __________________ [X} ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 Commission file number 001-31323 __________________ SLS INTERNATIONAL, INC. __________________ Incorporated under the Laws of the I.R.S. Employer Identification No. State of Delaware 52-2258371 1650 W. JACKSON, OZARK, MISSOURI 65721 (417) 883-4549 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: Common Stock SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None Indicate by check mark if the registrant is a well-seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] 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 past 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in the Proxy Statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act: Large accelerated filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [X] The aggregate market value of our common stock held by nonaffiliates was approximately $45,277,301 on March 21, 2006. On March 21, 2006, 46,608,310 shares of our common stock were outstanding, and the closing price per share of our common stock was $1.13. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement to be delivered to stockholders in connection with our 2006 Annual Meeting of Stockholders are incorporated by reference into Part III. ================================================================================ TABLE OF CONTENTS PAGE ---- PART I Item 1 Business...................................................... 1 Item 1A Risk Factors.................................................. 9 Item 1B Unresolved Staff Comments..................................... 16 Item 2 Properties.................................................... 16 Item 3 Legal Proceedings............................................. 16 Item 4 Submission of Matters to a Vote of Security Holders........... 17 PART II Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities......... 17 Item 6 Selected Financial Data...................................... 18 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.......................... 19 Item 8 Financial Statements and Supplementary Data.................. 23 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 24 Item 9A Controls and Procedures...................................... 24 Item 9B Other Information............................................ 24 PART III Item 10 Directors and Executive Officers of the Registrant........... 25 Item 11 Executive Compensation....................................... 25 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters................... 25 Item 13 Certain Relationships and Related Transactions............... 25 Item 14 Principal Accountant Fees and Services....................... 25 Item 15 Exhibits and Financial Statement Schedules................... 26 SIGNATURES.................................................................. 29 FINANCIAL STATEMENTS TABLE OF CONTENTS...................................... F-1 PART I ITEM 1. BUSINESS. 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 Theater 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. One key element of our strategy has been to raise customer awareness by entering into endorsement and promotion agreements with several music and entertainment industry performers and producers, including Gordon Sumner (professionally known as "Sting"), Quincy Jones and Mark Burnett. Further, in an effort to begin selling to the retail market, our corporate sales department has recently targeted major "big box" retailers. In 2005, these efforts resulted in a 100-store test market of our Q-Line Silver home theater system (developed in conjunction with Quincy Jones) at a Fortune 50 retailer. In 2006, we plan to initiate sales of our Q-Line Gold home theater system (also developed in conjunction with Quincy Jones) at a major U.S. electronics retailer. We anticipate the launch of this retail program to coincide with a feature of the Q-Line Gold on the reality television show "Apprentice," produced by Mark Burnett, in the second quarter of 2006. SLS International, Inc. was formed on July 25, 2000 and had no previous operations. On the same date, this corporation merged with Sound and Lighting Specialist Inc., its sole shareholder, and SLS International, Inc. was the surviving corporation. In 2004, we acquired Evenstar, Inc. through a merger with and into our subsidiary Evenstar Mergersub, Inc. 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. Our executive offices are located at 1650 West Jackson, Ozark, Missouri, 65721, with telephone number (417) 883-4549. Our website is www.slsloudspeakers.com. Our annual reports on Form 10-K (or Form 10-KSB) filed with the U.S. Securities and Exchange Commission are available on our website. Our quarterly reports on Form 10-Q (or Form 10-QSB) and current reports on Form 8-K are not yet available on the website, but we will provide electronic or paper copies of these reports free of charge upon written request. RECENT EVENTS On March 9, 2006, we announced the signing of a master Vendor Agreement with Best Buy Co., Inc. Under the terms of the Vendor Agreement, Best Buy will distribute the new Q Line Gold Home Theater Surround Sound System in 618 Best Buy locations throughout the U.S. commencing in May, 2006. The agreement provides that Best Buy will purchase the first 3,090 units of the Q Line Gold Home Theater Surround System that we supply. Following the sale of the initial order of 3,090 units, all additional units will be supplied to Best Buy on a consignment basis. 1 DEVELOPMENT OF RIBBON DRIVER LOUDSPEAKERS The function of loudspeakers is the accurate reproduction of sound delivered to an audience, whether in small or large venues. Loudspeakers traditionally have consisted in part of a component called a compression driver to achieve high-volume sound. The compression driver makes the mid-range and high frequency or treble sounds and a woofer makes the low frequency or bass sounds. Compression drivers consist of a diaphragm enclosed in a chamber. The diaphragm is typically formed as a partial sphere, similar to a ball that has been cut in half. The edges of the diaphragm are then wound many times with a fine electrical wire called a voice coil. Electrical current from an amplifier is sent through the wire and the diaphragm vibrates to produce the sound wave. The diaphragm is enclosed in a chamber with the sound exiting out of a relatively small hole that increases the velocity of the sound, similar to forcing air or water through a small hole to increase its velocity. The disadvantage of the compression driver is that before the sound waves are forced through the small hole they first bounce around inside the chamber and become distorted, which tends to produce its own resonant sound resulting in listening fatigue for audiences. Early versions of compression drivers used a diaphragm made of a linen-based manmade resin material. Today, compression drivers use a diaphragm made from aluminum or titanium and can produce the same high volume but with higher frequency sounds. Although today's compression drivers are superior to those of the past due to the new materials, the negative aspects of producing its own sound still exist to a degree because of the nature of the design of the compression driver. Ribbon drivers work in a different manner than compression drivers. The diaphragm of the ribbon driver is a flat piece of mylar plastic or, in the case of our ribbon drivers, a high temperature Kapton plastic. These materials are considerably thinner and lighter than the linen or even the aluminum or titanium diaphragms of the compression drivers. The ribbon diaphragm is laminated on one side with a thin coating of aluminum. This aluminum is then chemically etched to leave wire-like traces of aluminum that act as a voice coil, vibrating the diaphragm when current is applied. The diaphragm of the ribbon driver is not in a chamber and is open and visible to the air. The sound waves are not restricted and therefore they do not have the resonant, and therefore distorted, properties of the compression driver. Because the diaphragm of the ribbon driver is so thin and light, it reacts quickly to the electrical signal and does not introduce new or resonated sounds created by the material of the diaphragm itself, resulting in a more pure reproduction of the sound source without adding tones from the ribbon driver. In 2000, we retained Igor Levitsky, an electro-acoustics engineer, to develop a new technology ribbon driver for us. We requested that he develop two different-sized ribbon drivers and we paid a fixed fee for his work. The ribbon driver that we have developed uses new lightweight high-powered magnets and plastics that can withstand high temperatures. This design enables the speaker system to have increased power-handling ability and higher sound volume with substantial reliability and clarity. As we developed our ribbon driver line of loudspeakers we relied on our Tef 20 computer acoustic measurement system to analyze and measure sound waves. This system is the industry standard used by most of the major loudspeaker manufacturers in the design and manufacture of loudspeaker systems. Our Tef 20 system indicated that the ribbon driver systems that we were designing were superior in several ways to compression driver systems. The ribbon driver system had a smoother frequency response. The level of mid-range sound and treble sound was more even and therefore the loudspeaker reproduced sound in a more natural manner. Also, the ribbon driver did not produce the same level of distortion when played at higher sound pressure levels, as compared to the compression driver. These attributes resulted in a positive customer reaction to the quality of sound. 2 The market for the ribbon driver product line is new and growing. Our future success is uncertain because the loudspeaker market is experiencing rapid technological advances, changing customer needs and evolving industry standards. To realize our expectations regarding our operating results, we will depend on: o Market acceptance of our ribbon driver products o Our ability to compete in quality, price and customer service for our products o Our ability to develop, in a timely manner, new products and services that keep pace with developments in technology o Our ability to meet changing customer requirements o Our ability to enhance our current products and services and deliver them efficiently through appropriate distribution channels We estimate that we spent $124,379 in 2005, $77,065 in 2004 and $31,435 in 2003 on research and development activities. None of these costs are borne directly by our customers. PRODUCTS We sell our speaker systems in seven product lines: o The Professional Contractor Speaker System, a more expensive "Professional" line o The Universal Series Speaker System, a less expensive "Commercial" line o The Home Theater Speaker Systems o The Studio Series, for recording and broadcast studios o The Ribbon Line Array (RLA) Series, for contractor installations and touring companies o The Design Series, consisting of in-wall, in-ceiling and outdoor speakers for home theater and commercial installations o The Cinema Line for the cinema and movie theater market Sales of the Commercial line and Professional line of loudspeakers began in 2001. The Home Theater Systems, the Studio Series, the RLA Series and the Design Series were all developed in 2002 and 2003. In March 2004 we displayed our Cinema line of loudspeakers for the first time at the annual Show West Cinema trade show, and in December 2004, we made our first installation of cinema systems using ribbon drivers. Our Professional Contractor Speaker System line now consists of eighteen models of speaker systems, each model consisting of a speaker cabinet and components of ribbon drivers that provide the treble sounds and woofers that provide the bass sounds. This line is usually sold to large contractors and installed in churches, theaters, school auditoriums, casinos, night clubs and touring production companies. 3 Our Commercial line, the Universal Series Speaker System, consists of lower-cost speakers that are designed to be sold by music stores for orchestras, disc jockeys and the less expensive commercial market. There are twelve models of different size, with less expensive components that produce varying sound levels and area coverage capabilities. These models are equal in quality to, but do not produce the sound levels of, our Professional Contractor Speaker System Line. We recently developed a new line of loudspeakers for the home theater market. We intend to direct a substantial effort to capture a greater share of the home theater market. The home theater market requires equipment that uses five or more speakers placed around a room. This configuration provides the listener with "surround sound" similar to a movie theater experience. Almost all current movies are now produced in surround sound, which uses at least five speakers plus a sub-woofer system. Our Home Theater Loudspeaker System consists of four models that use the smallest unit of our Professional Contractor Loudspeaker System as their basis. In 2005 we developed, in conjunction with Quincy Jones, a line of 5.1 Home Theater systems called the "Q-Line." We launched the Q-Line Silver in 2005 in a 100-store test market at a Fortune 50 retailer. We intend to launch the Q-Line Gold in 2006. Our efforts in home theater marketing have led us to market and offer in-wall and in-ceiling speakers for the home theater and commercial segment of our industry. These products are called our Design Series and are being specified in many installations. Due to the unique design of our ribbon drivers we have developed a new series of speaker systems for the contractor installation and touring sound reinforcement markets. These products are part of our new RLA Series. This line has been receiving high acclaim in the industry and we have installed this product line in many prestigious locations. We have developed two new models of speaker systems for the recording studio and broadcast markets and have added them to our existing in-studio speaker that was originally part of our Professional line. We are now designating these three different speaker models as our Studio Series. We re-packaged certain models of our Professional Contractor Sound Systems and Universal Series for the cinema and movie theater market by simplifying the cabinetry. In a typical movie house, the speakers are not displayed in view of the public, which allows for simplified cabinetry. The new cabinetry is designed to be less costly, as are the other components, which we expect to provide our representatives with a cost advantage in marketing our system to cinema owners. At present, a total of ten models have been repackaged for this line. They were introduced to cinema companies in 2004 and sales of the Cinema Line grew at a rapid pace in 2005. Revenue from our ribbon driver product lines is expected to account for a material portion of our revenue for the foreseeable future. Our financial performance will depend on market acceptance of our ribbon driver technology and products. The sound system industry continually introduces technological developments, frequently announces new products, and has evolving industry standards and changing customer requirements. As a result, if our ribbon driver technology and product line do not rapidly achieve sufficient market acceptance, we may not be able to achieve expected revenues or profits. 4 Sales of each product line over the last three years, as a percentage of total sales, were as follows: PRODUCT LINE 2005 2004 2003 ------------ ---- ---- ---- RLA Series 41.3% 41.1% 55.7% Cinema Line 16.6% 3.5% 0 Professional Contractor 11.9% 14.2% 15.9% Home Theater 11.4% 13.7% 10.2% Universal Series 7.8% 14.1% 8.6% Design Series 6.4% 6.5% 1.5% Studio Series 1.6% 1.3% 2.7% Miscellaneous 3.0% 5.6% 5.4% Miscellaneous revenue primarily consists of spare and replacement parts. MANUFACTURING AND SOURCING We generally design and manufacture our own cabinets for our product lines, and on occasion contract certain models manufactured by independent, established, local and other woodcrafters. These manufacturers construct the cabinetry to our specifications. Our ribbon drivers are either directly manufactured or purchased from a non-affiliated manufacturer. The manufacture of our own ribbon drivers has resulted in a meaningful reduction in costs, as well as greater quality control. and we expect that it will enable our products to be more competitively priced. We do not manufacture the woofers used in our speakers. The principal suppliers of our woofers are Belisle Acoustics, Eminence, PHL, Beyma, and Seas Speaker Component Manufacturers. We use suppliers in foreign countries to produce components that are used in some models of our ribbon drivers and our headphone elements. Also, products used in our consumer and home theater product lines are manufactured by companies offshore. These companies are diverse and produce many products for other leading electronics companies and have capacities to deliver product quantities that far exceed our expected needs. Our sources of supply of other component sub-parts are all competitively priced and we have a sufficient number of other sources of supply available to us should the need arise for additional components. If an existing relationship with any current supplier terminates, we do not expect to have any difficulty in replacing that source. Our manufacturing and assembly operations for our core products, including our commercial and cinema lines, are performed at our headquarters in Ozark, Missouri. All of our fixed assets are located in the United States. SALES AND MARKETING Our corporate sales department and our independent consultants are building strong relationships with potential customers including several of the world's leading "big box" retail outlets. Also, the introduction of our Cinema Line in late 2004 and 2005 has been well received, resulting in rapid growth of this product line in 2005. These early results indicate that the Cinema Line will be a good source of revenue in the coming years. 5 One key element of our strategy has been to raise customer awareness by entering into endorsement and promotion agreements with several music and entertainment industry performers and producers, including Gordon Sumner (professionally known as "Sting"), Quincy Jones and Mark Burnett. Further, in an effort to begin selling to the retail market, our corporate sales department has recently targeted major "big box" retailers. In 2005, these efforts resulted in a 100-store test market of our Q-Line Silver home theater system (developed in conjunction with Quincy Jones) at a Fortune 50 retailer. In 2006, we plan to initiate sales of our Q-Line Gold home theater system (also developed in conjunction with Quincy Jones) at a major U.S. electronics retailer. We anticipate the launch of this retail program to coincide with a feature of the Q-Line Gold on the reality television show "Apprentice," produced by Mark Burnett, in the second quarter of 2006. On March 1, 2006, we had a backlog of approximately $377,000 in orders, compared to approximately $182,000 on March 31, 2005. Domestic. In addition to advertising in trade journals and attending industry conventions for promotion and sale of our products, we have established a network of dealers, contractors and distributors. Currently, we have approximately 200 dealers for our Professional and Commercial lines, 20 dealers for our Home Theater line, and 15 international distributors for our Professional, Commercial, and Home Theater lines. These outlets sell our products in approximately three-quarters of the U.S. and 15 foreign countries. The dealer agreements may be terminated without cause by either party on 30 days notice. International. We are also engaged in marketing and promotion internationally. Our international business involves a number of risks, including: o foreign currency exchange fluctuations o political and economic instability o difficulty in managing distributors or sales representatives o tariffs and other trade barriers o complex foreign laws and treaties including employment laws Because our sales are in U.S. currency, foreign currency exchange fluctuations could materially affect us negatively. A decrease in the value of foreign currencies as they relate to the U.S. dollar could make the pricing of our products more expensive than products of our foreign competitors that are priced in foreign currencies. Because of the fluctuating exchange rates and our involvement with a number of currencies, we are unable to predict future operating results. As a percentage of total sales, sales outside the U.S. accounted for 14.9% of sales in 2005, 20.5% in 2004, and 27.4% in 2003. COMPETITION The market for loudspeakers is highly competitive, with competition based primarily on product performance, brand recognition and price. Our speakers compete favorably in both product performance and price, but we lack brand recognition. In addition, most of our competitors are larger and more established companies with larger technical staffs, larger marketing and sales organizations, and significantly greater financial resources than we have. As a result, such competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They are able to devote greater resources to the development, sale and promotion of their products than we are able to devote. They may develop products that are superior in certain respects to our products or may develop products that achieve greater market acceptance. 6 The nature of the market for loudspeaker products is highly competitive, with constant innovation and new technology. As a result, our products may not compete as favorably in performance and price to products that our competitors may introduce in the future. Our success will depend, in part, upon our ability to continue to increase sales in our targeted markets. We may not be able to compete successfully with our competitors and the pressures from competitors may have a material adverse effect on us. Our success will depend in large part upon our ability to increase our share of our target market and to sell additional products to existing customers. However, future competition could result in price reductions, reduced margins or decreased sales of our products. PROPRIETARY TECHNOLOGY We are owners of proprietary ribbon driver technology for our PRD 500 models and PRD 1000 models, and we have one patent application directed to our ribbon driver technology. On September 5, 2002, we filed a patent application entitled "planar ribbon electro-acoustic transducer with high SPL capability and adjustable dipole/monopole low frequency radiation" in the U.S. Patent Office. Although the patent application has been filed, we cannot be certain that a patent will issue from the application or that the patent would give us an advantage over our competitors. The planar ribbon transducer allows for a greater flexibility in frequency responses required for different applications, such as high-fidelity consumer systems and multiple-driver line arrays. The different internal volumes of the transducer allows for different low-frequency characteristics for the transducer. Also, due to the design of our ribbon driver transducers, they do not produce the level of distortion as compared to conventional compression driver and dome tweeter transducers that are used by our competitors. On March 12, 2004, we acquired Evenstar, Inc., by a merger with and into our subsidiary, Evenstar Mergersub, Inc. As a result we became the owner of Evenstar's two patents that issued on May 13, 2003 and September 21, 2004 for Evenstar's digital amplification technology, which provides for substantially reduced production costs compared to amplifiers of comparable quality. These patents are directed to a Class D switching audio amplifier incorporating a four-state modulation that includes input-to-output drive, feedback signal isolation, dual topology output filtration and a low-inductance board layout. Since the acquisition of Evenstar, Evenstar's founder, an electrical engineer who joined SLS after we acquired his company, has been developing several models of the Evenstar amplifiers and making them ready for production. We introduced one of the models at the Audio Engineering Society convention in the fall of 2004 where it received a favorable response. The first Evenstar self-amplified SLS speakers became available in the fourth quarter of 2005 and are receiving favorable reviews by industry professionals. Also, several Evenstar models have been developed for consumer products similar to the new Q Line systems, and we expect to implement our designs into some of these new systems that are currently in the development stage. On May 9, 2005 we filed a provisional patent application in the U.S. Patent Office disclosing a new Evenstar amplification technique incorporating a novel modulation scheme that greatly reduces distortion, noise, and electromagnetic interference. We then filed a non-provisional patent application on June 13, 2005 to protect all common subject matter and benefit disclosed 7 within the provisional application. We entitled this new technology "Sigma Delta Amplification" and have incorporated it into our powered studio monitor PS8R which has been available since November 2005. Two additional powered studio monitors, PS1266 and PS1065, are also being designed to offer the Evenstar Sigma Delta Amplification technology and are expected to be available in 2006. We further plan to incorporate this technology along with the previous Evenstar patents in our powered professional products with expected availability in 2007. On January 5, 2006, we filed a patent application in the U.S. Patent Office for a transducer, headphone and method for reducing noise. The patent application discloses planar ribbon transducer technologies that we are incorporating into our newly developed ribbon noise-canceling (RNC) headphone. Our RNC headphone offers dramatically improved noise reduction and higher sound quality than other noise-canceling headphones currently being offered in the headphone industry. Moreover, the filing of the patent application moves us a step closer to an anticipated product launch targeted for the third quarter of 2006. The RNC headphone incorporates a microphone, a planar ribbon transducer and an electrical circuit for producing and transmitting an anti-noise signal that cancels the sound waves of noise inside the ear cup of the RNC headphone. The technologies disclosed in the patent application also may be applicable to different variations of headset products that may bring new opportunities to us in the future. Laws of some foreign countries do not protect or enforce proprietary rights to the same extent as do laws in the United States. Also, our domestic and international competitors may develop other technology that produces results similar to our technology. We expect that some loudspeaker models may be subject to patent infringement claims as the number of patents issued for products of our competitors grows. As a result, third parties may assert patent infringement claims against us in the future, and some of the claims may not be resolved in our favor. Any such claims, with or without merit, could be time-consuming and may result in costly litigation or may require us to enter into royalty or licensing agreements. The royalty or licensing agreements, if they become necessary, may not be available on terms that are favorable to us, or may not be available at all. In addition, we may be forced to commence litigation in the future to protect our trade secrets or proprietary rights, or to determine the validity and extent of the proprietary rights of others. Any litigation could result in substantial costs and diversion of our energy and resources. EMPLOYEES As of March 1, 2006 we have a total of 52 employees, four of which are executive, six are administrative, seven are in marketing and sales, one is in technical communications, six are in engineering, and 28 are in production. In the past, we have employed additional temporary and part-time employees to meet production obligations and fill orders. There is presently no labor union contract between any union and us. We do not anticipate our employees will seek to form or join a union for the foreseeable future. BUSINESS STRATEGY Sales by our Professional, Commercial, Cinema and Design Series distributors, as well as sales by our corporate sales department to "big box "retailers, are expected to be our primary source of business in coming years. We have promoted our Professional, Commercial, Cinema and Design Series products primarily through our dealer and sales representative network, conventions and trade magazines. 8 As our products gain recognition for their high-quality sound in the Professional and Commercial markets, we expect to capitalize on our reputation to market extensively to retail consumers. Our initial foray into the retail market has begun with the distribution of our Q-Line home theater systems. The Q-Line Silver has been sold in a test market of 100 stores at a Fortune 50 retailer. The retailer prohibited any marketing of the product while in such stores, but the product gained some brand recognition as our loudspeakers were used on the reality-based television series "Rock Star: INXS." In 2006, we plan to initiate sales of our Q-Line Gold home theater system at a major U.S. electronics retailer. We anticipate the launch of this retail program to coincide with a feature of the Q-Line Gold on the reality television show "Apprentice," produced by Mark Burnett, in the second quarter of 2006. Achievement of our business plan depends in large part on a significant sales increase in 2006 as a result of the launch of the Q-Line Gold home theater system. We intend to continue to develop products for additional segments of the consumer speaker markets, including personal sound systems that include headphones, MP-3 players, personal stereo docking stations, personal computer sound systems, and gaming system sound products as well as car audio and video systems. All of these markets have been reviewed and our technology has been implemented in several prototypes to compare to the competition. Our business plan includes the launch of one of these new products in 2006. We manufacture our own ribbon drivers, which provides cost savings compared to the cost of purchasing compression drivers or ribbon drivers from third parties, as well as greater quality control. We believe that both the cost savings and the quality of the lower distortion, as demonstrated by our Tef 20 analysis device, provide us with competitive advantages to establish a place in the home, commercial and professional loudspeaker markets. At the appropriate time, we intend to investigate possible strategic alliances with key industry participants to strengthen our image, our product components and our distribution pattern. We cannot be certain that a future alliance opportunity will present itself or, if an opportunity is presented, that it will result in a profitable working relationship. Our ability to develop and effectively market our existing products and new products is highly speculative and dependent on the availability of capital, our suppliers' performance, consumer acceptance of our products, performance by our competitors, and other risks, some of which are set forth below under the heading "Risk Factors." ITEM 1A. RISK FACTORS. An investment in our common stock involves various risks, including those described in the risk factors below. You should carefully consider these risk factors, together with all of the other information included and incorporated by reference in this report, before you decide to invest in our common stock. If any of the following risks, or any other risks not described below, develop into actual events, then our business, financial condition, results of operations, or prospects could be materially adversely affected, the market price of our common stock could decline further and you could lose all or part of your investment. 9 RISKS RELATED TO OUR BUSINESS WE HAVE A HISTORY OF LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE IF WE DO NOT ACHIEVE SUFFICIENT REVENUE TO ABSORB RECENT AND PLANNED EXPENDITURES. We have experienced significant operating losses since investing in the development of ribbon driver technology in 1998 and, through December 31, 2005 have an accumulated retained deficit of approximately $36,799,515. If we do not achieve continued revenue growth sufficient to absorb our recent and planned expenditures, we could experience additional losses in future periods. WE WILL DEPEND ON ADDITIONAL CAPITAL. Our ability to implement our strategy and expand our operations largely depends on our access to capital. To implement our long-term strategy, we plan to make ongoing expenditures for the expansion and improvement of our product line and the promotion of our products. To date, we have financed our operations primarily through sales of equity and the issuance of notes. We will need to issue additional equity or other securities to obtain the financing required to continue our operations. However, additional capital may not be available on terms acceptable to us. Our failure to obtain sufficient additional capital could curtail or alter our growth strategy or delay needed capital expenditures. OUR DEPENDENCE UPON THIRD-PARTY DEALERS FOR SALES MAKES US VULNERABLE TO THE EFFORTS OF OTHERS WHICH ARE BEYOND OUR CONTROL. Our distributors may not continue their current relationships with us and they may give higher priority to the sale of our competitors' products. In addition, to be effective, distributors must devote significant technical, marketing and sales resources to an often lengthy sales cycle. Our current and future distributors may not devote sufficient resources to market our products effectively and economic or industry conditions may adversely affect their ability to market or sell for us. A reduction in sales efforts or a discontinuation of distribution of our products by any distributor could lead to reduced sales and greater net losses. WE MAY NOT GAIN MARKET ACCEPTANCE OF OUR RIBBON DRIVER TECHNOLOGY. We believe that revenues from our ribbon driver product line will account for a material portion of our revenue for the foreseeable future. Our future financial performance will depend on the market acceptance of our ribbon driver technology and products. To date, we have had limited sales of products containing our new technology ribbon drivers. If our ribbon driver technology and product line do not gain sufficient positive market acceptance, we may not achieve anticipated revenue, profits or continued viability. IN THE LOUDSPEAKER MARKET, WE ARE SUBJECT TO INTENSE COMPETITION. Although our ribbon driver loudspeaker products are relatively new and emerging, the markets for loudspeaker products are extremely competitive and we expect such competition to increase. The market for sound enhancement products in general is intensely competitive and sensitive to new product introductions or enhancements and marketing efforts by our competitors. The market is sustained by ongoing technological developments, frequent new product announcements and introductions, evolving industry standards and changing customer requirements. We expect to experience increasing levels of competition in the future. Although we have attempted to design our loudspeaker systems to compete favorably with competitive products, we may not be able to establish and maintain our competitive position against current or potential competitors. Aggressive competition could cause us to have sales and profitability below expectations. 10 IF WE ARE UNABLE TO HIRE OR RETAIN QUALIFIED AND SKILLED PERSONNEL AS NECESSARY, WE MAY NOT BE ABLE TO DEVELOP NEW PRODUCTS OR SUCCESSFULLY MANAGE OUR BUSINESS. We believe our success will depend in large part upon our ability to identify, attract and retain highly skilled managerial, engineering, sales and marketing, finance and operations personnel. However, we may not be successful in identifying, attracting and retaining such personnel. Our success also depends to a great degree upon the continued contributions of our key management, engineering, sales and marketing, finance and manufacturing personnel, many of whom would be difficult to replace. In particular, we believe that our future success depends on John Gott, Chief Executive Officer. We presently maintain key person life insurance on Mr. Gott in the amount of $5 million, and we have an employment contract with him that expires in June 2008. If we experience the loss of the services of any of our key personnel, we may be unable to identify, attract or retain qualified personnel in the future. This could make it difficult for us to manage our business and meet key objectives, or achieve or sustain profits. OUR PATENT APPLICATION MAY NOT BE ISSUED AND EVEN IF IT IS ISSUED, WE STILL MAY NOT BE ABLE TO ADEQUATELY PROTECT THE PATENT OR OUR OTHER INTELLECTUAL PROPERTY. In September 2002, we filed a U.S. patent application on one portion of our proprietary ribbon driver technology. Our success will depend in significant part on our ability to obtain, preserve and defend U.S. patent protection for this technology. The patent may not be issued from the patent application. The issuance of a patent is not conclusive as to its validity or enforceability and, if a patent is issued, it is uncertain how much protection, if any, will be given to our patent if we attempt to enforce it. Litigation, which could be costly and time consuming, may be necessary to enforce our current patents or any patent issued in the future or to determine the scope and validity of the proprietary rights of third parties. A competitor may successfully challenge the validity or enforceability of a patent or challenge the extent of the patent's coverage. If the outcome of litigation is adverse to us, third parties may be able to use our patented technology without payment to us. Even if we are successful in defending such litigation, the cost of litigation to uphold the patent can be substantial. 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. We filed two additional patents in 2005 and one more in January 2006. It is possible that competitors may infringe our patents or successfully avoid them through design innovation. To stop these activities we may need to file a lawsuit. These lawsuits are expensive and would consume time and other resources. In addition, there is a risk that a court would decide that our patent is not valid, that we do not have the right to stop the other party from using the inventions, or that the competitor's activities do not infringe our patent. Our competitive position is also dependent upon unpatented technology and trade secrets, which may be difficult to protect. Others may independently develop substantially equivalent proprietary information and techniques that would legally circumvent our intellectual property rights. Currently, we have not registered any potential trademarks and we may not be able to obtain registration for such trademarks. THE USE OF OUR TECHNOLOGIES COULD POTENTIALLY CONFLICT WITH THE RIGHTS OF OTHERS. Our competitors, or others, may have or may acquire patent rights that they could enforce against us. If our products conflict with patent rights of others, third parties could bring legal actions against us or our suppliers or customers, claiming damages and seeking to enjoin manufacturing and marketing of 11 the affected products. If these legal actions are successful, in addition to any potential liability for damages, we could be required to alter our products or obtain a license in order to continue to manufacture or market the affected products. We may not prevail in any legal action and a required license under the patent may not be available on acceptable terms or at all. The cost to us of any litigation or other proceeding relating to intellectual property rights, even if resolved in our favor, could be substantial. WE MUST EXPAND OUR OPERATIONS TO COMMERCIALIZE OUR PRODUCTS, WHICH WE MAY NOT BE ABLE TO DO. We will need to expand and effectively manage our operations and facilities to successfully pursue and complete our commercialization efforts. We will need to add personnel, including management, and expand our capabilities, which may strain our existing managerial, operational, financial and other resources. To compete effectively and manage our growth, we must train, manage and motivate a substantially larger employee base, accurately forecast demand for our products and implement operational, financial and management information systems. In the event that we fail to expand or manage our growth effectively or if we cannot recruit qualified employees, our commercialization efforts could be curtailed or delayed. WE MAY ACQUIRE OTHER BUSINESSES OR TECHNOLOGIES, AND WE MAY NOT BE ABLE TO INTEGRATE AND OPERATE THE ACQUISITIONS. In March 2004 we acquired Evenstar, Inc. From time to time, we have considered the acquisition of other businesses or other technologies, and we continue to consider such acquisitions as opportunities arise. Some of these businesses and technologies, including Evenstar, are directly related to our business and others are not. If we make any such acquisitions, we may not be able to efficiently combine our operations with those of the businesses or technologies we acquire without encountering difficulties. These difficulties could result from a variety of issues, including incompatible operating practices, corporate cultures, product lines, or technologies. As a result, we may have difficulties in integrating, managing and operating the acquired businesses and technologies. RISKS RELATED TO OUR SECURITIES SINCE OUR COMMON STOCK IS THINLY TRADED, IT CAN BE SUBJECT TO EXTREME RISES OR DECLINES IN PRICE, AND YOU MAY NOT BE ABLE TO SELL YOUR SHARES AT OR ABOVE THE PRICE YOU PAID. You may have difficulty reselling shares of our common stock. You may not be able to resell your shares at or above the price you paid, or at a fair market value. The stock markets often experience significant price and volume changes that are not related to the operating performance of individual companies. These broad market changes may cause the market price of our common stock to decline regardless of how well we perform as a company. FUTURE SALES OF COMMON STOCK COULD DEPRESS THE PRICE OF OUR COMMON STOCK. Future sales of substantial amounts of our common stock pursuant to Rule 144 under the Securities Act of 1933 or otherwise could have a material adverse impact on the market price for the common stock at the time. On March 6, 2006, there were approximately 15,746,613 outstanding shares of our common stock held by stockholders that are deemed "restricted securities" as defined by Rule 144 under the Securities Act. The resale of many of these shares has been registered on a registration statement filed with the U.S. Securities and Exchange Commission. Upon sale pursuant to such registration statement, the shares would no longer be restricted securities. Also, under certain 12 circumstances, these shares may be sold without registration pursuant to the provisions of Rule 144. In general, under Rule 144, a person (or persons whose shares are aggregated) who has held the stock for one year may, under certain circumstances, sell within any three-month period a number of restricted securities that does not exceed the greater of 1% of the shares outstanding or the average weekly trading volume during the four calendar weeks preceding the notice of sale required by Rule 144. In addition, Rule 144 permits, under certain circumstances, the sale of restricted securities without any quantity limitations by a non-affiliate who has held the security for two years. Any sales of shares by stockholders pursuant to a registration statement or Rule 144 may have a depressive effect on the price of our common stock. WE MAY HAVE LIABILITY FOR PRIOR ISSUANCES OF OUR STOCK. From May 1, 2002 through May 10, 2004, warrant holders exercised 2,545,800 of our Class A Warrants and 22,600 of our Class B Warrants for a total of 2,568,400 shares of common stock. The warrant holders paid an aggregate of $1,340,700 for these exercises. From May 1, 2002 through May 10, 2004, the registration statement that we filed with the U.S. Securities and Exchange Commission to register the common stock issuable upon exercise of these warrants 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 intended to, but ultimately did not, make a rescission offer in 2005 to all warrant holders who exercised warrants during the period from May 1, 2002 through May 10, 2004. 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 any 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. We did not make the rescission offer in 2005, as we focused instead on capital-raising, new product launches, and other activities. In 2006, we intend to determine whether to make the rescission offer or to allow the statute of limitations to continue to run through their expiration under applicable state law. SHARES OF CONVERTIBLE PREFERRED STOCK MAY NOT HAVE BEEN VALIDLY ISSUED. In 2001 - 2003, we sold shares of our Convertible Preferred Stock, which is sometimes reflected in our financial statements as our Series A Preferred Stock. We subsequently discovered that the certificate of designation for the Convertible Preferred Stock had not been filed, and we made such filing in December 2004. The delay in filing the certificate of designation may have resulted in the shares of Convertible Preferred Stock not being validly issued under Delaware law. To date, we have issued 1,891,473 shares of the Convertible Preferred Stock, all of which were issued prior to the filing of the certificate of designation and 44,000 of which remain outstanding on March 21, 2006. All other shares have converted to common stock on a 10-to-1 basis, at a conversion price of $0.25 per share. We believe that the conversion to common stock cures any issues related to the potential invalid issuance of shares of Convertible Preferred Stock. We may have rescission liability for the 44,000 shares that have not converted, subject to the prior expiration of applicable statutes of limitation. 13 CERTAIN RESTRICTIVE COVENANTS MAY LIMIT OUR ABILITY TO RAISE ADDITIONAL CAPITAL AND AFFECT OTHER ASPECTS OF OUR BUSINESS. In our January 2005 private placement of Series C Preferred Stock and warrants, we entered into a securities purchase agreement with the investors. The agreement and the certificate of designation for the Series C Preferred Stock contain numerous covenants that limit our financing and other activities, including those described in the following paragraphs. In late 2005 and early 2006, we have been attempting to raise additional capital, and the restrictions contained in this agreement and the certificate of designation, have created a significant impediment to our capital-raising efforts. So long as at least 3,750 shares of the Series C Preferred Stock are outstanding and held by the original purchasers thereof, we may not pay any cash dividends, make distributions, redeem or repurchase any capital stock, or repay or prepay any previously existing indebtedness of ours other than as expressly required pursuant to the terms of such indebtedness. So long as any shares of the Series C Preferred Stock are beneficially owned by the original purchasers thereof, we may not issue or sell any rights, warrants or options to subscribe for or purchase our common stock, or any other securities directly or indirectly convertible into or exchangeable or exercisable for our common stock, at an effective conversion, exchange or exercise price that varies or may vary with the market price of our common stock. Prior to January 3, 2007, the investors in the January 2005 private placements have a right to participate in any issuance of equity securities, equity-linked securities, or convertible debt, subject to certain exceptions. The participation rights may prevent other potential investors from making offers for, or entering into agreements to purchase, our securities and thereby limiting our ability to raise capital. If we issue our common stock at a price per share less than the then-current exercise price of the 6,000,000 warrants issued together with the sale of our Series C Preferred Stock, the exercise price of the warrants shall be adjusted downward pursuant to a formula set forth in the warrants. WE ARE OBLIGATED TO REDEEM OUR SERIES C PREFERRED STOCK UPON THE OCCURRENCE OF CERTAIN EVENTS. Pursuant to the terms of the certificate of designation for our Series C Preferred Stock, we are required to redeem the Series C Preferred Stock upon the occurrence of certain events, including the following: o our common stock is suspended from trading on any of, or is not listed or quoted (and authorized) for trading on at least one of, the New York Stock Exchange, the American Stock Exchange, the NASDAQ National Market, the NASDAQ Capital Market or the OTC Bulletin Board for an aggregate of ten or more trading days in any twelve-month period; o the registration statement that registered the resale of shares of common stock issuable upon conversion of the Series C Preferred Stock and exercise of the warrants, after being declared effective, cannot be used by the holders of Series C Preferred Stock for the resale of all of the common stock issuable to them for an aggregate of more than 20 days, subject to certain exceptions; o we make an assignment for the benefit of creditors, or apply for or consent to the appointment of a receiver or trustee for us or for a substantial part of our property or business, or such a receiver or trustee shall otherwise be appointed; 14 o bankruptcy, insolvency, reorganization or liquidation proceedings or other proceedings for the relief of debtors shall be instituted by or against us or any subsidiary of ours and if instituted against us or any of our subsidiaries by a third party, shall not be dismissed within 60 days of their initiation; o if at least 3,750 shares of Series C Preferred Stock are outstanding and held by the original purchasers thereof and we do any of the following: (a) sell, convey or dispose of all or substantially all of our assets; (b) consummate specified mergers, consolidations or business combinations; (c) engage in transactions providing for sales or issuances by us or our stockholders that result in the purchaser owning or having the right to acquire greater than 35% of the outstanding shares of our common stock (calculated on a fully diluted basis); or (d) issue or agree to issue any equity or equity-linked securities or debt that is convertible into equity or in which there is an equity component, subject to certain exceptions; o we either fail to make any payment with respect to any of our indebtedness in excess of $250,000, subject to certain exceptions, or default under any agreement binding us, subject to certain exceptions; or o we breach any material term under the certificate of designation for our Series C Preferred Stock, the Series C Preferred Stock securities purchase agreement, the registration rights agreement or the warrants attached to the Series C Preferred Stock, subject to certain exceptions. Any such redemption would be made at a premium in excess of the purchase price of the shares of Series C Preferred Stock, as determined by a formula set forth in the certificate of designation for the Series C Preferred Stock. These requirements may cause us to pay a significant amount of money to redeem the Series C Preferred Stock or may cause us to avoid taking certain actions in order to prevent the occurrence of such redemption requirement. WE MAY BE REQUIRED TO PAY SUBSTANTIAL AMOUNTS TO THE INVESTORS IN OUR JANUARY 2005 PRIVATE PLACEMENT UPON THE OCCURRENCE OF CERTAIN EVENTS. In connection with the January 2005 private placement of our Series C Preferred Stock and warrants, we agreed to file a registration statement to register the resale of shares of our common stock by the investors in the private placement. We have an obligation to register additional shares that may be issuable from time to time as a result of potential adjustments to the preferred stock and warrants. We filed a registration statement to register the resale of these shares, and the registration statement was declared effective in February 2005. We could be required to pay amounts to each investor upon the occurrence of certain events, including (a) the number of the investors' shares registered on the registration statement is less than the number then issued or issuable to such investors pursuant to the Series C Preferred Stock and warrants; (b) sales of our common stock can not be made pursuant to the registration statement; or (c) our common stock is not traded, listed or included for quotation, as applicable, on the OTC Bulletin Board, American Stock Exchange or other stock exchanges or certain automated quotation systems. Each of the foregoing events are, to some extent, beyond our control. 15 If any of the foregoing events occur, then we would be required to pay each investor an amount equal to the product of (x) the number of shares of Series C Preferred Stock held by such investor (plus any shares of preferred stock that have been converted into shares of our common stock then held by such investor as if such shares of preferred stock had not been so converted) multiplied by the per share purchase price, multiplied by (y).02 for each thirty-day period prior to the elimination or termination of such event. Assuming that the 6,000,000 shares of Series C Preferred Stock originally issued remain the number outstanding during such periods, then the amounts payable pursuant to such provisions are $300,000 each thirty-day period. ITEM 1B. UNRESOLVED STAFF COMMENTS. This item is inapplicable, as we currently have no unresolved staff comments. ITEM 2. PROPERTIES. On February 10, 2006, following the sale of our headquarters, we entered into a Lease Agreement whereby we agreed to lease our headquarters, approximately 150,000 square feet, at 1650 W. Jackson, Ozark, Missouri from FRS, LLC, a Missouri limited liability company. Pursuant to the agreement, we agreed to lease the property for ten years, with a lease rate of $37,500 per month for the first five years and $43,750 per month thereafter, with adjustments and additional charges set forth in the agreement. Under the lease, we are responsible for expenses for taxes, insurance, maintenance and utilities at the property. For accounting and tax purposes, the lease is to be treated as an operating lease. The sole member of FRS, LLC is Rick Gregg. John M. Gott, our CEO and a Director, is a Manager and a Member owning a 50% interest in Bull Creek Ranch LLC. Rick Gregg is also a Member owning a 50% interest in Bull Creek Ranch LLC. Bull Creek Ranch, LLC is a former owner of the property at 1650 W. Jackson, Ozark Missouri, but was not a party to the purchase and sale, or the lease, described above. Nevertheless, due to the common ownership of Bull Creek Ranch LLC by Messrs. Gott and Gregg, FRS, LLC may be deemed as an affiliate of SLS International, Inc. for certain purposes. We believe that the sale of real estate and lease described above were consummated on arm's-length terms. ITEM 3. LEGAL PROCEEDINGS. In 2003, we completed a private placement of shares of our Series A Preferred Stock. One of the investors in the private placement was Dr. Christopher H. Brown. Dr. Brown purchased 20,000 shares of the Series A Preferred Stock for $50,000. After we closed the offering, Dr. Brown claimed that he submitted two separate subscription agreements and two separate checks, one of which was in the name of Dr. Brown and the other in the name of his professional corporation, Christopher H. Brown, B.S. Dent., D.D.S., P.A. He specifically claims that his professional corporation sought to purchase an additional 24,000 shares of our Series A preferred stock for $60,000. We have informed Dr. Brown that we received only one subscription agreement and one check, and we have cashed only the one check. Nevertheless, Dr. Brown filed suit against us, alleging breach of contract and negligence, in the U.S. District Court for the Western District of North Carolina (Christopher H. Brown, M.D., v. SLS International, Inc., filed April 29, 2005). His First Amended Complaint seeks 24,000 preferred shares in exchange for his payment of $60,000, or alternatively "money damages in an amount to be determined at trial, based on SLS' failure to timely issue [him] 24,000 shares of preferred stock," in addition to other unspecified relief. 16 In February 2004, we entered into an agreement with the owners of SA Sound B.V. and SA USA, Inc., providing us with an option to acquire such companies at any time prior to February 27, 2004 for a purchase price of 370,000 euros. We paid 50,000 euros for this option. The option agreement entitled us to a return of the option purchase price if the sellers failed to negotiate such stock purchase agreement in good faith, or if our due diligence disclosed material adverse facts about the companies. After completion of our due diligence, we determined not to exercise the option, and we asserted our right to a return of the option purchase price. The sellers challenged the return of such price and we sued the escrow agent in the Supreme Court of the State of New York (SLS International, Inc. v. B&B Beneer B.V., Campex Holding B.V., Serge Van Tuyn and Marcel Van Tuyn filed July 27, 2004). ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. This item is inapplicable, as no matters were submitted to a vote of our security holders during the quarter ended December 31, 2005. 17 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. Our common stock began trading on the Over-the-Counter Bulletin Board under the symbol "SITI.OB" on June 27, 2001. On October 13, 2005, we began trading on the American Stock Exchange under the symbol "SLS." The table below sets forth, by quarter, the sales information for our common stock as reported on the Over-the-Counter Bulletin Board and American Stock Exchange in our last two fiscal years. Prior to October 13, 2005, this information reflects bid prices, and thereafter sales prices. This information reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. PERIOD LOW HIGH - ----------------------------------------------------- ----------- ---------- Quarter Ended December 31, 2005 $0.97 $1.99 Quarter Ended September 30, 2005 $1.73 $2.52 Quarter Ended June 30, 2005 $1.90 $2.67 Quarter Ended March 31, 2005 $1.86 $3.04 Quarter Ended December 31, 2004 $1.47 $2.90 Quarter Ended September 30, 2004 $1.25 $2.85 Quarter Ended June 30, 2004 $2.21 $3.00 Quarter Ended March 31, 2004 $2.65 $3.46 On March 21, 2006, there were approximately 231 holders of record of our common stock, based on information furnished by our transfer agent. On March 21, 2006, the closing price of our common stock on the American Stock Exchange was $1.13 per share. We urge you to obtain current market quotations for shares of our common stock. We have not paid any cash dividends in our past two fiscal years and do not anticipate paying cash dividends in the foreseeable future. We intend to retain future earnings to fund the development and growth of our business. Any payment of dividends in the future will be at the discretion of our board of directors and will be dependent upon our earnings, financial condition, capital requirements and other factors deemed relevant by our board of directors. 17 SALES OF UNREGISTERED SECURITIES, AND REPURCHASES OF SECURITIES, DURING THE 2005 FOURTH QUARTER We did not issue any shares of common stock that were not registered under the Securities Act of 1933, as amended, and we did not repurchase any of our securities, during the quarter ended December 31, 2005. EQUITY COMPENSATION PLANS On December 31, 2005, we had the following securities issued and available for future issuance under equity compensation plans:
- ------------------------------------------------------------------------------------------------------------------------------- (C) NUMBER OF SECURITIES (A) REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO (B) FUTURE ISSUANCE UNDER EQUITY BE ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES REFLECTED WARRANTS AND RIGHTS WARRANTS AND RIGHTS IN COLUMN (A)) - ------------------------------------------------------------------------------------------------------------------------------ EQUITY COMPENSATION 2,270,000 shares of $1.62 per share 1,875,000 shares of PLANS APPROVED BY common stock common stock SECURITY HOLDERS - ------------------------------------------------------------------------------------------------------------------------------ EQUITY COMPENSATION 4,141,529 shares of $2.28 per share 0 PLANS NOT APPROVED common stock BY SECURITY HOLDERS - ------------------------------------------------------------------------------------------------------------------------------ TOTAL 6,411,529 shares of $1.70 per share of 1,875,000 shares of common stock common stock common stock - ------------------------------------------------------------------------------------------------------------------------------
For a description of the equity compensation plans not approved by our security holders (which consist solely of individual compensation arrangements for the benefit of consultants or pursuant to promotion agreements), see note 9 to our financial statements beginning on page F-1. ITEM 6. SELECTED FINANCIAL DATA FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31 2001 2002 2003 2004 2005 ------------ ------------ ------------ ------------ ------------ Revenue $ 353,797 $ 790,582 $ 968,245 $ 2,040,575 $ 4,015,099 Operating income (loss) (1,001,462) (2,215,26) (4,125,208) (8,646,333) (11,409,071) Net loss (1,040,174) (2,242,325) (3,979,341) (8,599,899) (10,004,388) Net loss per share $ (0.06) $ (0.14) $ (0.23) $ (0.38) $ (0.29) Cash and cash equivalents 48,390 4,240 1,482,786 10,712,858 195,573 Total assets 407,543 463,907 2,677,791 13,662,996 10,613,247 Long-term obligations 2,321 0 15,931 10,951 7,367 Shareholders' equity (262,166) (562,262) 2,248,489 12,645,461 8,749,853
18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. SLS International, Inc. was formed on July 25, 2000 and had no previous operations. On the same date, this corporation merged with Sound and Lighting Specialist Inc., its sole shareholder, and SLS International, Inc. was the surviving corporation. 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 Year ended December 31, 2005 as compared to the year ended December 31, 2004. For the year ended December 31, 2005, revenue increased 97% to $4,015,099 from $2,040,575 in 2004; which itself was a 111% increase from the $968,245 in revenue achieved in 2003. This continued "doubling of revenue" is a result of the further roll-out of our product line and customer acceptance of our products. Our newest product line, the Cinema Line accounted for 16.6% of total 2005 revenue compared to less than 4% in 2004, representing an increase of more than eight fold in dollar volume in one year. Our "core" lines of the Professional, Design, and RLA series all increased in excess of 75% in 2005 over 2004 levels. Gross profit percentage decreased to 24% in 2005 from 26% in 2004. During 2005, we moved our plant from a 35,000 square foot facility to our new location in Ozark, Missouri, which has 150,000 square feet. While our new facility significantly increases our production capacity, at the present time it is being underutilized until our volume of manufacturing activity increases. The move to the new building has increased our fixed plant costs. This increase in manufacturing overhead accounts for approximately 6% of our sales and therefore has reduced the gross profit rate by that amount. Had it not been for these additional costs our gross profit for 2005 would have increased to 30%. Improvement in our gross profit is expected as manufacturing volume increases faster than the fixed costs associated with our new facility. 19 General and administrative expenses for 2005 increased to $12,413,227 ($3,029,408 of which were non-cash charges) from $9,179,555 in 2004 ($5,166,737 of which were non-cash charges). The following table compares categories of our general and administrative expenses in 2005 to 2004: Year Ended Year Ended December 31, December 31, 2005 2004 ----------- ----------- Non-cash G&A expense items: Charges for stock and options issued for consulting and investor relation services $ 2,500,453 $ 4,179,266 Charges for options issued to directors and officers 372,191 87,786 Impairment charge - Evenstar, Inc. -- 848,502 Depreciation 156,764 51,183 ------------ ------------ Total non-cash G&A expenses 3,029,408 5,166,737 Cash G&A expense items: Advertising and promotion 2,860,994 572,364 Professional fees, consulting & investor relations 2,677,415 1,409,918 Compensation 1,608,216 701,186 Travel & Entertainment 594,929 200,529 Facilities 331,635 57,244 Office Support 299,816 77,006 Acquisitions - BG deal expired 100,000 -- Impairment charge - Evenstar, Inc -- 300,000 Other cash G&A expenses 910,814 694,571 ------------ ------------ Total cash G&A expenses 9,383,819 4,012,818 ------------ ------------ Total G&A expenses $12,413,227 $ 9,179,555 ============ ============ As shown in the preceding table, our cash G&A costs increased significantly in all areas. Advertising and promotional expenses increased a total of $2,288,631 due to increased activity in 2005 trade shows ($257,839), costs to produce demo and promotional units ($303,900), branding campaigns to achieve name recognition with retail customers ($1,005,805), promotional and educational videos ($52,500), and general increases in traditional media and collateral material ($668,587). The additional 22 employees at December 31, 2005 over December 31, 2004, including two new executives, additions to the administrative, sales, and engineering staffs, and new personnel in production increased total cash compensation (including benefits and taxes) by $907,030. Legal and accounting fees increased by $218,248 and consulting and investor relation services increased $1,049,249 for a total increase in Professional Fees and Consulting costs of $1,267,498. Included in this category are costs in excess of $600,000 directly attributable to compliance and additional audit costs of the Sarbanes Oxley Act, all incurred during 2005. Travel and entertainment costs associated primarily with more employees and increased sales and promotion activities increased $394,400 during 2005 over 2004. The move to our new facility resulted in increased insurance, building upkeep, and utilities amounting to $274,391. Non-cash costs decreased by $2,137,329. Increased compensation costs from stock options provided to officers and directors amounted to $284,405. Increased depreciation from our investment in plant and equipment was $105,581. Total stock based payments to consultants decreased a total of $1,678,813, comprised of a $723,183 increase in investor relations programs offset by a decrease of $2,041,730 in marking and promotional programs. Nearly all of the increase in investor relations programs arose from our CEO's grants of his personal stock or options for such stock to consultants of the Company. The decrease in promotional payments is due to the fact that most of the cost of our promotional agreements with Sting, Quincy Jones, and Mark Burnett occurred in 2004. In 2005 we reported a net loss of $10,004,338 as compared to a net loss of $8,599,899 in 2004. The loss from operations in 2005 amounted to $11,463,955 compared to the loss from operations in 2004 of $8,646,333. 20 Other income increased to $1,459,567 in 2005, compared to other income of $46,424 in 2004, due primarily to a non cash gain of $1,506,112 on the change in the valuation of our Class D warrants and interest income of $192,967 from certificates of deposits on hand during2005. This gain was partially offset by the loss of $234,000 incurred when we moved out of our prior headquarters in Springfield, Missouri. Year ended December 31, 2004 as compared to the year ended December 31, 2003. For year ended December 31, 2004, revenue increased to $2,040,575 from $968,245 in 2003, as a result of the further roll-out of our product line and customer acceptance of our products. Gross profit percentage decreased to 26% in 2004 from 38% 10 2003, primarily as a result of new personnel that were in training and sales of several large systems at high promotional discounts. General and administrative expenses in 2004 increased to $9,179,555 ($5,166,737 of which were non-cash charges) from $4,492,237 in 2003 ($1,799,248 Of which were non cash charges). Included in the increased general and administrative expenses are one-time charges totaling $1,658,889 for promotional services provided by performing artist Quincy Jones through Global Drumz, Inc. Of these charges, $1,408,889 are included as non-cash charges for stock and options issued for consulting and investor relations services and $250,000 are included as cash charges for consulting and investor relation services. In 2004, we reported an increased net loss of $8,599,859 as compared to a net loss of $3,979,341 in 2003, primarily as a result of the increased general and administrative expenses as well as a decrease in other income, which were partially offset by increased revenue. Other income decreased to $46,434 in 2004, compared to other income of $145,864 in 2003, due primarily to other income recognized in 2003 from the write-off of accounts payable. CONTRACTUAL OBLIGATIONS
- ---------------------------------------- ------------- -------------- -------------- ------------ Total Less than 1 1-3 years More than year 3 years - ---------------------------------------- ------------- -------------- -------------- ------------ Capital Lease Obligations $11,743 $4,376 $7,367 -0- - ---------------------------------------- ------------- -------------- -------------- ------------ Purchase Obligations $150,000 $150,000 -0- -0- - ---------------------------------------- ------------- -------------- -------------- ------------ - ---------------------------------------- ------------- -------------- -------------- ------------
FINANCIAL CONDITION On December 31, 2005, our current assets exceeded current liabilities by $3,721,485 as compared to December 31, 2004 when our current assets exceeded current liabilities by $12,229,108. On December 31, 2005, total assets exceeded total liabilities by $8,749,855 compared to December 31, 2004 when total assets exceeded total liabilities by $12,645,461. The decrease in working capital of $8,507,623 was due primarily to the use of cash to fund our operating loss, an increase in inventory of $2,284,648, the use of $3,500,000 for the February 2005 purchase of our new headquarters building in Ozark, Missouri, and other improvements and equipment purchases of $1,142,660; offset by an increase in accounts payable and other current liabilities of $849,442. In 2005, 2004 and 2003, we entered into consulting agreements that required us to issue an aggregate of 4,115,452 shares of common stock, options to purchase 100,000 shares of Class A Preferred Stock (each such share of preferred stock is convertible into 10 shares of common stock), and options to purchase 2,500,000 shares of our common stock. Total expenses accrued under such agreements were $3,452,802, $2,141,938 of which has been amortized through December 31, 2005, and the remainder of which is to be amortized in subsequent periods over the respective terms of such agreements. The difference between such total expenses and the amount amortized is reflected as unamortized cost of stock issued for services on the balance sheet. Accounts receivable increased 126% to $614,048 on December 31, 2005, compared to $271,429 on December 31, 2004. This increase was primarily due to the increased sales volume in 2005, especially fourth quarter of 2005 over the same period of 2004 21 Net fixed assets increased to $4,925,400 on December 31, 2005, from $437,304 a year earlier, due primarily to the February 2005 purchase of our new headquarters building and the purchase of a motor coach and new equipment, including office furniture and computers. Accrued liabilities decreased to $172,919 on December 31, 2005 from $630,503 on December 31, 2004, because in 2004 we had $600,000 of accrued finder's fees payable in connection with the deposits on sales of Series C Preferred Stock, which closed in January 2005, as described below. 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. In addition we have not paid notes payable and accounts payable on due dates. 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. Compared to year-end 2004, we are currently experiencing a significant decrease in our cash position, as we only had $195,573 in cash on December 31, 2005. This decrease was caused by an increase in inventories of $2.5 million (40% of which is represented by the Q-line Silver home theater systems), an increase in our fixed assets of $4.9 million mainly due to the purchase of our new headquarters building in Ozark, Missouri as well as other improvements and equipment, and the use of funds for our operating loss of $8 million; all which are partially offset by the $4.9 million in cash received by sale of our stock. In February 2006, we sold the headquarters building for gross proceeds of $4 million, temporarily improving our cash position. However, we still will be required to raise additional capital in or prior to the second quarter of 2006, or our operations and our ability to continue as a going concern will be significantly affected by capital constraints. In 2004 we privately sold our Series B Preferred Stock for total net proceeds of $5,102,250 in a private placement that commenced in March 2004 and closed in July 2004. We received funds from time to time upon sale of the preferred stock and placed the proceeds into our working capital upon receipt. Each share of Series B Preferred Stock was 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. On January 4, 2005, we completed a private placement of our Series C Convertible Preferred Stock for an aggregate purchase price of $15 million. 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 holder to exercise them) and may require holders to convert the preferred stock to common stock if certain conditions are met. On December 31, 2004, we were holding a deposit of $8,849,420, reflected on the consolidated balance sheet as "Deposits on Preferred Stock, Series C," which was applied to the purchase of Series C Preferred Stock on January 4, 2005. 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. In the past, we have been able to privately borrow money from individuals by the issuance of notes and have sold our stock to raise capital. 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. 22 Over the last few months of 2005 and the beginning of 2006, we have been trying to raise capital in either debt or equity financings, but have not yet been able to obtain capital on terms that are acceptable to us. The terms of our financing with the purchasers of our Series C Preferred Stock in January 2005 have created a significant impediment to our financing efforts. Among other issues, the terms of the Series C Preferred Stock prohibit us from raising in excess of $10 million in debt financing, prohibit us from securing the debt with any assets other than our inventory and accounts receivable, and require us to redeem the Series C Preferred Stock at a premium upon the issuance of any equity. Our inventory and accounts receivable do not provide an asset base that is sufficient for traditional asset-based lenders to provide $10 million in debt financing. In addition, potential investors have proposed several transactions on terms that would require consent of the holders of the Series C Preferred Stock, but the holders have either refused to provide their consent or have required additional conditions or consideration in order to provide such consent, and we have deemed such additional conditions or consideration to be unacceptable. We may not be able to obtain financing sufficient to fulfill our business plan or to otherwise maintain our operations, or if obtained, the terms of such financing may be on terms that are excessively costly, either directly or as a result of their effect on existing obligations, including the terms of the Series C Preferred Stock. 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 this report and economic, competitive and other factors affecting our operations, markets, products and services, expansion strategies and other factors discussed elsewhere in this report 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our only current borrowing is a note payable on equipment in the principal amount of $11,743 at December 31, 2005, which bears interest at a fixed rate of 5.16% and matures in September 2008. We have no other investments that are subject to market risk. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. See the financial supplement, beginning on page F-1. SLS INTERNATIONAL, INC. December 31, 2005 Report of Independent Registered Public Accounting Firm F-1 Consolidated Balance Sheet F-2 Consolidated Statement of Operations F-3 Consolidated Statement of Shareholders' Deficit F-4 Consolidated Statement of Cash Flows F-5 Consolidated Statement of Valuation and Qualifying Accounts F-6 Notes to Consolidated Financial Statements F-7 23 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. This item is inapplicable, as no such changes or disagreements have occurred. ITEM 9A. CONTROLS AND PROCEDURES. As of March 1, 2006, 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 concluded that our disclosure controls and procedures were effective as of December 31, 2005 for purposes of preparation of this Annual Report on Form 10-K. MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on our assessment we concluded that, as of December 31, 2005, our internal control over financial reporting was effective based on those criteria. Our management's assessment of the effectiveness of the company's internal control over financial reporting as of December 31, 2005 has been audited by Weaver & Martin LLC, an independent registered public accounting firm. Their report appears on page F-1. During the last quarter of 2005, there was no significant change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION. None. 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information required by this item is incorporated by reference from our 2006 Proxy Statement that will be filed within 120 days after the end of the 2005 calendar year. ITEM 11. EXECUTIVE COMPENSATION. Information required by this item is incorporated by reference from our 2006 Proxy Statement that will be filed within 120 days after the end of the 2005 calendar year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. Information required by this item is incorporated by reference from our 2006 Proxy Statement that will be filed within 120 days after the end of the 2005 calendar year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information required by this item is incorporated by reference from our 2006 Proxy Statement that will be filed within 120 days after the end of the 2005 calendar year. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. Information required by this item is incorporated by reference from our 2006 Proxy Statement that will be filed within 120 days after the end of the 2005 calendar year. 25 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Financial Statements and Schedules. The financial statements are set forth under Item 8 of this Annual Report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included. (b) Exhibits. The exhibits to this Report are listed below. Other than exhibits that are filed herewith, all exhibits listed below are incorporated herein by reference. Exhibits indicated by an asterisk (*) are the management contracts and compensatory plans, contracts or arrangements required to be filed as exhibits to this Report.
EXHIBIT WHERE LOCATED - ------- ------------- Amendment and Restatement of Certificate of Incorporation Exhibit 3(ii) to Registration Statement on Form SB-2 filed August 15, 2000 Certificate of Amendment to Certificate of Incorporation Appendix A to Definitive Proxy Statement, filed May 12, 2005 Certificate of Designations, Convertible Preferred Stock Exhibit 3.1 to Form 8-K filed January 6, 2005 Certificate of Designations, Series B Preferred Stock Exhibit 4.1 to Form 10-QSB filed August 13, 2004 Certificate of Designation, Series C Preferred Stock Exhibit 3.2 to Form 8-K filed January 6, 2005 By-Laws Exhibit 3(iii) to Registration Statement on Form SB-2 filed August 15, 2000 Amendment to By-Laws (Article VIII) Exhibit 3.4 to Annual Report on Form 10-KSB filed March 30, 2004 Amendment to By-Laws effective January 31, 2005 Exhibit 3.1 to Form 8-K filed February 4, 2005 Specimen Certificate of Common Stock Exhibit 4(i) to Amendment No. 1 to Registration Statement on Form SB-2 filed December 1, 2000 Form of Class C Warrant Exhibit 4.2 to Form 10-QSB filed August 13, 2004 Form of Distributor Agreement Exhibit 10(iv) to Amendment No. 2 to Registration Statement on Form SB-2 filed January 16, 2001 2000 Stock Purchase and Option Plan* Exhibit 99(i) to Registration Statement on Form SB-2 filed August 15, 2000 Form of Option* Exhibit 99(ii) to Registration Statement on Form SB-2 filed August 15, 2000 Option Agreement, dated as of May 19, 2003, between the Exhibit 10.1 to Form 10-QSB filed August 14, 2003 Company and Steerpike (Overseas) Ltd. Employment Agreement, dated March 12, 2004, between SLS Exhibit 10.2 to Form 8-K filed March 17, 2004 International, Inc. and Joel A. Butler Consulting Services Agreement, dated November 10, 2003, Exhibit 10.43 to Annual Report on Form 10-KSB filed between SLS International, Inc. and William F. Fischbach March 30, 2004 Stock Option Agreement, dated February 9, 2004, between SLS Exhibit 10.1 to Quarterly Report on Form 10-QSB filed International, Inc., and Ryan Schinman May 17, 2004
26
EXHIBIT WHERE LOCATED - ------- ------------- Letter Agreement, dated May 19, 2004, between SLS Exhibit 10.2 to Quarterly Report on Form 10-QSB filed International, Inc., and Kenny Securities Corp. May 17, 2004 Promotion Agreement, dated June 2, 2004, between SLS Exhibit 10.1 to Form 10-QSB filed August 13, 2004 International, Inc. and Global Drumz, Inc. Option Agreement, dated June 2, 2004, between SLS Exhibit 10.2 to Form 10-QSB filed August 13, 2004 International, Inc. and Global Drumz, Inc. Redeemable Warrant, dated June 2, 2004, issued by SLS Exhibit 10.3 to Form 10-QSB filed August 13, 2004 International, Inc. in favor of Global Drumz, Inc. Redeemable Warrant, dated March 23, 2004, issued by SLS Exhibit 10.4 to Form 10-QSB filed August 13, 2004 International, Inc. in favor of Kenny Securities Corp. Strategic Alliance Agreement Addendum, dated October 19, Exhibit 10.1 to Form 10-QSB filed November 15, 2004 2004, between Bohlender-Graebener Corporation and SLS International, Inc. Consulting Services Agreement, dated December 8, 2004, Exhibit 10.1 to Form 8-K filed December 17, 2004 between SLS International, Inc. and W. Curtis Hargis, Co. Lease Agreement, dated December 4, 2004, between Bull Creek Exhibit 10.2 to Form 8-K filed December 17, 2004 Ranch LLC and SLS International, Inc. Non-Exclusive Finder's Agreement, dated December 8, 2004, Exhibit 10.1 to Form 8-K filed January 6, 2005 between SLS International, Inc. and The Shemano Group, Inc. Option Agreement, dated as of May 19, 2003, between SLS Exhibit 10.2 to Form 8-K filed January 6, 2005 International, Inc. and Beth Broday Securities Purchase Agreement, dated January 3, 2005, among Exhibit 10.3 to Form 8-K filed January 6, 2005 SLS International, Inc., Baystar Capital II, L.P., PSO Trading IV, LLC, HFTP Investment L.L.C., and Royal Bank of Canada Registration Rights Agreement, dated January 3, 2005, among Exhibit 10.4 to Form 8-K filed January 6, 2005 SLS International, Inc., Baystar Capital II, L.P., PSO Trading IV, LLC, HFTP Investment L.L.C., and Royal Bank of Canada Warrant, dated January 4, 2005, issued to Baystar Capital Exhibit 10.5 to Form 8-K filed January 6, 2005 II, L.P. Warrant, dated January 4, 2005, issued to PSO Trading IV, Exhibit 10.6 to Form 8-K filed January 6, 2005 LLC Warrant, dated January 4, 2005, issued to HFTP Investment Exhibit 10.7 to Form 8-K filed January 6, 2005 L.L.C. Warrant, dated January 4, 2005, issued to Royal Bank of Exhibit 10.8 to Form 8-K filed January 6, 2005 Canada Consulting Agreement, dated January 31, 2005 and effective Exhibit 10.2 to Form 8-K filed February 4, 2005 as of November 18, 2004, between SLS International, Inc. and 3CD Consulting, LLC Promotion Agreement, dated June 14, 2005, by and among SLS Exhibit 10.1 to Form 8-K filed June 20, 2005 International, Inc., JMBP, Inc. and Mark Burnett Option Agreement, dated June 14, 2005, between SLS Exhibit 10.2 to Form 8-K filed June 20, 2005 International, Inc. and Mark Burnett Warrant Certificate, dated June 14, 2005, issued by SLS Exhibit 10.3 to Form 8-K filed June 20, 2005 International, Inc. in favor of Mark Burnett
27
EXHIBIT WHERE LOCATED - ------- ------------- 2005 Stock Incentive Plan* Appendix B to Definitive Proxy Statement filed May 12, 2005 Employment Agreement, dated June 17, 2005, between SLS Filed as Exhibit 10.1 to our Form 10-Q filed August 15, International and John M. Gott* 2005 Employment Agreement, dated June 17, 2005 between SLS Filed as Exhibit 10.2 to our Form 10-Q filed August 15, International and Steven Lamar* 2005 Employment Agreement, dated June 17, 2005, between SLS Filed as Exhibit 10.3 to our Form 10-Q filed August 15, International and Michael L. Maples* 2005 Form of Nonstatutory Stock Option Agreement under 2005 Filed as Exhibit 10.4 to our Form 10-Q filed August 15, Stock Incentive Plan* 2005 Form of Restricted Stock Agreement under 2005 Stock Filed as Exhibit 10.5 to our Form 10-Q filed August 15, Incentive Plan* 2005 Real Estate Purchase Agreement, between SLS International, Exhibit 10.1 to Form 8-K filed February 14, 2006 Inc. and FRS, LLC, dated February 10, 2006 Lease Agreement, between SLS International, Inc. and FRS, Exhibit 10.2 to Form 8-K filed February 14, 2006 LLC, dated February 10, 2006 Amendment to Employment Agreement, between SLS Exhibit 10.1 to Form 8-K filed March 14, 2006 International, Inc. and John M. Gott, dated March 10, 2006 and effective December 31, 2005* Amendment to Employment Agreement, between SLS Exhibit 10.2 to Form 8-K filed March 14, 2006 International, Inc. and Steven Lamar, dated March 10, 2006 and effective as of January 4, 2006* Amendment to Employment Agreement, between SLS Exhibit 10.3 to Form 8-K filed March 14, 2006 International, Inc. and Michael L. Maples, dated March 10, 2006 and effective as of January 4, 2006* Vendor Agreement, dated February 21, 2006, by and between Filed herewith Best Buy Purchasing LLC and SLS International, Inc. Addendum to the Vendor Agreement between Filed herewith Best Buy Purchasing, LLC and SLS International, Inc., February 21, 2006 Consignment Agreement, dated February 21, 2006, between Filed herewith Best Buy Purchasing LLC and SLS International Inc. Product Service Agreement, dated February 21, 2006, by and Filed herewith between SLS International, Inc. and Best Buy Stores, L.P. List of Subsidiaries of SLS International, Inc. Exhibit 21 to Annual Report on Form 10-KSB filed March 28, 2005 Consent of Weaver & Martin LLC Independent Certified Public Filed herewith Accountants Consent Order of Missouri Securities Division and SLS Exhibit 99(iv) to Post-Effective Amendment No. 1 filed May International, Inc. 30, 2001 Promotional Shares Lock-In Agreement Exhibit 99(v) to Post-Effective Amendment No. 1 filed May 30, 2001 Modification to Consent Order of Missouri Securities Exhibit 99.1 to Post-Effective Amendment No. 2 filed Division and SLS International, Inc. February 9, 2004
28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. By /s/ M. Maples ---------------------------------- M. Maples (Chief Financial Officer and Chief Operating Officer) Date: March 31, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 31, 2006. Signature Title --------- /s/ J. Gott Chief Executive Officer and Director (Principal Executive Officer) /s/ C. Foudree Director /s/ R. Luke, Ph.D. Director /s/ M. Maples Chief Financial Officer, Chief Operating Officer and Director /s/ R. Ring Director /s/ M. Maples Chief Financial Officer and Chief ---------------------- Operating Officer (M. Maples) (Principal Accounting Officer) 29 EXHIBIT INDEX
Number Exhibit Where Located - ------ ------- -------------- 3.1 Amendment and Restatement of Certificate of Exhibit 3(ii) to Registration Statement on Incorporation Form SB-2 filed August 15, 2000 3.2 Certificate of Amendment to Certificate of Appendix A to Definitive Proxy Statement filed Incorporation May 12, 2005 3.3 Certificate of Designations, Convertible Preferred Exhibit 3.1 to Form 8-K filed January 6, Stock 2005 3.4 Certificate of Designations, Series B Preferred Exhibit 4.1 to Form 10-QSB filed August 13, Stock 2004 3.5 Certificate of Designation, Series C Preferred Exhibit 3.2 to Form 8-K filed January 6, Stock 2005 3.6 By-Laws Exhibit 3(iii) to Registration Statement on Form SB-2 filed August 15, 2000 3.7 Amendment to By-Laws (Article VIII) Exhibit 3.4 to Annual Report on Form 10-KSB filed March 30, 2004 3.8 Amendment to By-Laws effective January 31, 2005 Exhibit 3.1 to Form 8-K filed February 4, 2005 4.1 Specimen Certificate of Common Stock Exhibit 4(i) to Amendment No. 1 to Registration Statement on Form SB-2 filed December 1, 2000 4.2 Form of Class C Warrant Exhibit 4.2 to Form 10-QSB filed August 13, 2004 10.1 Form of Distributor Agreement Exhibit 10(iv) to Amendment No. 2 to Registration Statement on Form SB-2 filed January 16, 2001 10.2 2000 Stock Purchase and Option Plan* Exhibit 99(i) to Registration Statement on Form SB-2 filed August 15, 2000 10.3 Form of Option* Exhibit 99(ii) to Registration Statement on Form SB-2 filed August 15, 2000 10.4 Option Agreement, dated as of May 19, 2003, Exhibit 10.1 to Form 10-QSB filed August 14, between the Company and Steerpike (Overseas) Ltd. 2003 10.5 Employment Agreement, dated March 12, 2004, Exhibit 10.2 to Form 8-K filed March 17, 2004 between SLS International, Inc. and Joel A. Butler 10.6 Consulting Services Agreement, dated November 10, Exhibit 10.43 to Annual Report on Form 10-KSB 2003, between SLS International, Inc. and William filed March 30, 2004 F. Fischbach 10.7 Stock Option Agreement, dated February 9, 2004, Exhibit 10.1 to Quarterly Report on Form between SLS International, Inc., and Ryan Schinman 10-QSB filed May 17, 2004 10.8 Letter Agreement, dated May 19, 2004, between SLS Exhibit 10.2 to Quarterly Report on Form International, Inc., and Kenny Securities Corp. 10-QSB filed May 17, 2004 10.9 Promotion Agreement, dated June 2, 2004, between Exhibit 10.1 to Form 10-QSB filed August 13, SLS International, Inc. and Global Drumz, Inc. 2004 10.10 Option Agreement, dated June 2, 2004, between SLS Exhibit 10.2 to Form 10-QSB filed August 13, International, Inc. and Global Drumz, Inc. 2004
Number Exhibit Where Located - ------ ------- -------------- 10.11 Redeemable Warrant, dated June 2, 2004, issued by Exhibit 10.3 to Form 10-QSB filed August 13, SLS International, Inc. in favor of Global Drumz, 2004 Inc. 10.12 Redeemable Warrant, dated March 23, 2004, issued Exhibit 10.4 to Form 10-QSB filed August 13, by SLS International, Inc. in favor of Kenny 2004 Securities Corp. 10.13 Strategic Alliance Agreement Addendum, dated Exhibit 10.1 to Form 10-QSB filed November 15, October 19, 2004, between Bohlender-Graebener 2004 Corporation and SLS International, Inc. 10.14 Consulting Services Agreement, dated December 8, Exhibit 10.1 to Form 8-K filed December 17, 2004, between SLS International, Inc. and W. 2004 Curtis Hargis, Co. 10.15 Lease Agreement, dated December 4, 2004, between Exhibit 10.2 to Form 8-K filed December 17, Bull Creek Ranch LLC and SLS International, Inc. 2004 10.16 Non-Exclusive Finder's Agreement, dated December Exhibit 10.1 to Form 8-K filed January 6, 2005 8, 2004, between SLS International, Inc. and The Shemano Group, Inc. 10.17 Option Agreement, dated as of May 19, 2003, Exhibit 10.2 to Form 8-K filed January 6, 2005 between SLS International, Inc. and Beth Broday 10.18 Securities Purchase Agreement, dated January 3, Exhibit 10.3 to Form 8-K filed January 6, 2005 2005, among SLS International, Inc., Baystar Capital II, L.P., PSO Trading IV, LLC, HFTP Investment L.L.C., and Royal Bank of Canada 10.19 Registration Rights Agreement, dated January 3, Exhibit 10.4 to Form 8-K filed January 6, 2005 2005, among SLS International, Inc., Baystar Capital II, L.P., PSO Trading IV, LLC, HFTP Investment L.L.C., and Royal Bank of Canada 10.20 Warrant, dated January 4, 2005, issued to Baystar Exhibit 10.5 to Form 8-K filed January 6, 2005 Capital II, L.P. 10.21 Warrant, dated January 4, 2005, issued to PSO Exhibit 10.6 to Form 8-K filed January 6, 2005 Trading IV, LLC 10.22 Warrant, dated January 4, 2005, issued to HFTP Exhibit 10.7 to Form 8-K filed January 6, 2005 Investment L.L.C. 10.23 Warrant, dated January 4, 2005, issued to Royal Exhibit 10.8 to Form 8-K filed January 6, 2005 Bank of Canada 10.24 Consulting Agreement, dated January 31, 2005 and Exhibit 10.2 to Form 8-K filed February 4, 2005 effective as of November 18, 2004, between SLS International, Inc. and 3CD Consulting, LLC 10.25 Promotion Agreement, dated June 14, 2005, by and Exhibit 10.1 to Form 8-K filed June 20, 2005 among SLS International, Inc., JMBP, Inc. and Mark Burnett 10.26 Option Agreement, dated June 14, 2005, between SLS Exhibit 10.2 to Form 8-K filed June 20, 2005 International, Inc. and Mark Burnett 10.27 Warrant Certificate, dated June 14, 2005, issued Exhibit 10.3 to Form 8-K filed June 20, 2005 by SLS International, Inc. in favor of Mark Burnett
Number Exhibit Where Located - ------ ------- -------------- 10.28 Stock Incentive Plan* Appendix B to Definitive Proxy Statement filed May 12, 2005 10.29 Employment Agreement, dated June 17, 2005, between Filed as Exhibit 10.1 to our Form 10-Q filed SLS International and John M. Gott* August 15, 2005 10.30 Employment Agreement, dated June 17, 2005, between Filed as Exhibit 10.2 to our Form 10-Q filed SLS International and Steven Lamar* August 15, 2005 10.31 Employment Agreement, dated June 17, 2005, between Filed as Exhibit 10.3 to our Form 10-Q filed SLS International and Michael L. Maples* August 15, 2005 10.32 Form of Nonstatutory Stock Option Agreement under Filed as Exhibit 10.4 to our Form 10-Q filed 2005 Stock Incentive Plan* August 15, 2005 10.33 Form of Restricted Stock Agreement under 2005 Filed as Exhibit 10.5 to our Form 10-Q filed Stock Incentive Plan* August 15, 2005 10.34 Real Estate Purchase Agreement, between SLS Exhibit 10.1 to Form 8-K filed February 14, International, Inc. and FRS, LLC, dated February 2006 10, 2006 10.35 Lease Agreement, between SLS International, Inc. Exhibit 10.2 to Form 8-K filed February 14, and FRS, LLC, dated February 10, 2006 2006 10.36 Amendment to Employment Agreement, between SLS Exhibit 10.1 to Form 8-K filed March 14, 2006 International, Inc. and John M. Gott, dated March 10, 2006 and effective December 31, 2005 10.37 Amendment to Employment Agreement, between SLS Exhibit 10.2 to Form 8-K filed March 14, 2006 International, Inc. and Steven Lamar, dated March 10, 2006 and effective as of January 4, 2006 10.38 Amendment to Employment Agreement, between SLS Exhibit 10.3 to Form 8-K filed March 14, 2006 International, Inc. and Michael L. Maples, dated March 10, 2006 and effective as of January 4, 2006 10.39 Vendor Agreement, dated February 21, 2006, by and Filed herewith between Best Buy Purchasing LLC and SLS International, Inc. 10.40 Addendum to the Vendor Agreement between Filed herewith Best Buy Purchasing, LLC and SLS International, Inc., February 21, 2006 10.41 Consignment Agreement, dated February 21, 2006, Filed herewith between Best Buy Purchasing LLC and SLS International Inc. 10.42 Product Service Agreement, dated February 21, Filed herewith 2006, by and between SLS International, Inc. and Best Buy Stores, L.P. 21 List of Subsidiaries of SLS International, Inc. Exhibit 21 to Annual Report on Form 10-KSB filed March 28, 2005 23 Consent of Weaver & Martin LLC Independent Filed herewith. Certified Public Accountants 99.1 Consent Order of Missouri Securities Division and Exhibit 99(iv) to Post-Effective Amendment No. SLS International, Inc. 1 filed May 30, 2001 99.2 Promotional Shares Lock-In Agreement Exhibit 99(v) to Post-Effective Amendment No. 1 filed May 30, 2001 99.3 Modification to Consent Order of Missouri Exhibit 99.1 to Post-Effective Amendment No. 2 Securities Division and SLS International, Inc. filed February 9, 2004
SLS INTERNATIONAL, INC. DECEMBER 31, 2005 Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheet F-4 Consolidated Statement of Operations F-5 Consolidated Statement of Shareholders' Deficit F-6 Consolidated Statement of Cash Flows F-7 Consolidated Statement of Valuation and Qualifying Accounts F-8 Notes to Consolidated Financial Statements F-9 F-1 SLS INTERNATIONAL, INC. NOTES TO FINANCIAL STATEMENTS To the Board of Directors and Stockholders SLS INTERNATIONAL, INC. Ozark, Missouri REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have audited the accompanying consolidated balance sheet of SLS International, Inc. as of December 31, 2005 and 2004 and the related consolidated statements of income, shareholders' equity, valuation and qualifying accounts, and cash flows for each of the three years in the period ended December 31, 2005. We also have audited management's assessment that SLS International, Inc. has maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). SLS International, Inc.'s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over the financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that that controls may become inadequate because of changes in conditions, or that the degree of of compliance with the policies may deteriorate. F-2 In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SLS International, Inc. as of December 31, 2005 and 2004 and the consolidated results of its operations and its cash flows for each of the three year period ended December 31, 2005 in conformity with generally accepted accounting principles accepted in the United States of America. Also, in our opinion, management's assessments that SLS International, Inc. maintained effective internal control over financial reporting reporting as of December 31, 2005 is fairly stated, in all material respects, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, SLS International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31,2005, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations and is dependent upon the continued sale of its securities or obtaining debt financing for funds to meet its cash requirements. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans with regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. WEAVER & MARTIN, LLC Kansas City, Missouri February 24,2006 F-3 SLS INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEET
December 31, December 31, 2005 2004 ----------- ----------- Assets Current assets: Cash $ 195,573 $10,712,858 Accounts receivable, less allowance for doubtful accounts of $45,000 as of December 31, 2005 and 2004 614,048 271,429 Inventory 4,193,236 1,908,588 Deposits - inventory 316,629 50,000 Deposits - merger -- 100,000 Prepaid expenses and other current assets 258,024 192,817 ----------- ----------- Total current assets 5,577,510 13,235,692 ----------- ----------- Fixed assets: Vehicles 283,233 51,949 Equipment 483,635 234,805 Leasehold improvements 6,488 245,681 Building 4,401,739 -- ----------- ----------- 5,175,095 532,435 Less accumulated depreciation 249,695 105,131 ----------- ----------- Net fixed assets 4,925,400 427,304 ----------- ----------- Prepaid Expense 110,337 -- ----------- ----------- Total assets $10,613,247 $13,662,996 =========== =========== Liabilities and Shareholders' Equity Current liabilities: Current maturities of long-term debt and notes payable $ 4,376 $ 29,101 Accounts payable 1,470,913 346,980 Customer Deposits 207,819 -- Accrued liabilities 172,919 630,503 ----------- ----------- Total current liabilities 1,856,027 1,006,584 ----------- ----------- Notes payable, less current maturities 7,367 10,951 Accrued Liabilities Class D Warrants -- -- ----------- ----------- Total long term liabilities 7,367 10,951 Total liabilities 1,863,394 1,017,535 Commitments and contingencies: Temporary Equity: Preferred stock, Series A, $.001 par, 2,000,000 shares authorized; 66,000 and 346,873 shares issued as of December 31, 2005 and December 31, 2004 66 347 Contributed Capital - preferred 348,625 1,707,367 Common stock, $.001 par: 125,000,000 shares authorized on December 31,2005 and 75,000 shares authorized on December 31,2004; 2,568,400 shares issued as of December 31,2005 and 2,568,400 shares issued as of December 31, 2004 2,568 2,568 Contributed capital - Common 1,338,132 1,338,132
F-4 SLS INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEET (CONTINUED)
December 31, December 31, 2005 2004 ----------- ----------- Preferred stock, Series B, $.001 par, 1,000,000 shares authorized; 89,700 and 196,050 shares issued as of December 31, 2005 and December 31, 2004 90 196 Preferred stock, Series C, $.001 par, 25,000 shares authorized; 14,450 and no shares issued as of December 31, 14 -- 2005 and December 31, 2004. Deposits on Preferred stock, Series C -- 8,849,420 Contributed capital - preferred 16,787,062 5,069,298 Common stock, $.001 par; 125,000,000 shares authorized; on December 31, 2005 and 75,000,000 shares authorized on December 31, 2004. 43,719,910 shares and 41,751,080 shares 43,719 39,184 issued as of December 31, 2005 and December 31, 2004 Common stock not issued but owed to buyers; 3,071 and 300,000 shares at December 31, 2005 and December 31, 2004 3 300 Contributed capital - common 28,339,951 20,543,959 Unamortized cost of stock issued for services (1,310,862) (1,363,973) Retained deficit (36,799,515) (23,541,337) ------------ ------------ Total shareholders' equity 8,749,853 12,645,461 ------------ ------------ $ 10,613,247 $ 13,662,996 ============ ============
The accompanying notes are an integral part of these consolidated financial statements F-5 SLS INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF OPERATIONS
Year Ended December 31, -------------------------------------------- 2005 2004 2003 ------------ ------------ ------------ Revenue $ 4,015,099 $ 2,040,575 $ 968,245 Cost of sales 3,065,827 1,507,353 601,213 ------------ ------------ ------------ Gross profit 949,272 533,222 367,032 General and administrative expenses 12,413,227 9,179,555 4,492,237 ------------ ------------ ------------ Loss from operations (11,463,955) (8,646,333) (4,125,205) Other income (expense): Interest expense (5,354) (1,907) (39,170) Interest and miscellaneous, net 192,967 48,341 185,034 Gain (loss) on disposal of fixed assets (234,158) -- -- Gain (loss) on valuation of Class D warrants 1,506,112 -- -- ------------ ------------ ------------ 1,459,567 46,434 145,864 ------------ ------------ ------------ Loss before income tax (10,004,388) (8,599,899) (3,979,341) Income tax provision -- -- -- ------------ ------------ ------------ Net loss (10,004,388) (8,599,899) (3,979,341) ------------ ------------ ------------ Deemed dividend associated with beneficial conversion of preferred stock (3,246,112) (4,097,877) (1,798,438) Premium - preferred series C (7,678) -- -- ------------ ------------ ------------ Net loss available to common shareholders $(13,258,178) $(12,697,776) $ (5,777,779) ============ ============ ============ Basic and diluted loss per share $ (0.29) $ (0.38) $ (0.23) ============ ============ ============ Weighted average shares outstanding 45,498,578 33,072,988 25,496,816 ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-6 SLS INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
Preferred Stock, Preferred Stock, Series A Series B ------------------------------------ Preferred Stock Deposit on Series C Discounts on Shares Amount Shares Amount Preferred C Shares Amount Preferred ---------- -------- ------- -------- ----------- ---------- -------- ----------- Balance, January 1, 2003 315,000 $ 315 -- $ -- $ -- -- $ -- $ (233,294) Net loss for the year -- -- -- -- -- -- -- -- Sales of preferred stock 1,468,300 1,468 -- -- -- -- -- -- Beneficial conversion of preferred -- -- -- -- (3,451,720) -- -- 3,451,720 Preferred discount amortization -- -- -- -- -- -- -- 1,798,438 Stock issued from prior period sales -- -- -- -- -- -- -- -- Conversion of preferred to (238,000) (238) -- -- -- -- -- -- Common stock issued for services -- -- -- -- -- -- -- -- Options issued to employees & directors -- -- -- -- -- -- -- -- Options issued for services -- -- -- -- -- -- -- -- Options exercised for common stock -- -- -- -- -- -- -- -- Amortization of stock issued for services -- -- -- -- -- -- -- -- Conversion of "A" warrants for services -- -- -- -- -- -- -- -- Common stock warrants exercised -- -- -- -- -- -- -- -- Other -- -- -- -- -- -- -- -- ---------- -------- ------- -------- ----------- ---------- -------- ----------- Balance, December 31, 2003 1,545,300 $ 1,545 -- $ -- $ -- -- $ -- $(1,886,576) ========== ======== ======== ======= =========== ========== ======== =========== Net loss for the year -- -- -- -- -- -- -- -- Sales of preferred stock with C Warrants -- -- 272,100 272 -- -- -- -- Beneficial conversion of preferred -- -- -- -- -- -- -- (2,211,300) Preferred discount amortization -- -- -- -- -- -- -- 4,097,876 Stock issued from prior period sales -- -- -- -- -- -- -- -- Conversion of preferred to common (1,200,600) (1,200) (76,050) (76) -- -- -- -- Common stock issued for services -- -- -- -- -- -- -- -- Options issued to directors -- -- -- -- -- -- -- -- Options issued for services -- -- -- -- -- -- -- -- Deposit on Series C preferred stock -- -- -- -- 8,849,420 -- -- -- Amortization of stock issued for services -- -- -- -- -- -- -- -- Common stock cancelled -- -- -- -- -- -- -- -- Common stock warrants exercised -- -- -- -- -- -- -- -- Common stock issued Evenstar acquisition -- -- -- -- -- -- -- -- Other 2,173 2 -- -- -- -- -- -- ---------- -------- ---- ------- ----------- ---------- -------- ----------- Balance, December 31, 2004 346,873 $ 347 196,050 $ 196 $ 8,849,420 -- $ -- $ -- ========== ======== ======== ======= =========== ========== ======== =========== Net loss for the year -- -- -- -- -- -- -- -- Sales of preferred stock with C Warrants -- -- -- -- (8,849,420) 15,000 15 (3,246,112) Beneficial conversion of preferred -- -- -- -- -- -- -- 3,246,112 Preferred discount amortization -- -- -- -- -- -- -- -- Stock issued from prior period sales -- -- -- -- -- -- -- -- Conversion of preferred to common (280,873) (281) (106,350) (106) -- (550) (1) -- Common stock issued for services -- -- -- -- -- -- -- -- Options issued to directors -- -- -- -- -- -- -- -- Options issued for services -- -- -- -- -- -- -- -- Deposit on Series C preferred stock -- -- -- -- -- -- -- -- Amortization of stock issued for services -- -- -- -- -- -- -- -- Common stock cancelled -- -- -- -- -- -- -- -- Common stock warrants exercised -- -- -- -- -- -- -- -- Common stock issued Evenstar acquisition -- -- -- -- -- -- -- -- Other -- -- -- -- -- -- -- -- ---------- -------- -------- ------- ----------- ---------- -------- ----------- Balance, December 31, 2005 66,000 $ 66 89,700 $ 90 $ -- 14,450 $ 14 $ -- ========== ======== ======== ======= =========== ========== ======== ===========
F-7
Common Stock Unamortized Cost of stock Contributed Amount Contributed issued Retained Capital-pref Shares Amount Unissued Capital for service Deficit Total ---------- ----------- ------- -------- ----------- ----------- ----------- ----------- Balance, January 1, 2003 41,852,183 21,453,528 21,454 1,222 3,386,624 (524,984) (5,065,782) (562,262) ---------- ----------- ------- -------- ----------- ----------- ----------- ----------- Net loss for the year -- -- -- -- -- -- (3,979,341) (3,979,341) Sales of preferred stock 3,669,282 -- -- -- -- -- -- 3,670,750 Beneficial conversion of pref -- -- -- -- -- -- -- -- Preferred discount amortization -- -- -- -- -- -- (1,798,438) -- Stock issued from prior period -- 1,220,000 1,220 (1,220) -- -- -- -- Conversion of preferred to 1,561,760 2,380,000 2,380 -- 1,559,618 -- -- -- Common stock issued for services 720,452 720 -- 912,316 (913,036) -- -- Options issued to employees & directors -- -- -- 23,134 -- -- 23,124 -- Options issued for services -- -- -- -- 1,142,432 -- -- 1,142,432 Options exercised for common stock -- 79,000 79 181 64,740 -- -- 65,000 Amortization of stock issued for services -- -- -- -- -- 656,816 -- 656,816 Conversion of "A" warrants for services -- 394,600 395 -- 199,605 -- -- 200,000 Common stock warrants exercised -- 1,982,600 1,983 -- 1,030,817 -- -- 1,032,800 Other 160 -- -- -- -- -- -- 160 ---------- ----------- ------- -------- ----------- ----------- ----------- ----------- Balance, December 31, 2003 $7,411,585 28,230,180 28,231 183 $ 8,319,286 $ (781,204) $10,843,561) $ 2,249,489 ========== =========== ======= ======= =========== =========== =========== =========== Net loss for the year -- -- -- -- -- -- (8,599,899 (8,599,899) Sales of pref stock C Warrants 4,828,418 -- -- -- 273,560 -- -- 5,102,250 Beneficial conv of preferred 2,211,300 -- -- -- -- -- -- -- Preferred discount amortization -- -- -- -- -- -- (4,097,876) -- Stock issued from prior period sales -- 183,000 183 (183) -- -- -- -- Conversion of pref to common (7,674,594) 12,766,500 12,767 -- 7,663,103 -- -- -- Common stock issued for services -- -- -- 300 479,700 (480,000) -- -- Options issued to directors -- -- -- -- 87,786 -- -- 87,786 Options issued for services -- -- -- -- 4,019,027 (814,781) -- 3,204,246 Deposit on Series C preferred stock -- -- -- -- -- -- -- 8,849,420 Amortization of stock issued for services -- -- -- -- -- 712,012 -- 712,012 Common stock cancelled -- (100,000) (100) -- 100 -- -- -- Common stock warrants exercised -- 328,400 328 -- 178,872 -- -- 179,200 Common stock issued Evenstar acquisition -- 300,000 300 -- 860,700 -- -- 861,000 Other 44 43,000 43 -- (43) -- (1) (43) ---------- ----------- ------- -------- ----------- ----------- ----------- ----------- Balance, December 31, 2004 $6,776,665 41,751,080 $41,752 $ 300 $21,882,091 $(1,363,973) (23,541,337) $12,645,461 Net loss for the year -- -- -- -- -- -- (10,004,388) (10,004,388) Sales of pre stock C Warrants 15,080,409 -- -- -- -- -- -- 2,984,892 Beneficial conversion of preferred -- -- -- -- -- -- -- -- Preferred discount amortization -- -- -- -- -- -- (3,246,112) -- Stock issued from prior period sales -- -- -- -- -- -- -- -- Conversion of pref to common (4,721,388) 4,132,230 4,132 -- 4,717,644 -- -- -- Premium on series C conversion -- 3,071 -- 3 7,675 -- 7,678) -- Common stock issued for services -- 300,000 300 -- 719,700 (720,000) -- -- Options issued to directors -- -- -- -- 196,000 -- -- 196,000 Options issued for services -- -- -- -- 954,928 -- -- 954,928 Deposit on Series C preferred stock -- -- -- -- -- -- -- -- Amortization of stock issued for services -- -- -- -- -- 773,110 -- 773,110 Common stock cancelled -- -- -- (300) 300 -- -- -- Services paid on behalf of the company -- -- -- -- 1,156,600 -- -- 1,156,600 Options exercised for common stock -- 100,000 100 -- 24,900 -- -- 25,000 Common stock warrants exercised -- -- -- -- -- -- -- -- Common stock issued for compensation -- -- -- -- -- -- -- -- Amortization of stock issued for compensation -- -- -- -- -- -- -- -- Other -- 5,000 5 -- 18,245 -- -- 18,251 ---------- ----------- ------- -------- ----------- ----------- ----------- ----------- Balance, December 31, 2005 $17,135,686 46,291,381 $46,289 3 29,678,083 $(1,310,862) (36,799,515) $ 8,749,853
The accompanying notes are an integral part of these consolidated financial statements. F-8 SLS INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, -------------------------------------------- 2005 2004 2003 ------------ ------------ ------------ Operating activities: Net loss $(10,004,388) $ (8,599,899) $ (3,979,341) Adjustments to reconcile net income to cash flows from operating activities: Depreciation and amortization 156,765 51,183 24,755 Amortization of cost of stock issued for services 662,768 712,012 856,816 Expense of stock options granted for services 2,418,887 3,293,987 1,165,566 Gain on sale of fixed assets 234,158 (11,000) -- Goodwill impairment charge -- 1,148,502 -- Gain (loss) on valuation of Class D warrants (1,506,112) -- -- Change in assets and liabilities: Accounts receivable, less allowance for doubtful accounts (342,619) 6,236 (112,641) Inventory (2,284,649) (1,318,291) )325,724) Deposits - inventory (266,629) (50,000) -- Deposits - merger 100,000 -- -- Prepaid expenses and other current assets (175,545) (185,967) 86 Accounts payable 1,123,932 (10,307) (60,162) Customer Deposits 207,819 -- -- Due to shareholders -- -- (23,193) Accrued liabilities (458,582) 604,365 (144,759) ------------ ------------ ------------ Cash used in operating activities (10,134,196) (4,359,179) (2,601,597) ------------ ------------ ------------ Investing activities: Proceeds from sale of fixed assets -- 11,000 -- Additions of fixed assets (4,889,018) (158,294) (318,724) ------------ ------------ ------------ Cash provided by (used in) investing activities (4,889,018) (155,294) (318,724) ------------ ------------ ------------ Financing activities: Sale of stock, net of expenses 4,534,238 5,291,950 4,768,550 Acquisition of subsidiary -- (400,000) -- Deposit received on Series C Preferred, net of expenses -- 8,849,420 -- Borrowing on notes payable -- -- 21,461 Repayments of notes payable (28,309) (4,825) (391,144) ------------ ------------ ------------ Cash provided by financing activities 4,505,929 13,736,545 4,398,867 ------------ ------------ ------------ Increase (decrease) in cash (10,517,285) 9,230,072 1,478,546 Cash, beginning of period 10,712,858 1,482,786 4,240 ------------ ------------ ------------ Cash, end of period $ 195,573 $ 10,712,858 $ 1,482,786 ============ ============ ============ Supplemental cash flow information: Interest paid $ 5,354 $ 157 $ 43,345 Income taxes paid (refunded) -- -- -- Noncash investing activities: Stock issued and options granted for services $ 2,418,887 $ 3,293,987 $ 2,278,602 Conversion of notes payable -- -- --
The accompanying notes are an integral part of these consolidated financial statements. F-9 SLS INTERNATIONAL, INC. CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
Additions Balance at charged to beginning costs and Balances at of year expenses deductions end of year ---------- ---------- ---------- ---------- Year ended December 31, 2003 Allowance for doubtful accounts $ 132,396 -- $ 87,396 $ 45,000 Income tax valuation allowance 1,123,700 741,200 -- 1,864,900 Year ended December 31, 2004 Allowance for doubtful accounts 45,000 -- -- 45,000 Income tax valuation allowance 1,864,900 1,382,440 -- 3,247,340 Year ended December 31, 2005 Allowance for doubtful accounts 45,000 -- -- 45,000 Income tax valuation allowance 3,247,340 2,700,615 -- 5,947,955
The accompanying notes are an integral part of these consolidated financial statements. F-10 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 1. SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS: Our primary business is the design and manufacture of loudspeakers based on our proprietary planar ribbon driver and unique cabinet designs. We sell our products primarily through dealers and contractors and are developing retail channels through various high volume consumer retail channels. INVENTORIES: Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory consists of finished goods, raw materials and parts. Included in inventory at December 31, 2005 is $1,474,481 of finished goods and $2,718,776 of raw materials. Included in inventory at December 31, 2004 is $497,369 of finished goods and $1,411,219 of raw materials. Also included in Inventory at December 31, 2005 and 2004 was $0 and $116,987 of goods consigned to sales representatives and dealers. FIXED ASSETS: Fixed assets are recorded at cost and depreciated over their estimated useful lives. Depreciation is provided on a straight-line basis. The lives used for items within each property classification range from 5 to 39 years. Maintenance and repairs are charged to expense as incurred. Depreciation expense was $156,764, $51,183, and $24,755 in the years ended December 31, 2005, 2004, and 2003. CONCENTRATION OF CREDIT RISK: The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents and trade receivables. The Company's cash equivalents are in major banks and financial institutions. From time to time, the Company's cash deposited with banks exceeded the FDIC insurance limit of $100,000. Concentrations of credit risk with respect to receivables are limited due to the large number of customers and their dispersion across geographic areas, however most are in the same industry; therefore, customers may be similarly affected by changes in economic and other conditions within the industry. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. As of December 31, 2005 and 2004, approximately 36% and 30%, respectively, of the Company's net accounts receivable balance was due from four customers. RESEARCH AND DEVELOPMENT: Research and development costs relating to both present and future products are expensed when incurred and included in operating expenses. Research and development costs were $124,349, $77,065 and $31,435 for the years ended December 31, 2005, 2004 and 2003. F-11 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. ADVERTISING AND PROMOTIONAL EXPENSES: Advertising and promotional expenses are charged to operations in the period incurred. Advertising and promotion expenses were $2,860,994, $414,337, and $150,713 for the years ended December 31, 2005, 2004, and 2003. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. Actual results could differ from those estimates, but management does not believe such differences will materially affect the Company's financial position, results of operations, or cash flows. REVENUE RECOGNITION: Revenue is recognized when the products are shipped to customers. ACCOUNTS RECEIVABLE: Accounts receivable are carried on a gross basis, with no discounting, less the allowance for doubtful accounts. No allowance for doubtful accounts is recognized at the time the revenue, which generates the accounts receivable, is recognized. Management estimates the allowance for doubtful accounts based on existing economic conditions, the financial conditions of the customers, and the amount and the age of past due accounts. Receivables are considered past due if full payment is not received by the contractual due date. Past due accounts are generally written off against the allowance for doubtful accounts only after all collection attempts have been exhausted. CASH EQUIVALENTS: The Company's cash equivalents consist principally of any financial instruments with maturities of generally three months or less and cash investments. The carrying values of these assets approximate their fair market values. LONG-LIVED ASSETS: Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived asset to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. The Company determined that as of December 31, 2005, there had been no impairment in the carrying value of long-lived assets. GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill and indefinite life intangible assets are recorded at fair value and not amortized, but are reviewed for impairment at least annually or more frequently if F-12 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. impairment indicators arise, as required by SFAS No. 142. As of December 31, 2005 and 2004 the Company had no goodwill or other intangible assets. See Note 8, Acquisitions, for goodwill impairment expense during 2004. There was no goodwill impairment expense recorded during 2005. FINANCIAL INSTRUMENTS: The carrying value of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short-term maturity of these instruments. Fair values are based on quoted market prices and assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates reflecting varying degrees of perceived risk. Based upon borrowing rates currently available to the Company with similar terms, the carrying value of notes payable and long-term debt approximates fair value. NET LOSS PER SHARE: The Company computes loss per share in accordance with SFAS No. 128, Earnings Per Share. This standard requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the diluted loss per share computation. The Company's potentially issuable shares of common stock pursuant to outstanding stock options and convertible preferred stock are excluded from the Company's diluted computation, as their effect would be anti-dilutive. RECENTLY ISSUED ACCOUNTING STANDARDS: In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51" (the Interpretation). The Interpretation requires the consolidation of variable interest entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise that has a controlling financial interest through ownership of a majority voting interest in the entity. The Interpretation was originally immediately effective for variable interest entities created after January 31, 2003, and effective in the fourth quarter of the Company's fiscal 2003 for those created prior to February 1, 2003. However, in October 2003, the FASB deferred the effective date for those variable interest entities created prior to February 1, 2003, until the Company's first quarter of fiscal 2004. The Company has completed the process of evaluating the Interpretation and believes its adoption will not have a material impact on its financial position or results of operations. F-13 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R), Share-Based Payment, which revised SFAS No. 123 and superseded APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires that companies recognize compensation expense associated with grants of stock options and other equity instruments to employees in the financial statements. Compensation cost will be measured based on the fair value of the instrument on the grant date and will be recognized over the vesting period. This pronouncement applies to all grants after the effective date and to the unvested portion of stock options outstanding as of the effective date. The Company anticipates that the effect of adopting this statement will not have a material effect on the financial statements. STOCK-BASED COMPENSATION: The Company accounts for its stock and options issued for services by non-employees based on the market value of the stock at the date of the agreement and the market value of the options as determined by the Black-Scholes pricing model. The cost is amortized to expense over the life of the agreement to provide services. The Company accounts for its stock option plan in accordance with the provisions of SFAS No. 123, "Accounting for Stock Based Compensation". SFAS No. 123 permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of the grant. Alternatively, SFAS No. 123 also allows entities to apply the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations and provides pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied. During 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, effective as of the beginning of the year. There had been no previous granting of options to employees and therefore this adoption had no effect on previous financial statements. See Note 14 for details of employee stock options issued during the years ended December 31, 2005, 2004 and 2003. INCOME TAXES: Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred taxes, which arise principally from temporary differences between the period in which certain income and expense items are recognized for financial reporting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes. Under this method, the computation of deferred tax assets and liabilities give recognition to the enacted tax rates in effect in the year the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to amounts that the Company expects to realize. F-14 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. RECLASSIFICATIONS Certain amounts in the financial statements for the prior period have been reclassified to conform to the current period's presentation. 2. Going Concern Matters The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements during the years ended December 31, 2005, 2004 and 2003, the company incurred losses of $10,004,388, $8,599,899, and $3,979,341 respectively. The financial statements do not include any adjustments relating to the recoverability and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern. It is management's plan to finance its operations for the foreseeable future primarily with proceeds from capital contributed by shareholders and to explore other financing options in the investment community. At December 31, 2005 no formal agreements had been entered into. There can be no assurance that these sources will provide sufficient cash inflows to enable the Company to achieve its operational objectives. 3. LONG TERM DEBT AND NOTES PAYABLE Long term debt and notes payable consists of the following at December 31, 2005 and 2004: December 31, 2005 2004 ------- ------- Notes payable to an individual, interest rate of 7% uncollateralized, principal due September of 2005 -- $25,000 Equipment note, payments in monthly installments of $407 beginning Oct. 2003, ending Sept. 2008. Interest at 5.16% 11,743 15,052 ------- ------- 11,743 40,052 Less current portion 4,376 29,101 ------- ------- Long-term portion $7,367 $10,951 ======= ======= The aggregate principal amounts due in the future are as follows: $4,376 in 2006, $4,607 in 2007, and $2,760 in 2008. The note payable to an individual for $25,000 was paid in full in June of 2005. Interest expense accrued on long-term debt was $5,354 and $1,907 in the years ended December 31, 2005 and 2004. 4. COMMITMENTS Rent expense for operating leases was approximately $71,400, $98,943 and $62,150 for the years ended December 31, 2005, 2004 and 2003. This lease had expired by December 31, 2005, so there are no future lease commitments under this lease. F-15 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. In February 2006, the building that serves as our principal location was sold to a third party and leased back to the company in a ten - year lease. The term of the lease runs from February 2006 through February 2016. Future minimum lease payments under this new lease are as follows: 2006 $ 412,500 2007 $ 450,000 2008 $ 450,000 2009 $ 450,000 2010 and thereafter $3,150,000 ---------- $4,912,500 5. INCOME TAXES The Company does not have an income tax provision in 2005, 2004 and 2003. The Company has loss carryforwards of approximately $17,493,985 expiring from 2011 to 2019. Deferred tax is comprised of the following: Non-current asset: 2005 2004 2003 ----------- ----------- ----------- Net operating loss $ 5,947,955 $ 3,247,340 $ 1,864,900 Valuation allowance (5,947,955) (3,247,340) (1,864,900) ----------- ----------- ----------- Total deferred tax, net -- -- -- =========== =========== =========== A percent reconciliation of the provision for income taxes to the statutory federal rate is as follows: 2005 2004 2003 ------ ------ ------ Statutory federal income tax rate (34.0%) (34.0%) (34.0%) Non deductible expense 16.6% 15.3% 17.0% Change in valuation allowance 17.4% 18.7% 17.0% ----- ----- ----- Effective tax rate 0.0% 0.0% 0.0% ===== ===== ===== 6. RELATED PARTY TRANSACTIONS In 2005, SLS entered into a three year consulting agreement with a consultant. SLS pays the consultant $10,000 per month under this agreement for services provided to the company. Upon signing the agreement, the consultant had no relationship with the company or any of its officers, but has since become the spouse of the President, Steve Lamar. F-16 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. There was an amount due from a shareholder of $511 as of December 31, 2004 and 2003. Amounts owed by or to shareholders to the Company are charged against or credited to interest. As of December 31, 2005 the amount due from shareholder was $0. In December of 2004, the Company entered into a real estate lease with a company 50% owned by the President of the Company. The lease contained an option to purchase the building for $3,500,000. In February of 2005, the Company exercised the option and purchased the building. The Company paid rent of $18,750 for January of 2005 before the purchase occurred. 7. MAJOR CUSTOMERS AND SUPPLIERS In 2005,the Company received approximately 33% of its revenue from five customers with the largest customer accounting for 17% of total revenue. The Company purchased approximately 51% of the cost of sales from five vendors with the largest vendor accounting for 21% of total cost of sales. In 2004, the Company received approximately 22% of its revenue from five customers with the largest customer accounting for 6% of total revenue. The Company purchased approximately 49% of the cost of sales from five vendors with the largest vendor accounting for 15% of total cost of sales. In 2003, the Company received approximately 32% of its revenue from five customers with the largest customer accounting for 16% of total revenue. The Company purchased approximately 87% of the cost of sales from five vendors with the largest two vendors accounting for 55% of total cost of sales. 8. ACQUISITIONS In February of 2004, the Company entered into an agreement with the owners of SA Sound B.V. and SA Sound USA, Inc. giving the Company 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. The Company paid 50,000 euros, approximately $63,000 for this option. The option agreement entitled the Company to a refund of the option price if the due diligence performed by the Company disclosed any material adverse facts about said companies. After completion of the due diligence, the Company determined not to exercise the option to purchase and has asserted its right to a refund of the option price. The sellers are challenging the return of the option price. $109,165 has been recorded as acquisitions expense in the year ended December 31, 2004 in relation to the option price and related legal fees for this acquisition attempt. F-17 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. In March of 2004, the Company completed a merger with Evenstar, Inc. into a newly formed, wholly owned subsidiary. In exchange for said merger, the Company paid $300,000 in cash and issued 300,000 shares of common stock to the seller. Based on market value of the common stock on the date of closing and the cash paid, the total acquisition price was $1,161,000. Simultaneously with the merger, the Company hired the seller as director of its electronics division. Evenstar, Inc had virtually no assets other than patents, valued at $12,498, and has not shown any revenue for the two years previous to the merger. The excess of the purchase price over the cost of the patents was recorded as goodwill in the first quarter of 2004. Simultaneously, the Company recorded a charge for impairment of goodwill of the same amount. Impairment charges relating to this merger were $1,148,502 for the year ended December 31, 2004. In April of 2004, the Company entered into a strategic alliance agreement with Bohlender-Graebener Corporation (BG). The Company paid BG $100,000 on April 2, 2004 for this agreement. This amount is recorded on the December 31, 2004 financial statements as deposits - merger. 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 the Company. During the term of the agreement BG was required to work with the Company, 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 the Company exclusive sales and marketing rights to certain BG products and the Company committed to purchase certain minimum quantities of various BG products at agreed-upon prices. In the event no agreement to merge the companies on mutually acceptable terms could be reached before termination of the agreement, BG was entitled to keep the $100,000 cash payment as consideration for its performance under the agreement. In October of 2004, the Company agreed to pay BG an additional $100,000 as prepayment of future inventory purchases and BG agreed to extend certain terms of the agreement by six months. As of December 31, 2005, no agreement to merge the companies had been reached and the $100,000 was recorded as acquisition expense in the year ended December 31, 2005. 9. STOCKHOLDERS' EQUITY Year ended December 31, 2003: In 2003, 1,966,000 Class A warrants were exercised for 1,966,000 shares of common stock for a total of $983,000. Also in 2003, 394,600 Class A warrants were exercised for 394,600 shares of common stock for services rendered. In 2003, 16,600 Class B warrants were exercised for 16,600 shares of common stock for a total of $49,800. F-18 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. In 2003, 260,000 options were exercised for 260,000 shares of common stock for a total of $65,000. In 2003, the Company sold 1,468,300 shares of preferred stock, series A, for $3,670,750. The preferred stock offering closed on July 31, 2003. This preferred stock contained a beneficial conversion feature. The feature allows the holder to convert the preferred to 10 shares of common stock one year after buying the shares. A discount on preferred shares of $3,451,720 relating to the beneficial conversion feature was recorded which was amortized over a one-year period beginning with the date the shareholders purchased their shares During 2003, 238,000 shares of preferred stock, series A, were converted to 2,380,000 shares of common stock. In February 2003, an agreement was signed with Tom Puccio for consulting services to be performed February 15, 2003 to August 25, 2003. As compensation for consulting services the Company agreed to issue 300,000 shares of common stock. Using the market value on the date the agreement was signed, the shares were valued at $93,000 and recorded as a debit in the equity section of the balance sheet as unamortized cost of stock issued for services. The cost was amortized over the six-month period of the agreement. Consulting expense relating to this agreement was $93,000 for the year ended December 31, 2003. In July 2003, the Company 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 SLS 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 were recorded over the two-year period of the agreement beginning July 31, 2003 and ended July 31, 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. Consulting expense relating to this agreement was $110,601, $1,027,985 and $1,142,432 for the years ended December 31, 2005, 2004 and 2003. As of December 31,2005 all 1,100,000 options have been earned and expensed. In October 2003, an agreement was signed with Zane Sellis for consulting services to be performed October 28, 2003 to October 28, 2005. As compensation for consulting services the Company agreed to issue 3,226 shares of common stock. Using the market value on the date the agreement was signed, the shares were valued at $5,162 and recorded as a debit in the equity section of the balance sheet as unamortized cost of stock issued for services. The cost was amortized over the two-year period of the agreement. Consulting expense relating to this agreement was $2,129, $2,580 and $453 for the years ended December 31, 2005, 2004 and 2003. As of December 31, 2005 all amortization for consulting services relating to this agreement have been expensed. F-19 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. In November 2003, an agreement was signed with George Iordanou for consulting services to be performed November 6, 2003 to November 6, 2005. As compensation for consulting services the Company agreed to issue 3,226 shares of common stock. Using the market value on the date the agreement was signed, the shares were valued at $4,774 and recorded as a debit in the equity section of the balance sheet as unamortized cost of stock issued for services. The cost was amortized over the two-year period of the agreement. Consulting expense relating to this agreement was $2027, $2,388 and $360 for the years ended December 31, 2005, 2004 and 2003. As of December 31, 2005 all amortization for consulting services relating to this agreement have been expensed. 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 consulting services the Company agreed to issue 400,000 shares of common stock. 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 will be amortized over the three-year period of the agreement. Consulting expense relating to this agreement was $260,000, $260,000 and $36,329 for the years ended December 31, 2005, 2004 and 2003. On December 31, 2005 there was $223,671 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. 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 December 31, 2005, Mr. Fischbach had earned no cash fee. In November 2003, an agreement was signed with Edward Decker for consulting services to be performed November 20, 2003 to November 20, 2005. As compensation for consulting services the Company agreed to issue 7,000 shares of common stock. Using the market value on the date the agreement was signed, the shares were valued at $15,050 and recorded as a debit in the equity section of the balance sheet as unamortized cost of stock issued for services. The cost was amortized over the two-year period of the agreement. Consulting expense relating to this agreement was $6,681, $7,524 and $845 for the years ended December 31, 2005, 2004 and 2003. As of December 31, 2005 all amortization for consulting Services relating to this agreement have been expensed. In November 2003, an agreement was signed with Christopher Obssuth for consulting services to be performed November 20, 2003 to November 20, 2005. As compensation for consulting services the Company agreed to issue 7,000 shares of common stock. Using the market value on the date the agreement was signed, the shares were valued at $15,050 and recorded as a F-20 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. debit in the equity section of the balance sheet as unamortized cost of stock issued for services. The cost was amortized over the two-year period of the agreement. Consulting expense relating to this agreement was $6,681, $7,524 and $845 for the years ended December 31, 2005, 2004 and 2003. As Of December 31, 2005 all amortization for consulting services relating to this agreement have been expensed. Year ended December 31, 2004: In 2004, 322,400 Class A warrants were exercised for 322,400 shares of common stock for a total of $161,200. All of the remaining Class A warrants expired on August 5, 2004. In 2004, 6,000 Class B warrants were exercised for 6,000 shares of common stock for a total of $18,000. All of the remaining Class B warrants expired on August 5, 2004. In 2004, no options were exercised for shares of common stock. In 2004, 1,200,600 shares of preferred stock, series A, were converted to 12,006,000 shares of common stock. In 2004, 100,000 shares of common stock were returned to the Company and cancelled as part of a lawsuit settlement. In 2004, 300,000 shares of common stock were issued for the merger with Evenstar, Inc. See Note 8. In 2004, the Company commenced an offering of Series B preferred stock and sold 272,100 shares of preferred stock, series B, for $5,102,250, net of expenses. This preferred stock contains a beneficial conversion feature. The feature allows the holder to convert the preferred to 10 shares of common stock six months after buying the shares. Attached to each preferred share is ten Class C warrants. Each Class C 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 greater than $10.50 for a period of 30 days, then such warrants are capable of being repurchased with a 30-day notice, at a price of $.001 per warrant. A discount on preferred shares of $2,211,300 relating to the beneficial conversion feature was recorded and was amortized over the six-month period beginning with the date the shareholders purchased their shares. As of December 31, 2004, $2,211,300 has been amortized to retained earnings and the unamortized discount on preferred shares was $0. In 2004, 76,050 shares of preferred stock, series B, were converted to 760,500 shares of common stock. F-21 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 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. As of December 31, 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 year ended December 31, 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% of the net sales realized from the retailer. As of December 31, 2005, Hargis had earned $1,735 based on the value provided to us in the year ended December 31, 2005. In February of 2004, an agreement was signed with Ryan Schinman for consulting services to be performed indefinitely. As compensation for consulting services the Company agreed to issue 50,000 options on the date of signing and 10,000 options per month thereafter. The options have a term of ten years and a strike price equal to the market price on their grant date. The strike price for the options granted in 2004 ranged from $1.45 to $3.10. Using the Black-Scholes pricing model, the options were valued at $215,600 and recorded as consulting expense for the year ended December 31,2004. In the year ended December 31, 2005, 120,000 options were granted to Ryan Schinmann for consulting services. The options have a strike price equal to market price on their grant date, ranging from $1.99 to $2.51. Using the Black-Scholes pricing model, the options were valued at $113,516 and recorded as consulting expense. Factors used in the Black-Scholes pricing model included: risk-free interest rates of 3.93% to 4.50%; strike prices of $1.99 to $2.51; market prices of $1.99 to $2.51; volatility rate of 21.13% to 25.87%; and a yield rate of 0.00%. In June 2004, the Company entered into an endorsement / consulting agreement with the recording artist Quincy Jones through Global Drumz, Inc. The Company made a cash payment of $250,000 to Global Drumz, Inc. on the date of the agreement. Pursuant to the agreement, the Company granted options to purchase 1,000,000 shares of its common stock in exchange for future endorsements of its products and various other consulting services. The option has a strike price of $2.00 and is exercisable for a period of five years. The Company also issued 1,000,000 Class C warrants, 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 F-22 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of its 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 June 2, 2009, the Company shall pay additional compensation of $250,000. Expense associated with the options was recorded over the six-month vesting period of the agreement. 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 was recorded at fair 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 six-month period. Factors used in the Black Scholes pricing model included: risk free interest rate of 3.30% to 3.71%; strike price of $2.00 for the options and $7.00 for the warrants; market price of 1.45 to 2.95; volatility rate of 29.28% to 32.36%; and a yield rate of 0.00%. The consulting expense relating to this agreement of $1,658,888 ($250,000 cash, $1,408,888 non cash) was all recorded during the year ended December 31, 2004 In 2004, no Class C warrants were exercised. As of December 31, 2004, 3,846,000 Class C warrants were outstanding. Year Ended December 31, 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 agreed to issue 1,000,000 options for shares of common stock. The options have a term of 3 years and a strike price of $2.00. 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 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 $271,592 and $31,996 for the years ended December 31, 2005 and 2004. On December 31, 2005, there was $511,193 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 $144,000 for the year ended F-19 F-23 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005. On December 31, 2005 there was $576,000 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. As of December 31, 2005, AV , 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 $900,000 plus 600,000 warrants, which were valued at $627,034 using the Black-Scholes pricing model and charged as an expense in the first quarter of 2005. 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 December 31, 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 December 31, 2005, the face value of the 14,450 outstanding shares are $15,326,826, of which $876,826 is premium. The face value of the preferred stock is convertible into common stock at $2.50 per share. As a result, on December 31, 2005, the 14,450 outstanding shares of preferred stock were convertible into 6,130,730 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 effect for a preset time period. Since this clause calls for a settlement alternative that would be avoided F-24 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS by the company under other settlement alternatives, we are required by EITF 00-19 to record a liability for the market value of the Class D warrants. The initial 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 market value are to be reported in our earnings statement. As of December 31, 2005, the Black-Scholes pricing model valued the warrants at $0. Consequently the decrease in the original liability of $1,506,112 to the December 31, 2005 value of $0 results in recognition of a gain of $1,506,112. In the year ended December 31, 2005, 284,873 shares of preferred stock, series A, were converted to 2,848,730 shares of common stock. There are 66,000 shares of series A preferred stock outstanding as of December 31, 2005. In the year ended December 31, 2005, 106,350 shares of preferred stock, series B, were converted to 1,063,500 shares of common stock. There are 89,700 shares of series B preferred stock outstanding as of December 31, 2005. In the year ended December 31, 2005, 550 shares of preferred stock, series C, were converted into 220,000 shares of common stock. The premium on these converted shares was $7,678 and is recorded in these financial statements as a stock dividend. The premium on these shares converted at $2.50 per share into an additional 3,071 shares of common stock. These shares were not issued as of December 31, 2005 are therefore shown in these financial statements as stock not issued but owed. 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. As of December 31, 2005, 100,000 additional warrants and option were vested. Using the Black-Scholes pricing model, these options and warrants were valued at $283,740 and recorded as consulting expense for the year ended December 31, 2005. Factors used in the Black-Scholes pricing model included: risk-free interest rate of 3.89%; strike price of $1.91 to $2.05 for the options and $6.50 for the warrants; market price of $2.05; volatility rate of 21.92% to 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 F-25 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 over the three-year term of each agreement. In the year ended December 31, 2005, $26,127 was recorded in compensation expense in relation to the prepaid signing bonuses. There is $123,873 remaining in prepaid expense as of December 31, 2005. The 1,125,000 shares of common stock were to be issued in January 2006, but the officers have elected to forgo their rights to receive the stock. Because the officers have given up the rights to the stock and the stock will not be issued, no expense has been recorded on this segment of the employment agreement in the year ended December 31, 2005 and there will be no expense in the future in regards to this stock. The 1,250,000 options will be earned evenly over the three-year 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 employment agreements at fair market value, using the Black-Scholes pricing model. Compensation expense relating to options earned for the twelve months ended December 31, 2005 was $104,966. Factors used in the Black-Scholes pricing model included: risk-free interest rate of $3.75 - 4.09%; strike price of $2.50; market price of $1.99 - $2.15; volatility rate of 22.13% - 25.87%; and a yield rate of 0.00%. As of December 31, 2005, 223,174 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 2005 the company's CEO transferred 70,000 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 $161,250 and recorded as consulting expense for the year ended December 31, 2005. year ended December 31, 2005. In 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 the options were valued at $995,350. Factors used in 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 0.00%. The options were recorded as consulting expense for year ended December 31, 2005. In the year ended December 31, 2005, 930,000 options were granted to directors of the Company. The options have a strike price of $2.50. 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% F-26 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 quarter ended June 30, 2005 was reduced by $490,868 in credits from the expiration of such options for a net expense of $196,000 for the year ended December 31, 2005. In 2005, no Class D warrants were exercised. As of December 31, 2005, there were 6,000,000 Class D warrants outstanding. In 2005, no Class C warrants were exercised. As of December 31, 2005, there were 3,846,000 Class C warrants outstanding. As of December 31, 2005 all Class A and B warrants were expired. 10. UNAMORTIZED COST OF STOCK AND OPTIONS ISSUED FOR SERVICES As detailed in Note 9, during the years ended December 31, 2002 through 2005, the Company issued common stock and options as part of consulting agreements that were to be expensed over various time periods. The value of stock issued and options granted totaled $720,000, $913,036 and $1,599,213 for the years ended December 31, 2005, 2004,and 2003, respectively. 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 years ended December 31, 2005, 2004 and 2003 $773,110, $712,012 and $656,816 was amortized into consulting expense. Unamortized cost of stock issued for services was$1,310,864 as of December 31, 2005 and $1,363,974 as of December 31, 2004. 11. CONSULTING AND INVESTOR RELATIONS SERVICES Consulting and investor relation services expense was $4,352,716, $4,982,014 and $3,104,153 for the years ended December 31, 2005, 2004, and 2003., Consulting expenses relating to stock issued for consulting agreements was $662,768, $712,012, and $656,816 (See Note 10) in the years ended December 31, 2005, 2004, and 2003 and relating to options issued for consulting agreements was $1,837,685, $3,467,254, and $1,142,432 (See Note 9)for the years ended December 31, 2005, 2004, and 2003. Various individuals and corporations performed consulting services and investor relation services for the Company during the years ended December 31, 2005, 2004, and 2003 and were paid cash in the amounts of $1,852,263, $802,748, and $1,304,905. F-27 SLS INTERNATIONAL,INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. STOCK OPTIONS In 2003, the Company issued 1,100,000 options for common stock as part of consulting agreements as detailed in Note 9 and 145,000 employee options as detailed in Note 13. In 2004, the Company issued 2,285,000 options for common stock as part of consulting agreements as detailed in Note 9 and 75,000 employee options as detailed in Note 13. In 2005, the Company issued 1,221,529 options for common stock as part of consulting agreements as detailed in note 9 and 1,450,000 employee options as detailed in Note 13. The following table summarizes the options granted and assumptions used in determining their value, using the Black-Scholes pricing model:
2003 2004 2005 ----------- ----------- ---------- Dividend Yield 0% 0% 0% Weighted Average Expected Stock Volatility 142.94%-146.60% 21.13%-32.86% 22.13%-25.87% Weighted Average Risk Free Interest Rate 2.85%-3.46% 3.30% - 4.50% 3.73% - 4.09% Expected Option Lives 5 to 10 years 3 to 5 years 3 to 10 years Value of Options Granted $1,142,432 $3,467,254* $2,308,545**
*Only options earned in 2004 are valued here. Options to be earned in 2005 have not been valued as they will be valued on the date they are earned. See Note . **Only options earned in 2005 are valued here. Total value includes some options issued in 2005 that were not valued until the date they were earned. Options to be earned in 2006 have not been valued as they will be valued on the date they are earned. See Note 9.
Options 2003 Weighted 2004 Weighted 2005 Weighted Average Average Average Exercise Exercise Exercise Price Price Price ---------- -------- ---------- --------- ---------- --------- Outstanding at beginning of year 500,000 $ 0.30 1,485,000 $ 0.27 3,845,000 $ 1.26 Granted 1,245,000 0.25 2,360,000 2.04 2,671,529 2.28 Exercised 260,000 0.25 -- -- 105,000 .25 Expired -- -- -- -- -- -- ---------- -------- ---------- --------- ---------- --------- Outstanding at end of year 1,485,000 $ 0.27 3,845,000 $ 1.26 6,411,529 $ 1.70 ========== ======== ========== ========= ========== =========
F-28 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. EMPLOYEE STOCK OPTIONS During the year ended December 31, 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 had been no previous grants of options to employees and therefore this adoption has no effect on financial statements prior to 2003. There were no employee stock options in any year prior to 2003. The board of directors approved 145,000 options for employees and directors in the year ended December 31, 2003. The options vested immediately. 10,000 options were approved for each of the three board members for their roles as directors of the company. 115,000 options were approved for employees of the Company for services rendered. Using the Black-Scholes pricing model, in accordance with the fair value recognition provision of FASB Statement No.123, the options were valued at $23,134 and recorded as compensation expense in the year ended December 31, 2003. The following table summarizes the options granted in 2003 and assumptions used in determining their value, using the Black-Scholes pricing model: Dividend Yield 0% Weighted Average Expected Stock Volatility 52.5% Weighted Average Risk Free Interest Rate 4.04% Expected Option Lives 10 years Value of Options Granted $23,134 Options 2003 Weighted ------- Average Exercise Price ------- ------ Outstanding at beginning of year -- -- Granted 145,000 $ .25 Exercised -- -- Expired -- -- ------- ------ Outstanding at end of year 145,000 $ 0.25 ======= ====== F-29 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The board of directors approved 75,0000 options for employees and directors in the year ended December 31, 2004. The options vested 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 $57,359 and recorded as compensation expense in the year ended December 31, 2004. The following table summarizes the options granted in 2004 and assumptions used in determining their value, using the Black-Scholes pricing model: Dividend Yield 0% Weighted Average Expected Stock Volatility 25.48% Weighted Average Risk Free Interest Rate 3.93% Expected Option Lives 10 years Value of Options Granted $57,359 Options 2004 Weighted ------- Average Exercise Price ------- ------ Outstanding at beginning of year 145,000 $ 0.25 Granted 75,000 $ 2.21 Exercised -- -- Expired -- -- ------- ------ Outstanding at end of year 220,000 $ 0.92 ======= ====== The board of directors approved 1,450,000 options for employees and directors in the year ended December 31, 2005. F-30 SLS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the options granted in 2005 and assumptions used in determining their value, using the Black-Scholes pricing model: Dividend Yield 0% Weighted Average Expected Stock Volatility 22.13-25.87% Weighted Average Risk Free Interest Rate 3.73-4.09% Expected Option Lives 10 years Value of Options Granted $300,966* * Only options earned in 2005 are valued here. Options to be earned in 2006 and beyond have not been valued as they will be valued on the date they are earned. Options 2005 Weighted ------- Average Exercise Price ------- -------- Outstanding at beginning of year 220,000 $ 0.92 Granted 1,450,000 $ 2.47 Exercised -- -- Expired -- -- ------- ------- Outstanding at end of year 1,670,000 $ 2.27 ======= ====== 14. TEMPORARY EQUITY - RESCISSION OFFERS Holders who exercised warrants during the period from May 1, 2002 through May 10, 2004 may be entitled to demand a rescission of such exercises. 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. The Company intended to, but ultimately did not, make a rescission offer in 2005 to all warrant holders who exercised warrants during the period from May 1, 2002 through May 10, 2004. The rescission offer would require the Company to repurchase shares of common stock issued upon exercise of warrants at their original exercise price, F-31 SLS INTERNATIONAL, INC NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $.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 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. The Company did not make the rescission offer in 2005, as it focused instead on capital-raising, new product launches, and other activities. In 2006, the Company intends to determine whether to make the rescission offer or to allow the statute of limitations to continue to run through their expiration under applicable state law. From 2001 to 2003, the Company sold shares of our Convertible Preferred Stock, which is reflected in these financial statements as our Series A Preferred Stock. The Company subsequently 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. As of December 31, 2005, there were 66,000 shares outstanding. All other convertible preferred stock has been converted to common stock on a 10-to-1 basis, at a conversion price of $0.25 per share. Because the current stock price is well above the conversion price, no adjustments to these financial statements have been recorded for this. The Company believes that the conversion to common stock cures any issues related to the potential invalid issuance of shares of Convertible Preferred Stock. The Company may have rescission liability for the 44,000 shares that have not converted as of March 21, 2006, subject to the prior expiration of applicable statutes of limitation. F-32 SLS INTERNATIONAL, INC NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. SUBSEQUENT EVENTS From January 1 to March 21, 2006, 22,000 shares of preferred stock, series A, were converted into 220,000 shares of common stock. From January 1 to March 21, 2006, no shares of preferred stock, series B, were converted. In March 2006, a consultant exercised 100,000 options for $30,000 and was issued 100,000 shares of common stock. In February 2006, the building that serves as our principal location was sold to a third party for gross proceeds of $4,000,000 and leased back to the company under a ten year operating lease. The term of the lease runs from February 2006 through February 2016. Future minimum lease payments under this new lease are as follows: 2006 $ 412,500 2007 $ 450,000 2008 $ 450,000 2009 $ 450,000 2010 and thereafter $3,150,000 ---------- $4,912,500 On March 8, 2006, the Board of Directors awarded stock options to 14 key employees, none of whom are executive officers, for an aggregate of 1,068,000 shares at the day's closing market price of $1.04. On March 9, 2006, we announced the signing of a master Vendor Agreement with Best Buy Co., Inc. Under the terms of the Vendor Agreement, Best Buy will distribute the new Q Line Gold Home Theater Surround Sound System in 618 Best Buy locations throughout the U.S. commencing in May, 2006. The agreement provides that Best Buy will purchase the first 3,090 units of the Q Line Gold Home Theater Surround System that we supply. Following the sale of the initial order of 3,090 units, all additional units will be supplied to Best Buy on a consignment basis. F-33 EX-10.39 2 ex10-39.txt MATERIAL CONTRACTS EXHIBIT 10.39 VENDOR AGREEMENT Effective Date: February 21, 2006 THIS VENDOR AGREEMENT (the "Agreement") is made and entered into by and between Best Buy Purchasing LLC, a Minnesota corporation ("Best Buy"), having its principal office at 7601 Penn Avenue South, Richfield, Minnesota, 55423, U.S.A., and SLS International, Inc., a corporation organized under Delaware law ("Vendor"), having its principal office at 1650 W. Jackson, Ozark, MO 65721. WHEREAS, This Agreement is intended to set forth the terms and conditions applicable to the purchase of goods from Vendor and their distribution, marketing and resale by Best Buy Purchasing LLC and its designated affiliates. NOW, THEREFORE, in consideration of the mutual covenants herein contained, the parties hereby agree as follows: 1. LICENSE TO SELL PRODUCTS 1.1 Appointment of Authorized Dealer. Vendor appoints Best Buy Purchasing LLC and each of its designated affiliates (collectively, "Dealer") as an authorized dealer. The designated affiliates will include Best Buy Stores, L.P., and BestBuy.com, Inc., or as updated from time to time upon notice to Vendor ("Affiliates"). 1.2 Territory. Vendor grants Dealer a non-exclusive license to distribute any products Vendor sells to Dealer ("Product" or "Products"), to end-users and commercial buyers in the United States (and its territories), Canada and other territories as may be agreed to by the parties from time to time. Dealer shall sell the Products through Dealer's sales channels including but not limited to its present and future retail stores in the Territory, Internet web sites, distribution centers and mail order distribution centers. 2. PRICING AND TAXES 2.1 Prices. Vendor will sell the Products to Dealer at the prices then in effect on its current price list, as may be changed from time to time, or as otherwise agreed between the parties. All prices, benefits and allowances offered to Dealer will not be less favorable than those prices, benefits or allowances extended to any other similarly situated customers of Vendor. Vendor's prices do not include sales, use, excise, or similar taxes. 2.2 Taxes. The amount of any valid present or future sales, use, excise, or other similar tax that is attributable to Dealer will be paid by Dealer; or in lieu thereof, Dealer will provide Vendor with a tax exemption certificate acceptable to the taxing authorities. 2.3 No Minimum Purchase Requirement. Dealer shall have no obligation or liability to purchase all or any particular volume of any type of Products or parts from the Vendor. Dealer does not guarantee, and is not obligated to issue, any particular number or type of purchase orders with the Vendor. Dealer shall not be liable to the Vendor for loss of business or revenues, or excess inventory, if Dealer's purchase orders do not meet the Vendor's expectations. 3. PURCHASE ORDERS Orders for Vendor's Products will be initiated by electronic purchase orders submitted by Dealer and will be binding upon the parties upon acceptance by Vendor, provided that Dealer reserves the right to cancel a purchase order at any time prior to the shipment date. Vendor will be deemed to have accepted a purchase order if Vendor fails to reject the purchase order by notifying Dealer within twenty-four (24) hours of its receipt thereof, not including weekends and nationally recognized holidays. 4. PAYMENT 4.1 Invoices. All Vendor invoices will be sent via Electronic Data Interchange (EDI) to Dealer no earlier than the Product shipment date in connection with each accepted and fulfilled purchase order. Dealer will pay amounts due in each such invoice pursuant to the credit terms established by the parties, which will be set forth in the Vendor Program Agreement, the terms of which will be agreed to by the parties and which will be attached as an addendum hereto, as further described in Section 10. The designated credit term will commence on the later of (a) the date Dealer receives Products at the FOB point specified in Section 5, or (b) the date Dealer is authorized to resell the applicable Products, i.e. the "street date." Payment will not be considered late by Vendor for purposes of calculating early payment discounts if payment is sent by Dealer within one (1) week of the due date or if payment is delayed because of an EDI communication failure or due to an indebtedness of Vendor to Dealer. No interest or other charges will be payable by Dealer upon this Agreement, or any resulting invoice, whether claimed by reason of late payment or otherwise. All transactions will be valued and paid in United States currency. 1 4.2 Right to Make Offset. Dealer may offset from Vendor's invoice any indebtedness of Vendor to Dealer, whether or not related to this Agreement. Vendor agrees to not contest Dealer's deduction if Vendor fails to send a written denial thereof, including all supporting documentation, to Dealer within ninety (90) days of the date of deduction (Dealer's check date). Such written denial will be made by Vendor by submitting notice to Dealer via Dealer's standard Dispute Control Document, available at Dealer's Vendor Extranet web site, WWW.EXTENDINGTHEREACH.COM. 4.3 Statement of Account. From time to time upon request by Dealer, Vendor will provide a complete statement of account that will include but not be limited to unpaid invoices and disputed deductions. Such statement of account will also disclose all credit memos issued and outstanding. The statement of account will be forwarded by electronic mail in spreadsheet format or by regular mail per Dealer's instructions. Statements for merchandising/inventory accounts will be separate from any statement of account for parts purchased by Dealer for Product service and out-of-warranty repairs. 4.4 Debit Balances. If Vendor is indebted to Dealer but there is no outstanding balance due to Vendor, Vendor will pay the amount due to Dealer via check or wire transfer in full within thirty (30) days of receipt of notification thereof from Dealer. If the amount in question is disputed, the parties agree to work in good faith to reconcile the matter so that payment to Dealer of any undisputed amount will be made within sixty (60) days of Dealer's original notice to Vendor. In no event will Dealer be obligated to take a credit against future purchases. 5. SHIPPING 5.1 Shipping Terms: The parties hereby agree to the ground shipment terms selected below: [ ] FOB Destination, Freight Prepaid by Vendor. Vendor will be responsible for carrier selection and routing instructions. Vendor will pay all costs and expenses incurred prior to the FOB point, including without limitation, insurance, freight, and any notification, sort and segregation charges. Title and risk of loss passes upon delivery at the destination specified by Dealer, which may include but is not limited to its stores, distribution centers, and third-party fulfillment providers. Vendor is encouraged to utilize Dealer's preferred carriers to improve on-time performance, minimize transit times and reduce the need for expedited shipments. [X] FOB Origin, Freight Collect and Allowed. Dealer will be responsible for carrier selection, routing instructions and pick-up appointments at Vendor's domestic origin facility. In addition, Dealer is responsible for carrier freight payments, submitting freight claims for loss and damage, scheduling appointments at destination, and tracking and tracing freight in transit. Title and risk of loss passes to Dealer upon delivery at Vendor's domestic origin shipping dock. Vendor agrees to have Products in ship-ready condition on the ship date specified in the applicable purchase order and provide forty-eight (48) hour notice of pick-up request to Dealer. The attached Collaborative Transportation Agreement, as amended from time to time by the parties, if applicable, contains additional terms that define the parties' responsibilities under this shipping arrangement. 5.2 Time is of the Essence. TIME IS OF THE ESSENCE OF THIS AGREEMENT WITH RESPECT TO THE SPECIFIED DATES FOR SHIPMENT OF PRODUCT. 5.3 Expedited Shipments. Vendor will pay any additional freight expenses incurred in connection with an expedited shipment arising from a shipment delay or other cause attributable to Vendor. Dealer will pay any additional freight expenses incurred in connection with an expedited shipment arising from a shipment delay or other cause attributable to Dealer. 5.4 Other Charges. Any charges related to special requests of Vendor to carrier, including loading assistance, detention, or any other instructions, prior to title passage, will be the responsibility of the Vendor. 5.5 Direct Import Addendum. Terms relating to Products that are imported by Dealer, if applicable, are set forth in the attached Direct Import Addendum, which is incorporated herein by reference. 6. PRICE PROTECTION; NOTICE OF PRICE INCREASES 6.1 Price Protection. If Vendor issues a price decrease for Products (a) the lower price will be reflected on Vendor's invoice with respect to any price decrease that occurs prior to shipment and (b) Dealer will receive price protection credit with respect to Dealer's on-hand inventory existing on the effective date of the price decrease, which will include Product wherever located (e.g., inventory located in stores, warehouses, return centers and Product in transit between these locations or from Vendor to Dealer). Dealer will submit a cost adjustment claim to Vendor that is supported by documentation that reflects Dealer's inventory records of Product subject to price protection credit. 2 6.2 Notice of Price Increases. Except as otherwise agreed, Vendor will give Dealer ninety (90) days prior written notice to Dealer of the effective date of any price increases. A price increase will not affect Dealer's cost on a purchase order accepted by Vendor prior to the effective date of such price increase. 7. RETURNS 7.1 Return Rights. Dealer will have the right to return for full credit or refund of Dealer's cost any Products (a) against which an allegation is made that the use of such Products infringes on any patent, trademark, trade secret, copyright, right of privacy or publicity, or any other tangible or intangible proprietary or intellectual property right; (b) that are not manufactured, packaged, or labeled in accordance with industry standards and/or all applicable laws, ordinances, rules, and regulations; (c) that are shipped in error or in non-conformance with Dealer's purchase order; (d) that have caused injury to person or property; and (e) that are damaged or Defective. Returned Products will be shipped FOB Origin, Freight Collect from Dealer's product return center, distribution center or stores, as the case may be. 7.2 Defective Products. For purposes of this Agreement, a "Defective" Product means any Product that is visually or operationally defective and Product that has been returned by a customer in accordance with Dealer's end-user return policy. Dealer's end-user return policy allows for the return of most Products with or without cause for a specified period after purchase, regardless of whether the Product packaging has been opened or whether the Product is actually defective. 7.3 Return Procedures. If a Vendor Return Authorization is first required by either party prior to Dealer's return of Product to Vendor, Vendor agrees to provide a unique Return Authorization number to Dealer within two (2) business days of Dealer's request. Vendor will allow delivery of return Product as of the day the Return Authorization is issued to Dealer. If Vendor requires that Dealer make an appointment to deliver returned Product, such appointment will be provided by Vendor within three (3) days of the carrier's expected arrival time. Upon shipment of the return Product to Vendor, Dealer will send a Return Goods Memo (debit memo) to Vendor that references the corresponding Return Authorization number, if any, along with quantity and dollar amounts on a per unit basis. Dealer may thereafter deduct the total dollar amount of the return Product from Vendor's invoice. Vendor agrees to send a credit memo to Dealer for the amount specified in the Return Goods Memo within ninety (90) days of the date of Dealer's deduction. Such credit memo will reference either Dealer's Return Goods Memo number or the Return Authorization number. Product returned to Vendor will be delivered in their original, undamaged containers, provided that Vendor will not consider a container with a removed UPC to be damaged for purposes of calculating the return credit if such UPC was removed by an end-user in connection with a Vendor-sponsored rebate offer. In the event Dealer rightfully requests a return of Products under this Agreement and Vendor fails to timely provide a Return Authorization or accept delivery thereof, Dealer may take any action in its sole and reasonable discretion at Vendor's expense, which may include but is not limited to storage, liquidation or destruction of the Products, provided however that if Dealer liquidates the Products, Dealer shall not be entitled to refund or credit. If Vendor receives Product from Dealer that Vendor believes is non-returnable and Dealer agrees, Vendor will return such Product to Dealer's originating Product returns location at Dealer's expense within ninety (90) days of Vendor's determination and the shipment cartons will reference the original return shipment's Return Authorization number or Return Goods Memo number. 7.4 Additional Return Rights. Additional or different return rights may be specified in a Vendor Program Agreement (e.g., stock-balancing, defective allowances) as mutually agreed to by the parties, as further described in Section 10, and as may be attached hereto. If the parties agree to a defective allowance, such allowance will replace Dealer's right to return Defective Products as provided herein, except that if the actual defective rate for a particular Product exceeds the applicable allowance, Dealer may either adjust the allowance accordingly or return the excess Defective Product to Vendor for full credit or refund. A defective allowance will have no effect upon Dealer's return rights as otherwise provided in this Agreement. 7.5 Warranty Returns; Appointment of Authorized Return Center. Vendor appoints Dealer as an "Authorized Return Center" for the return by end-users of those Products under a manufacturer's warranty. Except as may otherwise be agreed in a comprehensive Product Service Agreement, which will be an addendum hereto as further described in Section 11, Dealer will (a) receive the in-warranty Product from the end-user, (b) provide the end-user with an in-store credit ("In-Store Credit"), and (c) send the end-user's defective Product to Vendor after receiving Vendor's return authorization, if required. The appointment of Dealer as an Authorized Return Center is non-exclusive and will include all present and future Dealer locations which Dealer designates to accept the Product returns. This appointment of Dealer as an Authorized Return Center will survive the expiration or termination of this Agreement to the extent necessary to satisfy end-user warranty requests. 8. DISCONTINUED PRODUCT A "Discontinued Product" means any Product that Vendor has stopped manufacturing or any Product that undergoes a change in appearance or packaging. Vendor agrees to provide Dealer with at least ninety (90) days advance written notice of the occurrence of a Discontinued Product, or as soon as possible in the event that the discontinuance is caused by actions taken by a component part supplier of Vendor. Upon notice of such Discontinued Product, Dealer may, without penalty or liability, cancel any outstanding purchase orders (orders which have not yet been shipped by Vendor) pertaining to the Discontinued Product. With respect to Dealer's existing inventory of Discontinued Product, Dealer and Vendor will work together in good faith to either negotiate a cost markdown of such existing 3 inventory, or return such Discontinued Product to Vendor for full credit or refund; provided, however, if the parties do not mutually agree to either of the former, Dealer reserves the right to return the Discontinued Product for full credit or refund. 9. VENDOR PERFORMANCE AND OPERATIONS STANDARDS Other terms that are relevant to doing business with a particular operating division of Dealer or Affiliate may be found in the Vendor Performance and Operations Standards, which is a part of this Agreement and incorporated herein by reference. The Vendor Performance and Operations Standards may be accessed at Dealer's Vendor Extranet web site, WWW.EXTENDINGTHEREACH.COM The Vendor Performance and Operations Standards may include but is not limited to information concerning Electronic Data Interchange (EDI), Returns Procedures, Routing and Shipping Guides and the Shipping Performance Management Program, all of which may be updated from time to time by Dealer upon notice to Vendor. 10. VENDOR PROGRAM AGREEMENT Dealer and Vendor may agree upon certain business terms from time to time concerning matters such as Products, pricing, market development/cooperative advertising/merchandising funds, invoice credit terms, stock rotation, volume rebates, new store allowances, and the like. Such terms will be contained in one or more Vendor Program Agreements, which will be considered an addendum hereto, as amended from time to time by the parties in writing. In the event of conflict between business terms of any Vendor Program Agreement and this Agreement, the business terms contained in such Vendor Program Agreement will control. 11. PRODUCT SERVICE AND WARRANTY REPAIRS Dealer is committed to meeting its customers' high expectations concerning post-sale service and warranty repairs. A comprehensive Product Service Agreement between the parties may be necessary to ensure customer satisfaction. If applicable, the attached Product Service Agreement controls the servicing and warranty repairs of the Products and will be executed by both parties prior to or simultaneous with the execution of this Agreement. 12. TRADEMARKS; VENDOR-PROVIDED CONTENT 12.1 Trademark Use. Vendor grants Dealer a license to use, exhibit, excerpt, reproduce, publish, publicly perform and transmit via the Internet and otherwise use all trade names, trademarks, and service marks associated with the Products for the sole purpose of promoting and selling the Products. This Agreement does not grant Vendor any right or license to use Dealer's trade names, trademarks or service marks, promotional material, copy, graphics, themes, strategies, inventions, program, and files without first obtaining Dealer's express written approval, provided however that Vendor may refer to Dealer as an outlet for the Products. 12.2 Vendor Content. Vendor may provide to Dealer, without limitation, Product specifications, images, and other textual, graphical and/ or multimedia content regarding the Products for use in preparing advertising and promotional material ("Vendor Content"). Vendor hereby grants Dealer a license to use, exhibit, excerpt, reformat, modify, reproduce, publish, publicly perform and transmit via the Internet and otherwise use such Vendor Content for the sole purpose of advertising and promoting the Products. 12.3 Use After Termination. Upon termination of this Agreement, Dealer may continue to advertise and promote the Products, using the Vendor's trade names, trademarks, service marks and Vendor Content until inventory depletion. 13. CONFIDENTIALITY This Agreement and any information marked as confidential or, regardless of form (written/electronic/oral) or marking, is of the nature that a reasonable person would understand its owner would not want it disclosed to the public will be considered to be Confidential Information. Further, Confidential Information will also include (a) any document or data transaction between the parties; (b) matters of a technical nature such as trade secret processes or devices, know-how, data, formulas, inventions (whether or not patentable or copyrighted), specifications and characteristics of products or services planned or being developed, and research subjects, methods and results, (c) matters of a business nature such as information about costs, profits, pricing, policies, markets, sales, suppliers, customers (e.g., names and addresses), product plans, and marketing concepts, plans or strategies, (d) matters relating to project initiatives and designs, (e) matters of a human resources nature such as 4 employment policies and practices, personnel, including individual names, addresses, and telephone numbers; compensation and employee benefits, (f) other information of a similar nature not generally disclosed to the public. Each party agrees not to disclose Confidential Information except to employees, or a third party subject to a similar confidentiality agreement, which have a need to know to perform their responsibilities. Each party agrees to take at least the same precautions to protect Confidential Information as such party would utilize to ensure the protection, confidentiality and security of its own confidential information. Each Party, at its own expense, will properly use security procedures that are reasonably sufficient to ensure that all transmissions of documents are authorized and to protect its business records and data from improper access. Confidential Information will not include any information which (a) is or becomes generally known or available through no act or failure to act by the receiving party; (b) is already known by the receiving party as evidenced by its written records; (c) is hereafter rightfully furnished to the receiving party by a third party without restriction on disclosure; or (d) is disclosed in response to a valid order by a court or other governmental body, provided that the receiving party provides the disclosing party with prior written notice of such disclosure as soon as reasonably possible in order to permit the disclosing party to seek confidential treatment of such information. Upon the expiration or earlier termination of this Agreement, a party may, in writing, request either the prompt return or destruction, and a written certification of such destruction, of any Confidential Information provided to the other party. Each party further acknowledges that monetary damages may not alone be a sufficient remedy for unauthorized disclosure of Confidential Information and that the non-disclosing party will be entitled to seek all remedies and damages available in law and equity, including but not limited to such injunctive relief as may be deemed proper by a court of competent jurisdiction. 14. ADDITIONAL OBLIGATIONS OF VENDOR 14.1 Product Materials. Vendor will provide to Dealer, at no charge, an adequate number of Product samples, adequate copies of any marketing and technical information, service manuals, detailed Product specifications, end-user warranties and other Product data and materials. 14.2 Training. Vendor will assist with the training of Dealer personnel on Dealer's premises as reasonably necessary to ensure that Dealer's sales and service personnel will be adequately knowledgeable with respect to the Products. 14.3 Compliance with Laws. Vendor will notify Dealer within ten (10) days regarding the existence and nature of Vendor's knowledge of any material non-compliance with applicable laws, or its notice of a claim from a consumer (which, individually or in the aggregate, may reasonably be expected to result in material liability to Vendor and/or Dealer) that a Product is defective or does not comply with all applicable laws. 15. REPRESENTATIONS AND WARRANTIES 15.1 Vendor's Representations and Warranties. Vendor represents and warrants to Dealer that (a) it has the authority to enter into this Agreement and to sell the Products to Dealer, free and clear of all liens, charges, encumbrances, or other restrictions, and that the persons signing this Agreement on behalf of Vendor are authorized to sign; (b) the Products will be free from defects in material and workmanship, and will be fit and safe for the use(s) normally and reasonably intended; (c) the Products are of merchantable quality and will perform in conformance with specifications and Vendor samples; (d) it will provide a manufacturer's warranty to end-users of the Products that is generally consistent with or superior to industry standards; (e) it will comply with all applicable federal, state, and local laws and regulations in performing its obligations under this Agreement, including but not limited to laws and regulations pertaining to product design, manufacture, packaging and labeling and, if applicable, importation and the Foreign Corrupt Practices Act; and (f) the Products are not produced, manufactured, assembled or packaged by the use of forced labor, prison labor or forced or illegal child labor and that the Products were not trans-shipped for the purpose of mislabeling, evading quota or country of origin restrictions or for the purpose of avoiding compliance with forced labor, prison labor or child labor laws. 15.2 Dealer's Representations and Warranties. Dealer represents and warrants to Vendor that (a) it has the authority to enter into this Agreement, and that the persons signing this Agreement on behalf of Dealer are authorized to sign; (b) it will comply with all applicable federal, state, and local laws; and (c) it will exert commercially reasonable efforts to promote and sell the Products consistent with Dealer's sales, marketing and merchandising plans, as may be amended from time to time in Dealer's sole and absolute discretion. 16. TERM AND TERMINATION 16.1 Term. This Agreement will be effective for an initial term of one (1) year commencing on the Effective Date hereof and will automatically renew for successive periods of one (1) year each following the initial term of this Agreement unless either party gives the other written notice to the contrary at least thirty (30) days prior to the scheduled date of renewal or unless sooner terminated as provided herein. 16.2 Termination. Either party may terminate this Agreement at any time without cause upon ninety (90) days written notice to the other party. In the event a party is in material breach of this Agreement, this Agreement may be terminated immediately by the non-breaching party, provided that notice describing the breach has been provided to the breaching party and the breaching party has failed to cure such breach within thirty (30) days of its receipt thereof. 5 16.3 Events on Termination. (a) Without Cause. Upon expiration or the termination of this Agreement without cause, the parties will agree to either (i) completion by Dealer of sell-through of the remaining Product inventory; or (ii) return of the remaining Product inventory to Vendor, for which Dealer will receive a refund, at cost, less one-half (1/2) of the return freight expenses. (b) For Cause. Upon termination of this Agreement for cause, the parties will agree to either (i) completion by Dealer of sell-through of the remaining Product inventory; or (ii) return of the remaining Product inventory to Vendor at the breaching party's expense, and Dealer will receive a refund at Dealer's cost for all returned Products. 17. INDEMNIFICATION Vendor will indemnify, defend, and hold Dealer, its parent, affiliates, agents and employees, harmless from and against any and all claims, actions, liabilities, losses, costs and expenses arising from or in connection with (a) Vendor's breach of this Agreement, including but not limited to its representations and warranties; (b) acts or omissions of Vendor relating to the Products which includes, but is not limited to claims that the Products, or use thereof, caused personal injury, death, or real or personal property damage; (c) a Product recall, whether or not initiated by Vendor; (d) claims that the Products or any Vendor Content infringe, misappropriate or injure a third party's intellectual property or proprietary rights; (e) false or misleading Product specifications or other Vendor Content provided to Dealer to promote and sell the Products; and (f) Vendor's failure to promptly perform its obligations in connection with a rebate offer. Dealer agrees to give Vendor prompt written notice of any claims, to tender the defense to Vendor, and to grant Vendor the right to control settlement and resolution. Vendor agrees to pay all costs of liability, settlement and defense, including attorney fees and costs.. Dealer will indemnify, defend and hold Vendor, it affiliates, agents and employees, harmless from and against any and all claims, actions, liabilities, losses, costs and expenses arising from or in connection with (a) Dealer's breach of this Agreement, including but not limited to its representations and warranties; and (b) acts or omissions of Dealer relating to the Products, including but not limited to, altering Vendor Content or the Products so as to violate any intellectual property or proprietary rights of third parties. 18. INSURANCE 18.1 Comprehensive / Commercial General Liability. Vendor will procure and maintain throughout the term of this Agreement a policy of comprehensive general or commercial general liability insurance with a combined single limit of not less than one million dollars ($1,000,000) for each occurrence. 18.2 Workers Compensation; Automobile Liability. If Vendor's agents will be entering Dealer's premises, Vendor will procure and maintain throughout the term of this Agreement: (a) Workers Compensation insurance in an amount not less than the statutory limits and (b) automobile liability insurance with a combined single limit of not less than one million dollars ($1,000,000) for each occurrence for personal injury, including death, and property damage. 18.3 Umbrella Coverage. Vendor will procure and maintain throughout the term of this Agreement Umbrella coverage of not less than ten million dollars ($ 10,000,000). 18.4 Requirements. Vendor will supply Dealer with a Certificate of Insurance with respect to each of the foregoing policies, except Workers Compensation, that names BEST BUY CO., INC., ITS SUBSIDIARIES & AFFILIATES as an Additional Insured, and which also provides that such insurance will not be canceled or changed unless at least thirty (30) days prior written notice has been given to Dealer. The insurance required hereunder will be issued by an insurance company or companies authorized to do business in the United States. Vendor's insurance will be primary and required to respond to and pay claims prior to other coverage. 19. ASSIGNMENT 19.1 Assignment. This Agreement may not be assigned by either party without first obtaining the other party's express written consent, which consent will not be unreasonably withheld; provided, however, that either party may assign this Agreement, without obtaining the other party's express written consent, to (a) a successor corporation resulting from a merger, consolidation, or non-bankruptcy consolidation or to a purchaser of all or substantially all of either party's assets or a majority, or controlling interest in either party's voting stock, provided that the purchaser's net worth at the time of purchase is equal to or greater than that of the party in question, and further provided that the purchaser is not a competitor of the other party; and (b) a present or future subsidiary or affiliate. Any attempted assignment in violation of this Agreement will be null and void. 19.2 Assignment of Accounts Receivable. If Vendor assigns payments to an assignee/factor, Vendor understands and agrees that Vendor and the assignee/factor will be required to sign Dealer's standard acknowledgment form to assure Dealer that the assignee/factor understands the rights and obligations being assigned, including the right of Dealer to make offsets. 6 20. AUDIT RIGHTS; CLAIMS 20.1 Audit Rights. Upon reasonable prior written notice and at reasonable times during regular business hours, each party will have the right to audit the other party's books and records to assure compliance with the terms and conditions of this Agreement. If the audit reveals that a party is not performing in material compliance with the terms of this Agreement, then, in addition to any other legal and equitable rights and remedies available, the party not in compliance will reimburse the other for the reasonable costs of the audit. 20.2 Claims. Except as otherwise provided in this Agreement, claims by either party, however asserted, will be commenced within two (2) years from the date the cause of action accrues. 21. CONFLICT OF INTEREST AND CODE OF CONDUCT POLICIES Vendor agrees to respect and abide by Dealer's conflict of interest and code of conduct policies, which are available at WWW.EXTENDINGTHEREACH.COM and may be amended from time to time by Dealer. Vendor should contact Dealer's email hotline at VENDOR.RELATIONS@BESTBUY.COM for information concerning Dealer's policies and to discuss any ethical or conduct concerns that they may have as a result of their contact with Dealer personnel. Vendor understands and acknowledges that Dealer's conflict of interest and code of conduct policies address Vendor-paid travel, gifts and gratuities, offering and accepting bribes, family members and close personal relationships involving employees of both parties, personal investments in the other party, Vendor-sponsored charitable and other events, Vendor product samples, Vendor promotional copies, direct personal purchases from Vendors by Dealer employees, and awards, incentives and other spiffs from vendors. Vendor agrees to avoid conflict of interest situations with Dealer and to deal at arms length with Dealer. Dealer similarly agrees to abide by Vendor's policies concerning these subject matters. 22. FORCE MAJEURE Neither party will be in breach of this Agreement solely due to causes beyond the control and without the fault or negligence of such party. Such causes may include, but are not restricted to, acts of God or of a public enemy, acts of the government in either its sovereign or contractual capacity, fires, floods, epidemics, quarantine restrictions, strikes, freight embargoes, power failure, or failure of the U.S. postal system, but in every case the failure to perform will be beyond the control and without fault or negligence of the party failing to perform. Each party will inform the other of any Force Majeure event within five (5) business days of its occurrence. 23. NOTICES All notices, requests, demands and other communications that are required or may be given under this Agreement will be in writing and will be deemed to have been duly given if hand-delivered or mailed by either registered or certified mail, return receipt requested, or by a nationally recognized overnight courier service, receipt confirmed. In the case of notices via first-class mail or courier service, notices will be deemed effective upon the date of receipt. Notices will be addressed to the parties as set forth below, unless either party notifies the other of a change of address, in which case the latest noticed address will be used: Notices To Vendor: Notices To Dealer: - ------------------ ------------------ SLS International, Inc. Best Buy Purchasing LLC 1650 W. Jackson 7601 Penn Avenue South Ozark, MO 65721 Richfield, MN 55423-3645 Attn: Ed Moist Attn: Senior Vice President, Merchandising 417-883-4549 Copy To: Manager, Vendor Relations Copy To: General Counsel, Legal Department 24. GENERAL 24.1 Relationship of the Parties. The relationship between the parties will be that of independent contractor. Nothing herein will be construed as creating or constituting the relationship of employer/employee, franchiser/franchisee, principal/agent, partnership, or joint venture between the parties. 24.2 Governing Law; Jurisdiction. This Agreement will be governed by and interpreted under the laws of the State of Minnesota. 24.3 Enforceability. If any provision of this Agreement is held to be unenforceable by a court of competent jurisdiction, such provision will be more narrowly and equitably construed so that it becomes legal and enforceable, and the entire Agreement will not fail on account thereof and the balance of the Agreement will continue in full force and effect. 7 24.4 No Waiver. Any of the provisions of this Agreement may be waived by the party entitled to the benefit thereof. Neither party will be deemed, by any act or omission, to have waived any of its right or remedies hereunder unless such waiver is in writing and signed by the waiving party, and then only to the extent specifically set forth in such writing. A waiver with reference to one event will not be construed as continuing or as a bar to or waiver of any other right or remedy, or as to a subsequent event. 24.5 Counterparts and Electronics Signature. This Agreement may be executed in one or more counterparts, each of which will be deemed an original but all of which together will constitute one and the same instrument. This Agreement may be executed by facsimile or other "electronic signature" (as defined in the Electronic Signatures in Global and National Commerce Act of 2000) in a manner agreed upon by the parties hereto. 24.6 Entire Agreement; Amendments. This Agreement, including any addenda or exhibits attached hereto, contains the entire Agreement between the parties with respect to the subject matter hereof, supersedes all prior agreements, negotiations and oral understandings, if any, and may not be amended, supplemented, or modified in any way, except by an amendment in writing and signed by authorized representatives of the parties hereto. No amendment will be effected by the acknowledgement or acceptance of a purchase order, invoice, or other forms stipulating additional or different terms. This Agreement will inure to the benefit of and be binding upon each of the parties and their respective successors, assigns, heirs, executors, administrators, trustees and legal representatives. 24.7 Reservation of Rights. Duties and obligations imposed by this Agreement and rights and remedies available hereunder will be in addition to and not a limitation of duties, obligations, rights and remedies otherwise imposed or available by law except as otherwise provided herein. 24.8 Headings. Headings used in this Agreement are for the purposes of convenience only and will not affect the legal interpretation of this Agreement. 24.9 Draftsmanship. Each of the parties hereto has been represented by its own counsel. In the event of a dispute, no provision of this Agreement will be construed in favor of one party and against the other by reason of the draftsmanship of this Agreement. 24.10 Survival. The expiration or termination of this Agreement will not terminate vested rights of either party from any liabilities or obligations incurred under this Agreement prior to or which by their nature are intended to survive expiration or termination, including but not limited to provisions relating to confidentiality, warranties, indemnification, returns, and proprietary rights. 8 ADDENDA (CHECK IF APPLICABLE) Each checked Addendum is hereby incorporated into and made a part of this Agreement: [X] Vendor Program Agreement [ ] Configure to Order Agreement [X] Product Service Agreement [X] Consignment Agreement [X] Certificate of Insurance [X] Collaborative Transportation Agreement [X] Vendor Performance and Operations Standards [ ] Direct Import Addendum (available at www.extendingthereach.com)
IN WITNESS WHEREOF, this Agreement is made effective as of the date first written above. BEST BUY PURCHASING LLC VENDOR: SLS INTERNATIONAL, INC. (on behalf of its Affiliates) Authorized Officer: Authorized Officer: ------------------ ------------------ (Signature) (Signature) Name: Daniel Moe Name: Steven Lamar Title: VP-Vendor Management Title: President Date: February 28, 2006 Date: February 21, 2006 9 EX-10.40 3 ex10-40.txt MATERIAL CONTRACTS EXHIBIT 10.40 Addendum to the Vendor Agreement Between Best Buy Purchasing, LLC and SLS International, Inc. Effective Date: December 1, 2005 ------------------------------------- THIS ADDENDUM TO THE VENDOR AGREEMENT (the "Addendum") is made and entered into by and between Best Buy Purchasing LLC, a Minnesota corporation ("Best Buy"), having its principal office at 7601 Penn Avenue South, Richfield, Minnesota, 55423, U.S.A., and SLS International, Inc., a corporation organized under Delaware law ("Vendor"), having its principal office at 1650 W. Jackson, Ozark, MO 65721. WHEREAS, the parties entered into that Vendor Agreement dated December 1, 2005 (the "Vendor Agreement") pursuant to which Best Buy will purchase goods from Vendor, and distribute, market and resell those goods; WHEREAS, the parties entered into that certain Consignment Agreement dated February 22, 2006 (the "Consignment Agreement") pursuant to which Best Buy will distribute, market and resell Vendor's goods on a consignment basis; WHEREAS, the parties desire to amend the Vendor Agreement as set forth below; NOW, THEREFORE, in consideration of the foregoing and the mutual covenants set forth below, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereby agree as follows: 1. The Vendor Agreement, the Consignment Agreement, and the respective terms, provisions and definitions thereof shall continue in full force and effect and are hereby incorporated herein in their entirety by this reference hereto. Unless otherwise defined herein, each capitalized term used herein that is defined in the Vendor Agreement and/or the Consignment Agreement shall have the meaning specified for such term in the such Agreement. Any references to sections in this Amendment correspond to sections in the Vendor Agreement only. Provided however, that the sales calculation processes as outlined in the Consignment Agreement shall be used to calculate units sold. Only after Best Buy has recorded net sales of the initial three thousand ninety units, will Best Buy begin remitting payment for remaining units under the Consignment Agreement. 2. The parties agree that the Initial Shipment of Vendor's Products to Best Buy shall be subject solely to the terms and conditions of the Vendor Agreement, and that the terms and conditions of the Consignment Agreement shall not apply to the Initial Shipment. 3. For purposes of this Addendum, "Initial Shipment" shall mean 3,090 units of Vendor's Products set forth in a purchase order issued Best Buy on or before March 1, 2006. 4. Best Buy shall pay Vendor's invoice for the Initial Shipment within 30 days after delivery of the Initial Shipment. 1 5. This Addendum supplements and modifies the Vendor Agreement and the Consignment Agreement. Except as expressly modified herein, the Vendor Agreement and the Consignment Agreement remain in full force and effect in accordance with their respective terms and conditions. If there is any conflict between the terms of this Addendum and the Vendor Agreement or the Consignment Agreement, the terms of this Addendum shall control. IN WITNESS WHEREOF, the parties hereto have executed this Addendum as of the day first written above. BEST BUY PURCHASING LLC SLS INTERNATIONAL, INC. By: By: --------------------------- --------------------- Title: VP- Vendor Management Title: President 2 EX-10.41 4 ex10-41.txt MATERIAL CONTRACTS EXHIBIT 10.41 ADDENDUM CONSIGNMENT AGREEMENT [BEST BUY VENDORS] EFFECTIVE DATE: FEBRUARY 21, 2006 THIS CONSIGNMENT AGREEMENT ("Agreement") is made a part of and is hereby incorporated into the Vendor Agreement between Best Buy Purchasing LLC (a Best Buy Co., Inc. subsidiary) and its affiliates, having its principal place of business at 7601 Penn Avenue South, Richfield, Minnesota, USA 55423-3645 ("Consignee") and SLS International Inc. having its principal place of business at 1650 W. Jackson, Ozark, MO 65721 ("Consignor"), which became effective on December 1, 2005. This Agreement is intended to set forth the terms and conditions applicable only to the provision of consigned products from Consignor to Consignee and intended for resale via Consignee's Best Buy stores and/or Internet web sites. Such consigned products are described on EXHIBIT A hereto, as may be amended from time to time by agreement by the parties ("Consignment Product(s)"). All terms in the Vendor Agreement shall remain in full force and effect with respect to non-consigned products. With respect to Consignment Products, the following terms shall supplement the terms of the Vendor Agreement. In the event of conflict, the terms of this Agreement will control with respect to Consignment Product. 1. RESERVATION OF RIGHTS AND TITLE. Title to the Consignment Products is reserved in Consignor until sale of the Consignment Product by Consignee to Consignee's customers. Consignee agrees to cooperate with Consignor in effecting the protections afforded consignment sellers under Sections 9-103(d), 9-109 (a)(4) and 9-319 of the Uniform Commercial Code as adopted and in effect in the state of Minnesota, to the extent provided herein. Consignee agrees to execute UCC-1 financing statements as modified in the form attached as EXHIBIT B, provided that Consignor shall be responsible for preparation of such financing statements and for the filing of such financing statements and payment of all applicable filing and preparation costs. No security interest shall be granted in the proceeds from the sale of the Consignment Product. 2. SALE OF CONSIGNMENT PRODUCT. Consignee has sole discretion to determine the retail price of the Consignment Product and the right to determine the amount and frequency of any retail price changes. For each sale of a unit of Consignment Product, regardless of the retail sale price, Consignee shall pay Consignor the "Agreed Cost" for such Consignment Product, as set forth in EXHIBIT A, minus the allowances, deductions and vendor charge-backs agreed between the parties. Consignment Product sold and returned by a customer in accordance with Consignee's return policy shall not be considered a "sale" for purposes of calculating payments to Consignor. Consignment Product that is defective (which includes but is not limited to Consignment Product that is returned without the box, with an opened box, or with a damaged box) shall be the responsibility of Consignor, and may be returned to Consignor unless otherwise mutually agreed. Any amounts remaining from the sale after payment to Consignor as set forth herein shall be retained by Consignee. Consignee shall exert commercially reasonable efforts to sell the Consignment Product consistent with Consignee's sales, marketing and merchandising plans, which may be amended from time to time. 3. INVOICES; PAYMENT; ALLOWANCES. All transactions (e.g., purchase orders and invoices) shall be conducted via Electronic Data Interchange (EDI). Consignment Product shall not be payable until sell-through to Consignee's customers. However, upon shipment of the Consignment Product to Consignee, Consignor shall submit a corresponding invoice to Consignee that contains quantity, Agreed Cost, and stock-keeping unit (SKU) information. Further, Consignor's invoices shall contain net 30 payment terms as a placeholder; however, actual payment terms shall be as provided herein. Such invoice detail is necessary so that Consignee's merchandise receipt system can automatically match each invoice to the corresponding Consignment Product delivery and purchase order issued by Consignee. Any discrepancies (e.g., shortages) identified by Consignee will be reconciled with Consignor each month to assure that the parties agree to the correct inventory of Consignment Product held by Consignee. The parties will at this time make any necessary corrections to their records concerning invoices and quantities. If Consignor fails to submit EDI invoices in the manner specified above to Consignee to confirm the quantities of Consignment Products shipped, Consignee may in its discretion: (1) make payment to Consignor based upon quantities of Consignment Products as determined by Consignee's inventory records, which will result in a delay in Consignee's payment to Consignor; or (2) delay its payment to Consignor until Consignor produces the necessary EDI invoices or other documentation to confirm quantities of Consignment Products shipped. - -------------------------------------------------------------------------------- 2-11-03 Best Buy version Page 1 Consignee shall provide net point of sales data to Consignor via EDI on a weekly basis (i.e., net of customer returns) at no charge. Subject to the Consignor's obligation to provide accurate EDI invoices to Consignee on a timely basis, Consignee shall make a monthly payment to Consignor via US Mail fifteen (15) days following Consignee's fiscal month end. Payment will be based on final estimated monthly sales, which may not equal the sum of weekly sales transmissions to Consignor due to sales system corrections posted within two business days after fiscal month end. Agreed allowances/deductions may be set forth below or described in a separate writing between the parties: ADVERTISING ALLOWANCE: DEFECTIVE ALLOWANCE: PLACEMENT/END CAP ALLOWANCE: SHRINK ALLOWANCE: [OTHER]: 4. AUDITS. Consignor may audit Consignee's books and records pertaining solely to the subject matter of this Agreement no more than once per year, provided that Consignee shall be given reasonable written notice, and further provided that the audit shall take place at Consignee's facilities during normal business hours. Costs of the audit shall be borne by Consignor, provided that if a five percent (5%) or more discrepancy or shortfall is found, Consignee will reimburse the reasonable and documented costs of such audit. 5. TAXES. Consignee will be responsible for the collection and remittance of the appropriate sales tax to the proper taxing authorities and will provide state resale tax certificates to Consignor. Consignee shall report the consignment inventory, as listed on Consignee's general ledger, to the Consignor. Consignor will be responsible to pay any personal property taxes relating to the Consignment Product in Consignee's possession. Each party shall be responsible for reporting its own income derived from this Agreement and for payment of its own income taxes. 6. SHIPMENTS. Consignor will ship the Consignment Product to Consignee's designated shipping address (e.g., distribution centers and/or stores) at Consignor's risk and expense. Consignor shall be responsible for making shipping arrangements, scheduling, tracking, proof of delivery, tracing, and obtaining insurance for loss or damage while Consignment Products are in transit, and filing freight claims for loss and/or damage. If expedited shipment becomes necessary, in the reasonable opinion of both parties, due to the fault or delay of Consignor, then Consignor shall pay the costs of such expedited shipments to either Consignee's distribution centers or via drop ships to Consignee's stores, as requested by Consignee. If expedited shipment becomes necessary, in the reasonable opinion of both parties, due to the fault or delay of Consignee, then Consignor agrees to ship product, freight collect, to either Consignee's distribution centers, or stores via drop ship, as requested by Consignee; Consignee shall then charge back Consignor the difference between the standard ground shipping costs and the expedited shipping costs. The carrier (not Consignor) shall invoice Consignee in this latter freight collect situation. Consignor agrees not to include freight charges on any invoices under any circumstances. 7. RETURN OF GOODS. Consignee has 100% return rights with respect to the Consignment Product, whether in cases of defectives, obsoletes, slow-moving Consignment Products, upon termination, or otherwise. Except as otherwise expressly set forth in this Agreement, Consignee agrees to arrange and pay for return shipments. Notwithstanding the foregoing, the undersigned Consignee reserves the right to return, at Consignor's expense, any Consignment Products - -------------------------------------------------------------------------------- 2-11-03 Best Buy version Page 2 for which a claim is made that alleges that the Consignment Products (1) infringe any alleged patent, design, tradename, trademark, copyright, right of privacy, or any other tangible or intangible property rights, or (2) are not manufactured, packaged and labeled in accordance with best industry standards and/or all applicable laws, ordinances, rules and regulations by governmental departments, bodies and agencies governing and/or restricting the receipt and sale of Consignment Products by the undersigned Consignee, or (3) have caused injury to person or property. In addition, Consignor agrees to pay the cost of return shipments of substantially defective product. In all cases, Consignor agrees to provide a return authorization ("RA") within 48 hours of request. 8. FURTHER OBLIGATIONS OF CONSIGNEE. Consignee shall make an annual payment to Consignor at the most recent Agreed Cost per unit for any loss or damage to the Consignment Products, less any applicable discounts, allowances or other valid off set amounts, while such Consignment Products are in the care, custody, and control of Consignee. Notwithstanding the foregoing, Consignee agrees to use commercially reasonable efforts to protect and preserve the Consignment Products that are in the care, custody or control of Consignee, wherever located. Consignee further agrees to maintain all-risk property insurance in an amount adequate to fully insure all Consignment Products in the care, custody or control of Consignee, wherever located, in an amount not less than $5 Million, and will name Consignor as a loss payee on such policy where Consignor's interest appears. 9. FURTHER OBLIGATIONS OF CONSIGNOR. a. Consignor represents and warrants that (i) Consignor has full title to the Consignment Product, free and clear of all liens, charges and other encumbrances, and (ii) all Consignment Products delivered hereunder will have been manufactured, packaged, and labeled in accordance with best industry standards and all applicable laws, ordinances, rules, and regulations by governmental departments, bodies, and agencies governing and/or restricting the purchase, acceptance, resale, distribution or promotion of such Consignment Product by Consignee. b. Consignor will indemnify, defend, and hold Consignee, its parent, affiliates, agents and employees, harmless from and against any and all claims, actions, liabilities, losses, costs and expenses arising from or in connection with (a) Consignor's breach of this Agreement, including but not limited to its representations and warranties; (b) acts or omissions of Consignor relating to the Consignment Products which includes, but is not limited to claims that the Consignment Products, or use thereof, caused personal injury, death, or real or personal property damage; (c) a Consignment Product recall, whether or not initiated by Consignor; (d) claims that the Consignment Products infringe, misappropriate or injure a third party's intellectual property or proprietary rights; (e) false or misleading Consignment Product specifications provided to Consignee to promote and sell the Consignment Products; and (f) Consignor's failure to promptly perform its obligations in connection with a rebate offer. Consignee agrees to give Consignor prompt written notice of any claims, to tender the defense to Consignor, and to grant Consignor the right to control settlement and resolution. Consignor agrees to pay all costs of liability, settlement and defense, including attorney fees and costs. 10. CONSIGNOR-CONSIGNEE RELATIONSHIP. The parties do not intend to form a partnership or joint venture, principal-agent, employer-employee, or any other relationship other than that of consignor-consignee, and, where appropriate, licensor-licensee. It is fully understood that each party will exercise full power and authority, except for as specifically provided otherwise in writing and signed by both parties, to select the means, method and manner of performing all obligations required under this Agreement. Except as provided herein, neither party will have any right or authority and will not attempt to enter into any contract or commitment, or incur any debt or liability of any nature in the name of or on behalf of the other party. 11. TERM; TERMINATION. The term of this Agreement shall commence on the Effective Date, and shall continue for one year, but shall automatically renew on an annual basis unless terminated by either party upon advance written notice to the other. Termination shall not affect the parties' respective outstanding obligations. Upon termination, the parties will wind up their consignment relationship by conducting an account reconciliation to reach a final settlement. In the event Consignee's records reflect a debit balance with Consignor (defined as any amount owed by Consignor to Consignee), Consignee may (i) hold the Consignment Products as collateral until Consignor makes payment to Consignee; or (ii) if Consignee elects to purchase the remaining inventory of Consignment Product, deduct the debit balance amount from the amount payable to Consignor. Notwithstanding the foregoing, upon termination of this Agreement, Consignee may, at its option, (i) purchase the remaining Consignment Product in its possession (and negotiate in good faith for obtaining price protection), or (ii) return all or some of the Consignment Product to Consignor at Consignee's expense. - -------------------------------------------------------------------------------- 2-11-03 Best Buy version Page 3 Upon commencement of this Agreement, if the parties agree to convert existing non-consignment inventory in Consignee's possession into Consignment Product inventory, the parties shall make this conversion effective on the first day of Consignee's fiscal month. Similarly, upon termination or expiration of this Agreement, if the parties agree to convert existing consignment inventory into non-consignment inventory, the parties shall make this conversion effective on the first day of Consignee's fiscal month. 12. ASSIGNMENT. Neither party may assign this Agreement without first obtaining the written consent of the other party. Provided, however, that a party may assign this Agreement, without the consent of the other party, to (a) a purchaser of all or substantially all of the assigning party's assets or a majority or controlling interest in the assigning party's voting stock, provided that the purchaser's net worth at the time of purchase is equal to or greater than that of the assigning party, and further provided that the purchaser is not a competitor of the other party to this Agreement; or (b) to a present or future subsidiary or affiliate of the assigning party. 13. GOVERNING LAW. This Agreement shall be governed and controlled in all respects by the laws of the State of Minnesota, excluding its conflict of law rules. 14. ENTIRE AGREEMENT. This consignment agreement, and the accompanying exhibits, contains all the terms and conditions with respect to the consignment of the Consignment Products named herein. No modification of these terms and conditions shall be of any force unless such modification is reduced to writing and signed by the undersigned Consignor and Consignee. However, the parties may from time to time amend the description of products and Agreed Cost terms contained on EXHIBIT A, without necessarily reducing the same to a writing signed by both parties. CONSIGNOR: SLS INTERNATIONAL, INC. By: --------------------------------------------------------- Name: Steven Lamar Title: President Date: February 21, 2006 CONSIGNEE: BEST BUY PURCHASING LLC By: ----------------------------------------------------- Name: Daniel Moe Title: VP- Vendor Management Date: February 28, 2006 - -------------------------------------------------------------------------------- 2-11-03 Best Buy version Page 4 EXHIBIT A TO CONSIGNMENT AGREEMENT DESCRIPTION OF CONSIGNMENT CONSIGNMENT PRODUCTS AGREED COST SKU # TBD Consignment Product Description: $ /Unit 5.1 Black 1000 watt Home Theater in a Box with Subwoofer - -------------------------------------------------------------------------------- 2-11-03 Best Buy version Page 5 EX-10.42 5 ex10-42.txt MATERIAL CONTRACTS EXHIBIT 10.42 ADDENDUM PRODUCT SERVICE AGREEMENT THIS PRODUCT SERVICE AGREEMENT ("Service Agreement") is effective as of February 21, 2006 ("Effective Date"), by and between SLS INTERNATIONAL, INC. ("Vendor") and BEST BUY STORES, L.P. ("Best Buy"). This Service Agreement is attached to and incorporated in the Vendor Agreement between BEST BUY PURCHASING, LLC and Vendor, dated February 21, 2006 ("Vendor Agreement"). 1. RETENTION OF BEST BUY. a. Warranty and Non-Warranty Services. Vendor appoints Best Buy as a manufacturer/factory authorized servicer ("Authorized Servicer") to service and/or otherwise facilitate the repair of Products (as defined in the Vendor Agreement). Best Buy will perform the services in accordance with one or more of the following service models selected by the parties ("Services"). Best Buy and Vendor agree to the service model(s) summarized and selected below. Best Buy and Vendor further agree to comply with the appropriate signed Attachment(s), incorporated in to this Service Agreement. [ ] BREAK/FIX MODEL - ATTACHMENT A. In summary: Best Buy receives the Product from the customer, Best Buy or its agent repairs the Product, and the customer receives the repaired Product. If the Product is under warranty, Best Buy submits a warranty claim to Vendor for Best Buy's labor and for any parts purchased by Best Buy. If the Product is not under warranty, then the customer pays Best Buy for Best Buy's labor and for parts used to repair the Product. If Best Buy and Vendor select this service model, then the fully signed Attachment A is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. [ ] DEDUCT FROM INVOICE ("DFI") - ATTACHMENT B. In summary: Based upon estimations of service needs, Vendor grants Best Buy a discount from the sale price of each unit of Product purchased by Best Buy as compensation for Best Buy's future performance of warranty services. When a customer requires warranty services under this model, Best Buy performs part or all of the services at its own cost, as long as the defects are not due to a catastrophic error (defined below). If Best Buy and Vendor select this service model, then the fully signed Attachment B is attached to and incorporated in this Service Agreement to set forth each party's respective rights and obligations. [ ] REPLACEMENT IN FIELD - ATTACHMENT C. In summary: Best Buy or its agent determines that the Product is defective, the customer is given a merchandise voucher in an amount corresponding to the cost of the Product, and the customer's defective Product is disposed of by Best Buy. Vendor reimburses Best Buy for the voucher. If Best Buy and Vendor select this service model, then the fully signed Attachment C is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. X OUT TO VENDOR - ATTACHMENT D. In summary: Vendor repairs the Products. Best Buy submits a warranty claim to Vendor for any associated labor, handling, and shipping fees. If Best Buy and Vendor select this service model, then the fully signed Attachment D is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. [ ] RETAIL EXCHANGE - ATTACHMENT E. In summary: A customer brings the in-warranty Product to Best Buy, the customer is given an in-store credit, and the customer's defective Product is sent to Vendor. Best Buy submits a warranty claim to Vendor for the in-store credit, associated labor/handling fees, and shipping costs. If Best Buy and Vendor select this service model, then the fully signed Attachment E is attached to and incorporated in this Service Agreement to set forth each party's respective rights and obligations. By INITIALING the boxes below, the appropriate service representatives of Best Buy and Vendor agree to the service model(s) selected above. The parties further agree to comply with the terms of this Service Agreement and the appropriate Attachment(s). --------------- ----------- Best Buy Vendor --------------- ----------- --------------- ----------- b. Service Locations. The appointment of Best Buy as an Authorized Servicer include all present and future Best Buy locations which Best Buy designates to perform the servicing and repair ("Service Locations"). d. Non-Exclusivity. The appointment of Best Buy as an Authorized Servicer is on a non-exclusive basis. Vendor may perform Services in its own facilities and may appoint other parties to perform Services. e. No Minimum Guarantees. Vendor and Best Buy understand that Vendor does not guarantee any minimum number of repair or service jobs nor does it guarantee any minimum amount of revenue to Best Buy, except as may be otherwise set forth in this Service Agreement. 2. COMPENSATION. Vendor will compensate Best Buy for its performance of Services in accordance with the appropriate Attachment(s). If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. 3. TERM; TERMINATION. a. Term. This Service Agreement commences on the Effective Date and remains in effect for as long as the Vendor Agreement between the parties remains in effect, as amended or modified, subject to the following provisions. Best Buy Product Service Agreement Master'6 Page 1 If the Vendor Agreement terminates or expires or if the Service Agreement terminates or expires, this Service Agreement will continue in full force and effect for the amount of time necessary for Best Buy to sell all of the Products in Best Buy's possession or sold to Best Buy, plus the applicable time period of the warranty for each such Product, plus the time period specified or allowed under this Service Agreement and Attachment(s) for Best Buy to prepare, submit, and be paid for all Services performed. b. Termination for Cause Following Failure to Cure. Either party may, at any time, terminate this Service Agreement if the other party breaches any of the terms of this Service Agreement and then fails to cure within 30 days of its receipt of written notice of such breach. c. Immediate Termination for Cause. Either party may terminate this Service Agreement if: (1) the other party breaches Sections 6 or 11 of this Service Agreement; (2) the other party becomes insolvent, or is adjudged a bankrupt or makes an assignment for the benefit of creditors; (3) a receiver of any property for the other party is appointed in any action, suit or proceeding by or against that party and is not removed within ninety days after appointment; or (4) the other party has, within any 12 month period, received notice of breach in accordance with Section 3(b), cured said breach, and again breached said particular term of the Service Agreement. Termination under this Section 3(c) is effective upon the breaching party's receipt of written notice from the other party. d. Termination without Cause. Notwithstanding any provisions of this Service Agreement to the contrary, Best Buy may terminate this Service Agreement upon fifteen days prior written notice to Vendor. e. Survival. The provisions of Sections 5, 6, 9, 11, 12, and 13 will survive any termination or expiration of this Service Agreement. 4. OBLIGATIONS. A. VENDOR OBLIGATIONS. (1) Insurance. Vendor will maintain fire, theft, and comprehensive liability insurance protection sufficient to cover customers' and Best Buy's property in Vendor's custody. (2) Qualified Staff and Training Programs. Vendor will maintain a qualified staff of service and training personnel having technical familiarity with the Products. Such staff must also be trained and qualified under all applicable safety laws, regulations, and practices. Vendor's service and training personnel will provide training programs, which will be offered to Best Buy from time to time. (3) Manuals; Fixes; Technical Assistance. As applicable and without charge to Best Buy, Vendor will promptly supply the following to each Best Buy Service Location: (a) three hard copies of the service manual ("Manual") for each Product or full access to the Manual via an internet site; (b) all training materials and information; (c) technical information on all the Products and replacement parts, including Product exploded views, part numbers, Product to part cross reference information and cost information; (d) if applicable, at least one restore solution to enable Best Buy to restore the operating system, software, and other original installations of any Products that are computers; (e) updated materials and notification of any service "fixes" (repairs to the Product that require special instruction or improved replacement parts provided by Vendor); (f) updated information regarding parts substitutions and parts no longer available; and (g) all other materials necessary or useful in repairing or servicing the Products. Notwithstanding any term to the contrary, Vendor agrees to give each Service Location the authority to use a reasonable number of copies of Vendor's copyrighted material (at no charge or cost to Best Buy) for purposes of repairing the Products. In addition, Vendor will provide technical and other assistance over the telephone to Best Buy during the hours of 8:30 a.m. to 5:00 p.m., Central Time, every business day of the year, at no cost to Best Buy. (4) Part Information and Order Fulfillment Service Provider. Best Buy may designate a third party service provider to provide part information services and customer in-warranty replacement part order fulfillment services. Vendor shall enter into a separate agreement with such designated third party service provider. (i) Without charge to Best Buy, Vendor will promptly supply the following to such Best Buy's designated third party service provider in the format as determined by such third party service provider: (a) Product to part cross reference information; (b) the Manual for each Product or full access to the Manual via an internet site; (b) updated information regarding parts substitutions and parts no longer available; and (c) other materials necessary or useful in repairing or servicing the Products. (ii) Vendor agrees to pay Best Buy for warranty claims for replacement parts purchased by such third party service provider and subsequently invoiced to Best Buy. Vendor agrees that compensation for such warranty claim shall include the same reimbursement rate for in-warranty part claims that is usually owed to Best Buy for any other similar warranty claim, labor, shipping, handling fees and associated administrative costs in accordance with the following rates: ---------------------------------- --------------------------- NA ---------------------------------- --------------------------- ---------------------------------- --------------------------- ---------------------------------- --------------------------- (5) Licenses and Permits. Vendor will secure and maintain in good standing all licenses and permits required by federal, state or local authorities and will require each of its technicians and trainers to obtain any required licenses and permits. (6) Laws and Regulations. Vendor will comply with all applicable federal, state and local laws and regulations in performing its responsibilities under this Service Agreement and in any of its dealings with Best Buy and its customers. (7) Non-Infringement. Vendor warrants and represents that, in the course of complying with its obligations and duties under this Service Agreement, it will not violate or infringe upon any patent, copyright, trade secret or other property or contract right of any other person. (8) Policies and Procedures. While on Best Buy's premises and/or fulfilling its obligations under this Service Agreement, Vendor and persons employed or conducting business with Vendor will comply with all policies and procedures promulgated by Best Buy as to Best Buy's premises. (9) Special Equipment. "Special Equipment" is testing/repair equipment unique to Vendor or non-standard in the Product repair industry. If Vendor requires any Special Equipment, then Vendor will supply such Special Equipment to each of the present and future Best Buy Service Locations at no cost to Best Buy. Best Buy Product Service Agreement Master'6 Page 2 (10) Parts. Vendor represents and warrants that any replacement parts shipped and/or sold to Best Buy by Vendor will be (a) free and clear of all liens, encumbrances, charges, and other restrictions and (b) new or refurbished. B. BEST BUY OBLIGATIONS. (1) Insurance. Best Buy will maintain fire, theft, and comprehensive liability insurance protection sufficient to cover all customer owned Products in Best Buy's custody. (2) Qualified Staff. Best Buy will maintain a qualified staff of service personnel having technical familiarity with the Products. Some of Best Buy's service personnel may participate in training programs offered by Vendor from time to time. (3) Maintain Equipment. Best Buy will maintain test and repair equipment in good working order. Best Buy will also maintain storage facilities for work in process. (4) Parts. If replacement parts are required for warranty Services, Best Buy will use only those replacement parts that (a) are the equivalent in specifications and quality to the original parts supplied with the Products or (b) meet the form, fit, and function of parts to repair such Product or (c) meet such other specifications agreed upon by the parties. If replacement parts are required for non-warranty Services, Best Buy will use any replacement part meeting the form, fit, and function of parts to repair such Product. (5) Licenses and Permits. Best Buy will secure and maintain in good standing all licenses and permits required by federal, state, or local authorities and will require each of its technicians to obtain any required licenses and permits. (6) Laws and Regulations. Best Buy will comply with all applicable federal, state, and local laws and regulations in performing its responsibilities under this Service Agreement. (7) Policies and Procedures. While on Vendor's premises and/or fulfilling its obligations under this Service Agreement, Best Buy and persons employed or conducting business with Best Buy will comply with all policies and procedures promulgated by Vendor as to Vendor's premises. 5. INDEMNIFICATION. a. Vendor's Indemnity. Vendor will indemnify, defend and hold harmless, Best Buy (its affiliates and their respective officers, directors, employees and agents) from and against any and all losses, costs, obligations, liabilities, damages, actions, suits, causes of action, claims, demands, settlements, judgments, and other expenses, (including but not limited to cost of defense, settlement, and reasonable attorney's fees) of whatever type or nature, including but not limited to damage or destruction to property, injury (including death) to any person, which are asserted against, incurred, imposed upon or suffered by Best Buy by reason of, or arising from (1) a breach of this Service Agreement by Vendor; (2) any actual or alleged infringement of a patent, copyright, trademark or other proprietary rights; (3) servicing and/or repairs made to a Product according to Vendor procedures, service manuals, service information, and/or other instructions or information; (4) the acts or omissions of Vendor (its officers, directors, employees or agents); (5) the violation of any law, rule, regulation, or authority by Vendor (its officers, directors, employees or agents), including but not limited to product safety and reliability laws, and consumer protection and human rights laws; and (6) Product recall expenses, including but not limited to lost profits and consequential damages. b. Best Buy's Indemnity. Best Buy will indemnify, defend and hold harmless, Vendor from and against any and all losses, costs, obligations, liabilities, damages, actions, suits, causes of action, claims, demands, settlements, judgments, and other expenses, (including but not limited to cost of defense, settlement, and reasonable attorney's fees) of whatever type or nature, including but not limited to damage or destruction to property, injury (including death) to any person, which are asserted against, incurred, imposed upon or suffered by vendor by reason of, or arising from (1) a breach of this Service Agreement by Best Buy; (2) Best Buy's warranty, service employment and sales practices, except for those performed according to Vendor's procedures, Manuals, service information, and/or other instructions or information; (3) any actual or alleged infringement of a patent, copyright, trademark or other proprietary rights by Best Buy service; and (4) the violation of any law, rule, regulation, or authority by Best Buy service, including but not limited to consumer protection and human rights laws. 6. CONFIDENTIALITY. a. Vendor's Proprietary Information. In the course of performance hereunder, Best Buy will use or be furnished with proprietary information, materials, tools and methodologies known as "Vendor Proprietary Information," which will be identified by Vendor prior to being delivered to Best Buy. Except as necessary to perform under the terms of this Service Agreement, Best Buy will not disclose, publish, reproduce, or make use of any Vendor Proprietary Information without the express written consent of Vendor. Vendor Proprietary Information means confidential or privileged information originated by Vendor and relating to the subject matter of this Service Agreement, whether furnished to Best Buy before or after the Effective Date, including but not limited to Ribbon Technology, which is not generally available to others. b. Best Buy's Confidential Information. "Confidential Information" of Best Buy means all information provided by Best Buy or Best Buy's agents to Vendor, relating in any way to the subject matter of this Service Agreement, whether furnished before or after the date of this Service Agreement and regardless of the manner in which furnished. Confidential Information includes (but is not limited to): (i) all information relating to a customer such as a name, address, products purchased, repairs completed; (ii) all information received from customers including the raw data, reports, compilations of such data or information; (iii) information relating to the repairs and parts purchased; (iv) work papers, analyses, compilations, projections, and statistical data; (v) cost for the Product, repairs, servicing, and replacement parts; (vi) identities of any current or pending or future vendors or planned products and services to be offered or withdrawn by Best Buy to customers; (vii) planned and future promotions and grand opening dates; (viii) Best Buy's business plans and forecasts; and (ix) any documents or other items marked "Confidential" or specifically communicated by Best Buy as "Confidential". c. Additional Definitions. For purposes of this Section 6, "Information" refers to Vendor's Proprietary Information when disclosed by Vendor or to Best Buy's Confidential Information when disclosed by Best Buy or its agents. "Disclosing Party" shall refer to the party disclosing Information to the other party hereunder, and "Receiving Party" refers to the party receiving the Information hereunder. Best Buy Product Service Agreement Master'6 Page 3 d. Expiration of Confidentiality. Such Information is the sole property of the Disclosing Party and constitutes confidential trade secrets of the Disclosing Party, to be held by the Receiving Party in trust and solely for the Disclosing Party's benefit. The Receiving Party agrees that, except as required in the performance of its obligations to the Disclosing Party hereunder and as permitted by the Disclosing Party, the Receiving Party will not publish, reproduce, disclose or make any use of any such Information unless or until: (i) such Information enters the public domain other than by a breach of this provision of this Service Agreement by the Receiving Party, its employees or affiliates; (ii) such Information becomes known to the Receiving Party from a source other than the Disclosing Party, other than by the breach of an obligation of confidentiality owed to the Disclosing Party, or other than by a third party acting to assist the Disclosing Party and/or the Receiving Party regarding this Service Agreement; (iii) the Disclosing Party expressly authorizes the publication or disclosure of such Information in writing; and (iv) as may be required by law to be disclosed, but the Receiving Party must first give the Disclosing Party a minimum of ten days prior written notice so that the Disclosing Party may seek a protective order requiring that the Information and/or documents to be disclosed be used only for the purposes for which the order was issued. e. Requirements. The Receiving Party will take at least the same precautions to ensure the protection, confidentiality, and security of the Information entrusted to it as it would to protect its own confidential information but in no event less than a reasonable standard. The Receiving Party will also limit the access to such Information to only those employees and agents having a need to know, and the Receiving Party will instruct such employees and agents concerning their obligations to maintain confidentiality. Promptly upon the Disclosing Party's request, the Receiving Party will return to the Disclosing Party all Information and/or destroy and certify such destruction of all Information; however, the parties agree that Best Buy shall not be obligated to return and/or destroy Manuals and other technical information relating to the Products or replacement parts. f. Damages. The Receiving Party acknowledges that monetary damages may not alone be a sufficient remedy for unauthorized disclosure of Information and that the Disclosing Party will be entitled, without waiving any other rights or remedies, to seek such injunctive or equitable relief as may be deemed proper by a court of competent jurisdiction. Further, the Receiving Party agrees that if there is a breach or threatened breach of the provisions regarding confidentiality, the Disclosing Party will be (i) irrevocably harmed; (ii) entitled to a temporary restraining order, injunction, and/or other equitable relief against the commencement or continuance of such breach, and (iii) entitled to such relief without the requirement of posting a bond or proving injury as a condition of relief. 7. RELATIONSHIP OF PARTIES. Best Buy and Vendor acknowledge that each will perform its duties and obligations under this Service Agreement as an independent contractor. This Service Agreement does not create a joint venture, partnership, employment or agency relationship between the parties. 8. REPORTS ON PROGRESS AND NOTIFICATIONS. a. Reports on Progress. From time to time at the request of the other party, (i) Best Buy will provide such reasonable reports as to its progress in performing its obligations under this Service Agreement as Vendor may uniformly require of its Authorized Servicers, and (ii) Vendor will provide reasonable reports as to its progress in performing its obligations under this Service Agreement, including reports related to the availability of replacement parts, as well as fill rates and turn-times for replacement parts. b. Notification of Claims. Vendor will notify Best Buy on a monthly basis of any claims or complaints made by a customer or other third party regarding the Warranty Services rendered by Best Buy under this Service Agreement. Such reports must contain: (i) information reasonably requested by Best Buy, (ii) the identity of the party making the complaint, (iii) a description of the grievance, (iv) the date of receipt by Vendor of the complaint, and (v) the date and action taken to resolve the complaint (if any). 9. LIMITATION OF LIABILITY. THIS SECTION 9 APPLIES TO THE SERVICE AGREEMENT ONLY. IN NO EVENT WILL BEST BUY BE LIABLE TO VENDOR FOR INJURY OR DAMAGE TO BUSINESS, PROFITS, REVENUES OR GOODWILL OF VENDOR OR FOR ANY CONSEQUENTIAL OR INCIDENTAL DAMAGES, HOWEVER CAUSED, WHETHER FOR BREACH OF WARRANTY, BREACH OF CONTRACT, REPUDIATION OF CONTRACT, TERMINATION, NEGLIGENCE, OR OTHERWISE, EVEN IF IT HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. 10. PURCHASES. Neither party may purchase goods or equipment in the name of the other party. Neither party may make or incur any debts, liabilities, obligations, or contracts in the name or upon credit of the other party. Vendor is not entitled to utilize any discount, bonus, or other marketing incentive earned by or made available to Best Buy or Best Buy employees. 11. TRADEMARKS. a. Vendor's Trademarks. During the term of this Service Agreement, Best Buy may use Vendor's trademarks, trade names, service marks and other identifying marks of Vendor for the purpose of advertising and alerting the public (and others) that Best Buy is an Authorized Servicer of Vendor Products. b. Best Buy's Trademarks. This Service Agreement does not grant Vendor any rights or license to use Best Buy's trademarks, trade names, service marks or any other identifying marks of Best Buy. Under no circumstances may Vendor use any of Best Buy's trademarks, trade names, service marks or any other identifying marks of Best Buy without first obtaining Best Buy's prior express written consent. 12. WAIVER OF LIENS. Vendor waives and relinquishes any and all materialman's, mechanics, workman's and other liens, statutory or otherwise, upon the property of the Best Buy customer. Best Buy Product Service Agreement Master'6 Page 4 13. MISCELLANEOUS. a. Notices. Any notice required to be given to Vendor or Best Buy under this Service Agreement must be sent to the following addresses: If to VENDOR: SLS International, Inc. 1650 W. Jackson Ozark, MO 65721 Phone No.: (417) 883-4549 FAX No.: (417) 883-2723 ========================= ======================= If to BEST BUY: Best Buy Stores, L.P. With a copy to: Best Buy Stores, L. P. 7601 Penn Avenue South 7601 Penn Avenue South Richfield, MN 55423-3645 Richfield, MN 55423-3645 Attention: Rick Selvey, Vice President Attn: General Counsel, Legal Department FAX No.: FAX No.: ======== =========
Any party, by written notice as set forth above, may change the address to which subsequent notices are to be sent to such party. b. Assignment. Unless otherwise specified within this Service Agreement or applicable Attachments, Vendor will not delegate, subcontract, assign or transfer any of its rights, duties, or obligations under this Service Agreement without the prior express written consent of Best Buy. If Best Buy grants such consent, Vendor will be solely responsible for the conduct of all agents and assignees of Vendor, and the granting of such consent will not modify or affect the duties of Vendor to Best Buy under this Service Agreement. Best Buy may assign its rights hereunder to its parent, subsidiaries, or affiliates. Best Buy may delegate various duties and obligations hereunder to Vendor-authorized third party service providers, third party call centers, and third party parts procurement agents. c. Governing Law. This Service Agreement is to be governed and interpreted in accordance with the laws of the State of Minnesota. The parties to this Service Agreement consent to the jurisdiction of the state and federal courts located in Minneapolis, Minnesota. d. Amendments. This Service Agreement may not be modified except by a writing referencing this Service Agreement and signed by both parties. e. Headings. The headings contained in this Service Agreement are for the convenience of reference and are not of substantive effect. f. Nonexclusivity. This Service Agreement is not intended to create an exclusive relationship between Best Buy and Vendor. g. Severability. If any provision within this Service Agreement is deemed or declared unenforceable, invalid, or void by a court of competent jurisdiction, the same will not impair any of the other provisions, which will be enforced in accordance with their respective terms. h. Entire Service Agreement. This writing is intended by the parties as the final and binding expression of their agreement and is a complete and exclusive statement of the terms. This writing supersedes all prior negotiations, representations, and agreements. This Service Agreement is intended by the parties to co-exist with the terms of the Vendor Agreement. Whenever necessary or proper, the singular imports the plural or vice versa, and masculine, feminine and neuter expressions are interchangeable. i. Remedies; Waiver. No failure or delay by either party to exercise any right, power, or privilege provided under the Service Agreement or by applicable law will operate as a waiver; nor will any single or partial exercise of any such right, power, or privilege preclude any other or future exercise of any other right, power, or privilege. The remedies provided within this Service Agreement are in addition to any rights or remedies provided by law. j. Warranty of Authority. Each party represents and warrants to the other that it (1) is duly organized, validly existing, and in good standing under the laws of the jurisdiction of its organization, and (2) has the requisite power and authority to execute and deliver, and to perform its obligations under, this Service Agreement. Each party represents and warrants to the other that this Service Agreement has been duly authorized, executed, and delivered by such party and constitutes a valid and binding obligation of such party enforceable against such party according to its terms. IN WITNESS WHEREOF, the parties have executed this Product Service Agreement as of the Effective Date. VENDOR Date: February 21, 2006 Sign: ________________________ Print: Steven Lamar Title: President Federal I.D.: 52-2258371 BEST BUY STORES, L.P. Date: March 6, 2006 Sign: _________________________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 5 BREAK/FIX MODEL - ATTACHMENT A If Best Buy and Vendor select the "Break/Fix Service Model" on page one of the Service Agreement, then this fully signed Attachment A is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. All other terms of the Service Agreement, not specifically amended or modified by this Attachment A, are to remain in full force and effect. All capitalized terms not otherwise defined in this Attachment A will have the meaning ascribed in the Service Agreement. 1. PRODUCTS. Vendor appoints Best Buy as an Authorized Servicer to service and repair the following Products ("Services"): -------------------------------------------------- PRODUCT DESCRIPTION -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- 2. COMPENSATION. a. For Warranty Services. Best Buy will perform Services on Products under warranty ("Warranty Services") without charge to customers provided that: (1) the Warranty Services are within the terms and guidelines of Vendor's Warranty, (2) Vendor or its third party parts provider promptly supplies the replacement parts requested by Best Buy, and (3) Vendor promptly pays Best Buy the amounts set forth within this Attachment A for the Warranty Services. Vendor will compensate Best Buy in accordance with Section 3(f), entitled "Payment for Replacement Parts," and Section 4(d), entitled "Satisfaction of Warranty Claims," and other relevant provisions of this Attachment A. b. Non-Warranty Services. Best Buy may perform Services on Products not under warranty ("Non-Warranty Services") for customers. Best Buy will establish the charges for the Non-Warranty Services, and, except for shipping/handling expenses incurred by Best Buy due to defective replacement parts as set forth in Section 3(g) of this Attachment A, Vendor is not obligated or responsible for any payment to Best Buy for such Non-Warranty Services. c. Handling Fees. The Vendor agrees to pay Best Buy a Handling Fee equal to 15% of the gross invoiced parts cost to Best Buy for warranty repairs to compensate Best Buy for the cost of processing part orders, processing backorders and short ships, reconciliation of accounting statements, storage, information technology data processing and services cost, part return sorting and packing, collection and matching of Return Goods Memos, Best Buy's parts ordering and processing administrative cost. c. Rates. The parties agree to the following rates. Vendor agrees to pay the rates for Warranty Services in accordance with Section 4. Vendor agrees to pay for defective replacement parts used in Non-Warranty Services in accordance with Section 3(g). ------------------------------------------------ ------------------- BASIS RATES ------------------------------------------------ ------------------- Labor, including No Apparent Defects MAJOR - $ * ___________________ * ___________________ * ___________________ INTERMEDIATE - $ * ___________________ * ___________________ * ___________________ MINOR - $ * ___________________ * ___________________ * ___________________ ------------------------------------------------ ------------------- ------------------------------------------------ ------------------- ------------------------------------------------ ------------------- 3. REPLACEMENT PARTS. a. Generally. In performing Non-Warranty Services or Warranty Services, Best Buy may acquire replacement parts for the Products ("Parts") from Vendor or from third party parts providers, subject to Section 4(B)(4) of the Service Agreement. Notwithstanding Section 13(b) of the Service Agreement, Vendor may sell Parts to third party parts distributors, and Best Buy may acquire Parts from such distributors. Best Buy may use third party service providers to accommodate manual or non-standard Vendor order processes. b. Parts. Subject to Section 4(A)(9) of the Service Agreement, Vendor will ship Parts for the Products that (1) are the equivalent in specifications and quality to the original parts supplied with the Products, or (2) meet such other specifications agreed upon by the parties. Vendor will maintain an inventory of general replacement Parts and special parts as may from time to time be required by Best Buy for the longer of five years or the period prescribed by applicable law. Best Buy is not obligated to retain or store replaced Parts. Best Buy Product Service Agreement Master'6 Page 6 c. Vendor Parts Vendor will ship the Parts to Best Buy such that they are received by Best Buy within three (3) business days from the time that Best Buy submits the order to Vendor. Vendor will ship all Parts at its sole cost via next day air parcel, next day air freight, or the best method for receipt at the Service Location within three (3) business days of Best Buy's order. Title and risk of loss passes to Best Buy upon receipt at the Service Location. d. Universal Parts. In the event that Vendor fails to ship Parts to Best Buy such that they are received by Best Buy within (3) business days from the time that Best Buy submits the order to Vendor, Best Buy may acquire and use standardized parts which lack the Vendor specific insignia grades ("Universal Parts") to perform the Services. Vendor will fully pay the warranty claims including reimbursement to Best Buy for the costs associated with the Universal Parts. e. 14-day Return Authorization. In the event that Best Buy has not received the Part from Vendor and Best Buy has not acquired and used a Universal Part within fourteen calendar days of the date the Part was ordered by Best Buy from Vendor, Best Buy may return the affected Product for a full credit or refund and may give the customer a new replacement Product (at Vendor's expense). Within 7 calendar days of Vendor's receipt of Best Buy's request for Vendor's authorization of such Product Return ("Return Authorization"), Vendor shall issue and deliver a Return Authorization number to Best Buy for the return of the affected Product. Upon the issuance of a Return Authorization number, Vendor shall cancel Best Buy's part order, failure to cancel Best Buy's part order shall result in $25 fee for each part number on each part order Vendor fails to cancel as provided in this Section assessed against Vendor on a quarterly basis. f. Unavailable Parts. In the event that on the date of Best Buy's original order of the Part from Vendor, the expected time of arrival at Best Buy of a Part (or its Universal Part equivalent) needed to perform the Services exceeds 14 calendar days, Best Buy may immediately return the affected Product for a full credit or refund and may give the customer a new replacement Product (at Vendor's expense). In order to reduce storage and handling costs, Vendor shall issue and deliver a Return Authorization number to Best Buy for return of the affected Product within 7 days of authorizing such return. g. Rejection of Return Authorization Request. A request for a Return Authorization for in-warranty product may be rejected by Vendor in the event that Best Buy failed to comply with Vendor's authorization procedures or incorrect information was submitted to Vendor in the request for such Return Authorization. In the event that a request for a Return Authorization from Best Buy is rejected by Vendor, Best Buy shall be entitled to an immediate full credit for the affected Product if upon review by the parties the rejection of the Return Authorization was in error or upon correction of the information or procedure at issue. In the event that Vendor erroneously rejects greater than 2.0% of Return Authorization requests, Best Buy's credit for the affected Product shall be increased by 25% of the Product cost to cover Best Buy's added handling costs. h. Pricing. Vendor guarantees that it will sell Parts to Best Buy at the lowest prices in effect for any similarly situated Vendor customer or the lowest prices available, whichever is lower. All Price changes must be mutually agreed upon at least 90 days prior to the price change effective date. Vendor must provide Best Buy with documentation of price changes for any price changes over 2% of parts cost.. Best Buy may audit Vendor's pricing to verify its receipt of the lowest pricing. If the audit reveals that Best Buy is not receiving the lowest pricing, then, in addition to Best Buy's other legal and equitable rights and remedies, Vendor will reimburse Best Buy for the reasonable costs of the audit. Best Buy does not guarantee any minimum number of Parts orders nor does it guarantee any amount of revenue to Vendor under this Service Agreement. i. Taxes. Unless otherwise stated, prices for Parts do not include sales, use, excise, or similar taxes. Consequently, Best Buy will pay the amount of any valid sales, use, excise, or other similar tax, attributable to Best Buy's purchase of Parts; or in lieu thereof, Best Buy will provide a tax exemption certificate acceptable to the taxing authorities. j. Payment for Replacement Parts. If Best Buy acquires Parts for Warranty Services from Vendor or from a third party, then Vendor must pay all reasonable costs associated with the Parts, including cost for the Parts and shipping/handling costs. If Best Buy acquires Parts for Non-Warranty Services from Vendor, then Best Buy must pay all costs associated with the Parts, including cost for the Parts and shipping/handling costs, subject to subsection (g) below. If Best Buy disputes an invoice in good faith and in a timely manner, Best Buy is entitled to receive the discount even if the good faith dispute is resolved beyond the discount date. If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. k. Defective Parts. For purposes of this Service Agreement, the term "defective" when referring to Parts means a Part that is visually or operationally defective. Best Buy may return to Vendor all defective Parts for full credit or refund, to be applied or paid to Best Buy within thirty (30) days of Vendor's receipt of the defective Parts. Further, Vendor will promptly pay all shipping/handling costs associated with the defective Parts. Vendor warrants its Parts for the longer of the following alternatives: (1) a minimum of 90 days from the date the Warranty Services and/or Non-Warranty Services are complete or (2) until the expiration of the warranty on the Product. l. Discontinuation of Parts. Vendor will provide Best Buy with written notice of the discontinuation of any Parts not later than seven days following Vendor's knowledge of such discontinuation. Best Buy may return, at its own expense, the discontinued Parts inventory to Vendor for full credit within 90 days of the date of Vendor's notification. m. Recall of Parts. Vendor will provide Best Buy with written notice of the recall of any Parts immediately upon Vendor's issuance of such recall. Best Buy may return, at Vendor's expense, freight prepaid, the recalled Parts inventory to Vendor in exchange for replacement Parts or full credit and Best Buy's handling fees and expenses. n. Return of Parts. Best Buy reserves the right to return, at Vendor's expense and for full credit (if there are sufficient funds to offset) or refund of the purchase price under the net payment terms herein, any Parts for which a claim is made alleging that (1) the use of the Parts infringes any alleged patent, design, tradename, trademark, copyright, right of privacy or publicity, or any other tangible or intangible proprietary right; or (2) the Parts are not manufactured, packaged, and/or labeled in accordance with industry standards and/or all applicable laws; or (3) the use of the Parts has caused injury to person or property. In addition to any other return rights set forth in this Service Agreement, within ninety (90) days of receipt by Best Buy, Best Buy may return for an immediate full refund (or offset against amounts owed Best Buy) of Best Buy's costs, any of the Parts. Vendor will not apply any penalty, re-stocking, or other fees or liabilities to Parts returns. o. Repurchase of Parts. Upon the final termination or expiration of this Service Agreement, Vendor will submit a bid to repurchase the Parts remaining in Best Buy's possession. If Best Buy accepts such bid, Best Buy will ship the repurchased Parts to Vendor upon receipt of payment or credit or offset. Such payment, credit or offset must be received by Best Buy within sixty days of the date of the final termination or expiration of this Service Agreement. Best Buy will pay freight and shipment will be FOB Best Buy dock. Title and risk of loss will pass to Vendor upon delivery to the carrier at Best Buy's dock. Best Buy Product Service Agreement Master'6 Page 7 4. SUBMISSION AND PAYMENT OF WARRANTY CLAIMS. a. Effective Warranty. Best Buy may perform Warranty Services on a Product after first obtaining acceptable proofs of purchase and then ascertaining that the Product is under warranty. Acceptable proofs of purchase include receipts issued to the customer at the time of sale from Best Buy (such as invoices or credit card receipts) or data retrieved from Best Buy's electronic records. Acceptable proofs of purchase must contain the date of purchase of the goods and a description of the goods. Notwithstanding any term to the contrary, those Products under warranty that are owned by Best Buy ("Store Stock Units") are entitled to Warranty Services. For so long as the Products are under the Vendor warranty, Best Buy's labor and costs, including replacement parts, will be paid by Vendor. b. Vendor's Payment Obligations. In accordance with subsections (d) and (e) below, Vendor will timely pay a labor fee to Best Buy for performing the Warranty Services, including instances in which Best Buy (using reasonable efforts) detects no apparent Product defect ("Labor Fees"). The applicable Labor Fees are set forth in Section 2(c) of this Attachment A. The Labor Fees may be revised periodically by mutual written agreement of the parties. If requested by Best Buy, Vendor will provide Parts to Best Buy to perform the Warranty Services and to replace Parts previously sold by Vendor to Best Buy and used by Best Buy to repair defective Products under Vendor Warranty. For Warranty Services performed by Best Buy, Vendor is obligated to compensate Best Buy for the following: (1) Labor Fees; (2) Parts, in accordance with Section 3(f) of this Attachment A; (3) all associated shipping/handling costs and expenses; and (4) other fees agreed upon by the parties (cumulatively referred to as "Warranty Services Fees").Best Buy requires a separation of labor dollars and part dollars on Vendor reimbursement claim detail. c. Submission of Warranty Claims. Best Buy will submit all warranty claims (including Labor Fees, costs associated with Parts, and shipping/handling expenses) to Vendor within thirty days of the completion of Warranty Services. Best Buy will submit each warranty claim using a properly completed NARDA form (or its electronic equivalent). Best Buy will provide 2 different electronic formats for use in warranty claim processing. d. Satisfaction of Warranty Claims. Vendor will pay Warranty Services Fees (by check or via electronic funds transfer) to Best Buy within thirty days of Vendor's receipt of a completed NARDA form. Vendor will send all reimbursements and payments due Best Buy to the address designated by Best Buy. If the payments due Best Buy are not properly made, Best Buy may offset such amounts against amounts owed to Vendor by Best Buy, whether under this Service Agreement or otherwise. e. Rejection of Claims. Notwithstanding any provisions of any other agreements (whether presently existing or otherwise) to the contrary, the following procedure will apply regarding Vendor's rejection of warranty claims. If Vendor rejects a warranty claim submitted or re-submitted by Best Buy, Vendor will give Best Buy a written notice of rejection of the claim within thirty (30) days of Vendor's receipt of the claim from Best Buy. The notice of rejection must set forth, specifically and completely, the basis for rejection and the necessary action to be taken by Best Buy in order to make the claim valid and conforming. If Best Buy does not receive such a notice of rejection within such thirty days, the claim will be conclusively deemed valid and conforming, and Best Buy is entitled to full payment for the claim as prescribed in this Service Agreement. Best Buy will then have sixty (60) days from its receipt of the notice of rejection to cure the non-conforming claim and re-submit the claim to Vendor. Following Best Buy's re-submission and cure of the non-conformances set forth within the initial notice of rejection, Vendor will pay the warranty claim. IN WITNESS WHEREOF, the parties have executed this Attachment A as of the Effective Date of the Service Agreement. VENDOR Date: February 21, 2006 Sign: ____________________________________ Print: Steven Lamar Title: President Federal I.D.: 52-2258371 BEST BUY STORES, L.P. Date: March 6, 2006 Sign: ____________________________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 8 DEDUCT FROM INVOICE ("DFI") - ATTACHMENT B If Best Buy and Vendor select the "DFI Service Model" on page one of the Service Agreement, then this fully signed Attachment B is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. All other terms of the Service Agreement, not specifically amended or modified by this Attachment B, are to remain in full force and effect. All capitalized terms not otherwise defined in this Attachment B will have the meaning ascribed in the Service Agreement. 1. PRODUCTS. Vendor appoints Best Buy as an Authorized Servicer to service and repair the following Products ("Services"): -------------------------------------------------- PRODUCT DESCRIPTION -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- 2. SCOPE OF SERVICES; COMPENSATION. a. Non-Warranty Services. Best Buy may perform Services on Products not under warranty ("Non-Warranty Services") for customers. Best Buy will establish the charges for the Non-Warranty Services, and, except as set forth in Sections 4(f) and 4(g) of this Attachment B, Vendor is not obligated or responsible for any payment to Best Buy for such Non-Warranty Services. b. Warranty Services. Best Buy will perform Services on Products under warranty ("Warranty Services") without charge to customers provided that: (1) the Warranty Services are within the terms and guidelines of Vendor's Warranty, and (2) Vendor promptly fulfills its obligations under this Service Agreement. The parties agree to the below selected DFI Service Model alternative and to the terms of the relevant provisions of this Attachment B. [ ] Under this DFI Service Model alternative, Best Buy, in exchange for a discount from the invoice price of each Product, absorbs parts and labor costs associated with its Warranty Services. As compensation for parts and labor associated with Best Buy's performance of Warranty Services under this alternative, Vendor grants to Best Buy a discount from the invoice price on each unit of Product purchased by Best Buy. -------------------------------- --------------------------- PRODUCT DESCRIPTION DFI AMOUNT -------------------------------- --------------------------- $ -------------------------------- --------------------------- $ -------------------------------- --------------------------- [ ] Under this DFI Service Model alternative, Best Buy, in exchange for a discount from the invoice price of each Product, absorbs the labor costs associated with its Warranty Services. As compensation for labor associated with Best Buy's performance of Warranty Services under this Service Agreement, Vendor grants to Best Buy a discount from the invoice price on each unit of Product purchased by Best Buy. In addition, Vendor must either (a) supply all necessary replacement parts to Best Buy or (b) compensate Best Buy for costs associated with Best Buy's acquisition of replacement parts from a third party. -------------------------------- --------------------------- PRODUCT DESCRIPTION DFI AMOUNT -------------------------------- --------------------------- $ -------------------------------- --------------------------- $ -------------------------------- --------------------------- [ ] Under this DFI Service Model alternative, Best Buy, in exchange for a discount from the invoice price of each Product, destroys the defective Product, gives the customer a new Product, and absorbs all associated costs. As compensation for costs associated with Best Buy's performance of Warranty Services under this alternative, Vendor grants to Best Buy a discount from the invoice price on each unit of Product purchased by Best Buy. -------------------------------- --------------------------- PRODUCT DESCRIPTION DFI AMOUNT -------------------------------- --------------------------- $ -------------------------------- --------------------------- $ -------------------------------- --------------------------- By INITIALING the boxes below, Best Buy and Vendor agree to the DFI Service Model alternative and associated compensation method selected above. ---------------- ----------- Best Buy Vendor ---------------- ----------- ---------------- ----------- c. Catastrophic or Substantial Defects. "Catastrophic or Substantial Defect" occurs when _________ percent or more of any particular model of Product are affected by defects related to usefulness, value, or safety of the Product. A Product recall constitutes a Catastrophic or Substantial Defect. Vendor must fully and promptly compensate Best Buy for all costs of Warranty Service resulting from Catastrophic or Substantial Defect. Best Buy Product Service Agreement Master'6 Page 9 3. TERM AND TERMINATION. The provisions of this Section 3 of Attachment B are to fully replace the terms of Sections 3(a), entitled "Term," and 3(b), entitled "Termination for Cause" of the Service Agreement. a. Term. This Service Agreement (including Attachment B) commences on the Effective Date and is to remain in effect for the longer of the following alternatives: (i) until the expiration of the warranty period for the Products purchased by Best Buy from Vendor under the DFI Service Model or (ii) as long as the Vendor Agreement between the parties remains in effect, as amended or modified. b. Termination. Notwithstanding any provision to the contrary, Best Buy may terminate Attachment B of this Service Agreement upon thirty days prior written notice to Vendor, provided such termination occurs after the expiration of the warranty period for those Products that were purchased from Vendor under the DFI Service Model. 4. REPLACEMENT PARTS. a. Generally. In performing Non-Warranty Services or Warranty Services, Best Buy may acquire replacement parts for the Products ("Parts") from Vendor or from third party parts providers, subject to Section 4(B)(4) of the Service Agreement. Notwithstanding Section 13(b) of the Service Agreement, Vendor may sell Parts to third party parts distributors, and Best Buy may acquire Parts from such distributors. b. Quality; Inventory. Subject to Section 4(A)(9) of the Service Agreement, Vendor will ship Parts for the Products that (1) are the equivalent in specifications and quality to the original parts supplied with the Products, or (2) meet such other specifications agreed upon by the parties. Vendor will maintain an inventory of general replacement Parts and special parts as may from time to time be required by Best Buy for the longer of five years or the period prescribed by applicable law. Best Buy is not obligated to retain or store replaced Parts. c. Shipping; Universal Parts. Vendor will ship the Parts to Best Buy such that they are received by Best Buy within seventy-two hours of the time that Best Buy submits the order to Vendor. Vendor will ship all Parts via the best method for receipt at the Service Location within seventy-two hours of Best Buy's order. Title and risk of loss passes to Best Buy upon receipt at the Service Location. If the Part is not received by Best Buy within seventy-two hours, Best Buy may acquire and use standardized parts which lack Vendor-specific insignia or grades ("Universal Parts") to perform the Services. If Best Buy has not received the Part from Vendor within fourteen days of the date the Part was ordered by Best Buy and if Best Buy has not acquired and used Universal Parts within such fourteen days, then Best Buy may give the customer a new replacement Product ("Replacement Product"). d. Pricing. This subsection applies only if the price of Parts is not already included in the initial deduction from Product invoice. Vendor guarantees that it will sell Parts to Best Buy at the lowest prices in effect for any similarly situated Vendor customer or the lowest prices available, whichever is lower. Subject to the preceding sentence, Vendor may reduce or increase prices to Best Buy at any time, upon at least thirty days prior written notice. Best Buy may audit Vendor's pricing to verify its receipt of the lowest pricing. If the audit reveals that Best Buy is not receiving the lowest pricing, then, in addition to Best Buy's other legal and equitable rights and remedies, Vendor will reimburse Best Buy for the reasonable costs of the audit. Best Buy does not guarantee any minimum number of Parts orders nor does it guarantee any amount of revenue to Vendor under this Service Agreement. e. Taxes. This subsection applies only if the price of Parts is not already included in the initial deduction from Product invoice. Unless otherwise stated, prices for Parts do not include sales, use, excise, or similar taxes. Consequently, Best Buy will pay the amount of any valid sales, use, excise, or other similar tax, attributable to Best Buy's purchase of Parts; or in lieu thereof, Best Buy will provide a tax exemption certificate acceptable to the taxing authorities. f. Payment for Replacement Parts and Replacement Products. (1) When Parts are Obligation of Vendor. If Best Buy acquires Parts for Warranty Services from Vendor or from any third party and if the acquisition of Parts for Warranty Services is an obligation of Vendor (i.e., under the second DFI Service Model alternative), then Vendor must pay all reasonable costs associated with the Parts, including applicable costs for the Parts, shipping/handling, Universal Parts, and Replacement Products (per Section 4(c) of this Attachment B). (2) When Parts are Obligation of Best Buy. If Best Buy acquires Parts for Warranty Services from Vendor or from any third party and if the acquisition of Parts for Warranty Services is an obligation of Best Buy (i.e., under the first DFI Service Model alternative), then Best Buy must pay all reasonable costs associated with the Parts, including costs for the Parts and shipping/handling. However, Vendor must pay Best Buy for (i) costs associated with Universal Parts due to Vendor's failure to timely ship a Part ordered by Best Buy and (ii) Replacement Products, per Section 4(c) of this Attachment B. Further, if Best Buy is unable to acquire the necessary Parts from a third party parts distributor, then Best Buy may acquire the Parts directly from Vendor or Vendor's designated third party parts distributor. (3) Parts for Non-Warranty Services. If Best Buy acquires Parts for Non-Warranty Services from Vendor or from a third party, then Best Buy must pay all costs associated with the Parts, including costs for the Parts and shipping/handling. However, Vendor must pay Best Buy for (i) costs associated with Universal Parts due to Vendor's failure to timely ship a Part ordered by Best Buy and (ii) Replacement Products, per Section 4(c) of this Attachment B. (4) Invoice Disputes. If Best Buy disputes an invoice in good faith and in a timely manner, Best Buy is entitled to receive the discount even if the good faith dispute is resolved beyond the discount date. If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. g. Defective Parts. For purposes of this Service Agreement, the term "defective" when referring to Parts means a Part that is visually or operationally defective. Best Buy may return to Vendor all defective Parts for full credit or refund, to be applied or paid to Best Buy within thirty days of Vendor's receipt of the defective Parts. Further, Vendor will promptly pay all shipping/handling costs associated with the defective Parts. Vendor warrants its Parts for the longer of the following alternatives: (1) a minimum of 90 days from the date the Warranty Services and/or Non-Warranty Services are complete or (2) until the expiration of the warranty on the Product. h. Discontinuation of Parts. Vendor will provide Best Buy with written notice of the discontinuation of any Parts not later than seven days following Vendor's knowledge of such discontinuation. Best Buy may return, at its own expense, the discontinued Parts inventory to Vendor for full credit. Best Buy Product Service Agreement Master'6 Page 10 i. Return of Parts. Best Buy reserves the right to return, at Vendor's expense and for full credit (if there are sufficient funds to offset) or refund of the purchase price, any Parts for which a claim is made alleging that (1) the use of the Parts infringes any alleged patent, design, tradename, trademark, copyright, right of privacy or publicity, or any other tangible or intangible proprietary right; or (2) the Parts are not manufactured, packaged, and/or labeled in accordance with industry standards and/or all applicable laws; or (3) the use of the Parts has caused injury to person or property. In addition to any other return rights set forth in this Service Agreement, within sixty (60) days of receipt by Best Buy, Best Buy may return for an immediate full refund (or offset against amounts owed Best Buy) of Best Buy's costs, any of the Parts. Vendor will not apply any penalty, re-stocking, or other fees or liabilities to Parts returns. j. Repurchase of Parts. Upon the final termination or expiration of this Service Agreement, Vendor will submit a bid to repurchase the Parts remaining in Best Buy's possession. If Best Buy accepts such bid, Best Buy will ship the repurchased Parts to Vendor upon receipt of payment or credit or offset. Such payment, credit or offset must be received by Best Buy within sixty days of the date of the final termination or expiration of this Service Agreement. Best Buy will pay freight and shipment will be FOB Best Buy dock. Title and risk of loss will pass to Vendor upon delivery to the carrier at Best Buy's dock. 5. WARRANTY CLAIMS FOR DEFECTS. a. Submission of Claims. If the Products purchased from Vendor by Best Buy under this DFI Service Model have Catastrophic or Substantial Defects, then Best Buy may submit warranty claims for costs associated with Best Buy's labor and Parts that are in excess of the dollar amount initially deducted from the Product invoice. Vendor will pay such costs for Catastrophic and Substantial Defects within thirty days after receiving a completed NARDA form from Best Buy. b. Rejection of Claims. Notwithstanding any provisions of any other agreements (whether presently existing or otherwise) to the contrary, the following procedure will apply regarding Vendor's rejection of such warranty claims. If Vendor rejects a warranty claim submitted or re-submitted by Best Buy, Vendor will give Best Buy a written notice of rejection of the claim within thirty days of Vendor's receipt of the claim from Best Buy. The notice of rejection must set forth, specifically and completely, the basis for rejection and the necessary action to be taken by Best Buy in order to make the claim valid and conforming. If Best Buy does not receive such a notice of rejection within such thirty days, the claim will be conclusively deemed valid and conforming, and Best Buy is entitled to full payment for the claim as prescribed in this Service Agreement. Best Buy will then have sixty days from its receipt of the notice of rejection to cure the non-conforming claim and re-submit the claim to Vendor. Following Best Buy's re-submission and cure of the non-conformances set forth within the initial notice of rejection, Vendor will pay the warranty claim. IN WITNESS WHEREOF, the parties have executed this Attachment B as of the Effective Date of the Service Agreement. VENDOR Date: _____ ____, 200__ Sign: ___________________________ Print: ___________________________ Title: ___________________________ Federal I.D.: __________________ BEST BUY STORES, L.P. Date: _____ ____, 200__ Sign: ___________________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 11 REPLACEMENT IN FIELD - ATTACHMENT C If Best Buy and Vendor select the "Replacement in Field Service Model" on page one of the Service Agreement, then this fully signed Attachment C is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. Under this Replacement in Field Service Model, (1) a customer brings the in-warranty Product to Best Buy or a Best Buy technician visits the customer's home, (2) Best Buy determines that the Product is defective, (3) Best Buy promptly gives the customer a merchandise voucher in an amount equivalent to the price paid by the customer for the Product ("Voucher"), and (4) Best Buy disposes of the customer's defective Product. Vendor reimburses Best Buy for the cost of the Voucher. All other terms of the Service Agreement, not specifically amended or modified by this Attachment C, are to remain in full force and effect. All capitalized terms not otherwise defined in this Attachment C will have the meaning ascribed in the Service Agreement. 1. PRODUCTS. Vendor appoints Best Buy as an Authorized Servicer to act in accordance with this Replacement in Field Service Model for the following Products ("Services"): -------------------------------------------------- PRODUCT DESCRIPTION -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- 2. SCOPE OF SERVICES; COMPENSATION. a. Non-Warranty Services. Best Buy may service those Products not under warranty ("Non-Warranty Services") for customers. Best Buy will establish the charges for the Non-Warranty Services, and Vendor is not obligated or responsible for any payment to Best Buy for such Non-Warranty Services. b. Warranty Services. Best Buy may perform Services on Products under warranty ("Warranty Services") without charge to customers provided that the Warranty Services are within the terms and guidelines of Vendor's Warranty. Vendor and Best Buy agree to the rates set forth below: ------------------------------- --------------------------- SERVICE WARRANTY RATE ------------------------------- --------------------------- Merchandise Voucher (cost of Product) ------------------------------- --------------------------- $ ------------------------------- --------------------------- $ ------------------------------- --------------------------- 3. REIMBURSEMENT. a. Effective Warranty. Best Buy may perform Warranty Services on a Product after first obtaining acceptable proofs of purchase and then ascertaining that the Product is under warranty. Acceptable proofs of purchase include receipts issued to the customer at the time of sale from Best Buy (such as invoices or credit card receipts) or data retrieved from Best Buy's electronic records. Acceptable proofs of purchase must contain the date of purchase of the goods and a description of the goods. Notwithstanding any term to the contrary, those Products under warranty that are owned by Best Buy ("Store Stock Units") are entitled to Warranty Services. For so long as the Products are under the Vendor warranty, Vendor will reimburse Best Buy for the Warranty Services. b. Vendor's Payment Obligations. In accordance with Sections 2(b) of this Attachment C, Vendor will promptly reimburse Best Buy for the cost of the Voucher provided to the customer. Such reimbursement may be in the form of a credit or as otherwise mutually agreed upon. 4. TIMEFRAME FOR COMPLETION OF SERVICES. Best Buy will use commercially reasonable efforts to promptly provide the customer with a Voucher. 5. DISPOSAL OF DEFECTIVE/DEFECTIVE PRODUCT. Best Buy must dispose of the customer's damaged/defective Product by either (a) destroying the Product or (b) selling the Product to a third party who is aware of the defects/damage to the Product. Best Buy is not obligated to retain or store damaged/defective Product. 6. NON-WARRANTY SERVICE - REPLACEMENT PARTS. a. Generally. In performing Non-Warranty Services, Best Buy may acquire replacement parts for the Products ("Parts") from Vendor or from third party parts providers, subject to Section 4(B)(4) of the Service Agreement. Notwithstanding Section 13(b) of the Service Agreement, Vendor may sell Parts to third party parts distributors, and Best Buy may acquire Parts from such distributors. b. Quality; Inventory. Subject to Section 4(A)(9) of the Service Agreement, Vendor will ship Parts for the Products that (1) are the equivalent in specifications and quality to the original parts supplied with the Products, or (2) meet such other specifications agreed upon by the parties. Vendor will maintain an inventory of general replacement Parts and special parts as may from time to time be required by Best Buy for the longer of five years or the period prescribed by applicable law. Best Buy is not obligated to retain or store replaced Parts. Best Buy Product Service Agreement Master'6 Page 12 c. Shipping; Universal Parts. Vendor will ship the Parts to Best Buy such that they are received by Best Buy within seventy-two hours of the time that Best Buy submits the order to Vendor. Vendor will ship all Parts via next day air parcel, next day air freight, or the best method for receipt at the Service Location within seventy two hours of Best Buy's order. Title and risk of loss passes to Best Buy upon receipt at the Service Location. If the Part is not received by Best Buy within seventy-two hours, Best Buy may acquire and use standardized parts which lack Vendor-specific insignia or grades ("Universal Parts") to perform the Services. Further, if Best Buy has not received the Part from Vendor within fourteen days of the date the Part was ordered by Best Buy and if Best Buy has not acquired and used Universal Parts within such fourteen days, then Best Buy may return the affected Product for a full credit or refund and may give the customer a new replacement Product (at Vendor's expense). d. Pricing. Vendor guarantees that it will sell Parts to Best Buy at the lowest prices in effect for any similarly situated Vendor customer or the lowest prices available, whichever is lower. Subject to the preceding sentence, Vendor may reduce or increase prices to Best Buy at any time, upon at least thirty days prior written notice. Best Buy may audit Vendor's pricing to verify its receipt of the lowest pricing. If the audit reveals that Best Buy is not receiving the lowest pricing, then, in addition to Best Buy's other legal and equitable rights and remedies, Vendor will reimburse Best Buy for the reasonable costs of the audit. Best Buy does not guarantee any minimum number of Parts orders nor does it guarantee any amount of revenue to Vendor under this Service Agreement. e. Taxes. Unless otherwise stated, prices for Parts do not include sales, use, excise, or similar taxes. Consequently, Best Buy will pay the amount of any valid sales, use, excise, or other similar tax, attributable to Best Buy's purchase of Parts; or in lieu thereof, Best Buy will provide a tax exemption certificate acceptable to the taxing authorities. f. Payment for Replacement Parts. If Best Buy acquires Parts for Non-Warranty Services from Vendor, then Best Buy must pay all costs associated with the Parts, including cost for the Parts and shipping/handling costs, subject to subsection (g) below. If Best Buy disputes an invoice in good faith and in a timely manner, Best Buy is entitled to receive the discount even if the good faith dispute is resolved beyond the discount date. If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. g. Defective Parts. For purposes of this Service Agreement, the term "defective" when referring to Parts means a Part that is visually or operationally defective. Best Buy may return to Vendor all defective Parts for full credit or refund, to be applied or paid to Best Buy within thirty (30) days of Vendor's receipt of the defective Parts. Further, Vendor will promptly pay all shipping/handling costs associated with the defective Parts. Vendor warrants its Parts for a minimum of 90 days from the date the Non-Warranty Services are complete. h. Discontinuation of Parts. Vendor will provide Best Buy with written notice of the discontinuation of any Parts not later than seven days following Vendor's knowledge of such discontinuation. Best Buy may return, at its own expense, the discontinued Parts inventory to Vendor for full credit. i. Return of Parts. Best Buy reserves the right to return, at Vendor's expense and for full credit (if there are sufficient funds to offset) or refund of the purchase price, any Parts for which a claim is made alleging that (1) the use of the Parts infringes any alleged patent, design, tradename, trademark, copyright, right of privacy or publicity, or any other tangible or intangible proprietary right; or (2) the Parts are not manufactured, packaged, and/or labeled in accordance with industry standards and/or all applicable laws; or (3) the use of the Parts has caused injury to person or property. In addition to any other return rights set forth in this Service Agreement, within sixty (60) days of receipt by Best Buy, Best Buy may return for an immediate full refund (or offset against amounts owed Best Buy) of Best Buy's costs, any of the Parts. Vendor will not apply any penalty, re-stocking, or other fees or liabilities to Parts returns. j. Repurchase of Parts. Upon the final termination or expiration of this Service Agreement, Vendor will submit a bid to repurchase the Parts remaining in Best Buy's possession. If Best Buy accepts such bid, Best Buy will ship the repurchased Parts to Vendor upon receipt of payment or credit or offset. Such payment, credit or offset must be received by Best Buy within sixty days of the date of the final termination or expiration of this Service Agreement. Best Buy will pay freight and shipment will be FOB Best Buy dock. Title and risk of loss will pass to Vendor upon delivery to the carrier at Best Buy's dock. IN WITNESS WHEREOF, the parties have executed this Attachment C as of the Effective Date of the Service Agreement. VENDOR Date: February 21, 2006 Sign: __________________________ Print: Steven Lamar Title: President Federal I.D.: 52-2258371 BEST BUY STORES, L.P. Date: March 6, 2006 Sign: __________________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 13 OUT TO VENDOR - ATTACHMENT D If Best Buy and Vendor select the "Out to Vendor Service Model" on page one of the Service Agreement, then this fully signed Attachment D is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. All other terms of the Service Agreement, not specifically amended or modified by this Attachment D, are to remain in full force and effect. All capitalized terms not otherwise defined in this Attachment D will have the meaning ascribed in the Service Agreement. 1. PRODUCTS. Vendor appoints Best Buy as an Authorized Servicer to (a) identify the existence of a defect in or damage to the customer's Product and (b) complete the appropriate paperwork to initiate Product repair by Vendor ("Services"). The "Products" covered by this Attachment D are as follows: -------------------------------------------------- PRODUCT DESCRIPTION -------------------------------------------------- Q-Line Gold -------------------------------------------------- -------------------------------------------------- 2. SCOPE OF SERVICES; COMPENSATION. a. Non-Warranty Services. Best Buy may service and repair Products not under warranty ("Non-Warranty Services") for customers. Best Buy will establish the charges for the Non-Warranty Services, and Vendor is not obligated or responsible for any payment to Best Buy for such Non-Warranty Services. b. Warranty Services. Best Buy may perform Services (defined above) on Products under warranty ("Warranty Services") without charge to customers provided that: (1) the Warranty Services are within the terms and guidelines of Vendor's Warranty, and (2) Vendor promptly fulfills its obligations under this Service Agreement. Vendor's service level obligations are set forth in Section 3 of this Attachment D. Best Buy and Vendor agree to the below selected Out to Vendor Service Model(s) alternative and to the terms of the relevant provisions of this Attachment D. [ ] Under this Out to Vendor Service Model alternative, (1) Best Buy identifies the existence of a defect in or damage to the customer's Product ("Defective Product"), obtains a tracking number from Vendor, and ships the Defective Product to Vendor, and (2) Vendor ships a refurbished Product ("Refurbished Product") to the Service Location such that the Service Location receives it within four days of Vendor's receipt of Best Buy's request for a tracking number. The Refurbished Product must be at least the equivalent in value to the Defective Product. As compensation for labor and shipping/handling associated with Best Buy's performance of Warranty Services under this alternative, Vendor will pay to Best Buy the following amounts: - ---------------------------------------- ---------------------------- ------- SERVICE PRODUCT DESCRIPTION(S) RATE - ---------------------------------------- ---------------------------- ------- Shipping/Handling $actual - ---------------------------------------- ---------------------------- ------- Labor (including No Apparent Defect) $25.00 - ---------------------------------------- ---------------------------- ------- [ ] Under this Out to Vendor Service Model alternative, (1) Best Buy identifies the existence of a defect in or damage to the customer's Product ("Defective Product"), obtains a tracking number from Vendor, and ships the Defective Product to Vendor, and (2) Vendor repairs the customer's actual Defective Product and ships it to the Service Center such that the Service Center receives the repaired Product ("Repaired Product") within five days of Vendor's receipt of the Defective Product. THIS ALTERNATIVE IS THE ONLY OUT TO VENDOR SERVICE MODEL ALTERNATIVE AVAILABLE WHEN THE DEFECTIVE PRODUCT CONTAINS MEMORY. As compensation for labor and shipping/handling associated with Best Buy's performance of Warranty Services under this alternative, Vendor will pay to Best Buy the following amounts: - ---------------------------------------- ------------------------------ ----- SERVICE PRODUCT DESCRIPTION(S) RATE - ---------------------------------------- ------------------------------ ----- Shipping/Handling $ - ---------------------------------------- ------------------------------ ----- Labor (including No Apparent Defect) $ - ---------------------------------------- ------------------------------ ----- By INITIALING the boxes below, Best Buy and Vendor agree to the Out to Vendor Service Model alternative(s) and associated compensation method(s) selected above. ---------------- ----------- Best Buy Vendor ---------------- ----------- ---------------- ----------- 3. VENDOR'S SERVICE LEVELS. When repairing customer's Products or refurbishing Defective Products, Vendor will employ a standard of care, skill, and diligence consistent with the highest professional standards practiced in the industry. Under the first Out to Vendor Service Model alternative, Vendor must ship Refurbished Products to the appropriate Best Buy Service Location such that the Best Buy Service Location receives it within four days of Vendor's receipt of Best Buy's request. Also, under the first Out to Vendor Service Model alternative and in accordance with all applicable laws and regulations, Vendor must inform the customer (and the Best Buy Service Location) that the Refurbished Products are, in fact, refurbished. Under the second Out to Vendor Service Model alternative, Vendor must repair the customer's actual Defective Product and ship it to the Service Location such that the Service Location receives the Repaired Product within five days of Vendor's receipt of the Defective Product. Best Buy Product Service Agreement Master'6 Page 14 4. SUBMISSION AND PAYMENT OF WARRANTY CLAIMS. a. Effective Warranty. Best Buy may perform Warranty Services on a Product after first obtaining acceptable proofs of purchase and then ascertaining that the Product is under warranty. Acceptable proofs of purchase include receipts issued to the customer at the time of sale from Best Buy (such as invoices or credit card receipts) or data retrieved from Best Buy's electronic records. Acceptable proofs of purchase must contain the date of purchase of the goods and a description of the goods. Notwithstanding any term to the contrary, those Products under warranty that are owned by Best Buy ("Store Stock Units") are entitled to Warranty Services. For so long as the Products are under the Vendor warranty, Vendor will pay Best Buy's labor and shipping/handling costs. b. Vendor's Payment Obligations. In accordance with Sections 2(b) and 4(d) of this Attachment D, Vendor will pay a labor fee to Best Buy for performing the Warranty Services, including instances in which Best Buy (using reasonable efforts) detects no apparent Product damage/defect ("Labor Fees"). The Labor Fees may be revised periodically by mutual written agreement of the parties. Vendor will compensate Best Buy for Labor Fees, all associated shipping/handling costs and expenses, and other fees agreed upon by the parties (cumulatively referred to as "Warranty Services Fees"). c. Submission and Conformation of Warranty Claims. Upon a request for Warranty Services, Best Buy will request a tracking number from Vendor, who will promptly issue said tracking number to Best Buy. Best Buy will submit warranty claims (including Warranty Service Fees) to Vendor within 30 days after receiving the Repaired Product or Refurbished Product from Vendor. d. Satisfaction of Warranty Claims. Within thirty days of Vendor's receipt of a completed electronic form, Vendor will pay Warranty Services Fees (by check or via electronic funds transfer) to Best Buy. Vendor will send all reimbursements and payments due Best Buy to the address designated by Best Buy. If the payments due Best Buy are not properly made, Best Buy may offset such amounts against amounts owed to Vendor by Best Buy, whether under this Service Agreement or otherwise. e. Rejection of Claims. Notwithstanding any provisions of any other agreements (whether presently existing or otherwise) to the contrary, the following procedure will apply regarding Vendor's rejection of warranty claims. If Vendor rejects a warranty claim submitted or re-submitted by Best Buy, Vendor will give Best Buy a written notice of rejection of the claim within 30 days of Vendor's receipt of the claim from Best Buy. The notice of rejection must set forth, specifically and completely, the basis for rejection and the necessary action to be taken by Best Buy in order to make the claim valid and conforming. If Best Buy does not receive such a notice of rejection within such 30 days, the claim will be conclusively deemed valid and conforming, and Best Buy is entitled to full payment for the claim as prescribed above. Best Buy will then have 60 days from its receipt of the notice of rejection to cure the non-conforming claim and re-submit the claim to Vendor. Following Best Buy's re-submission and cure of the non-conformances set forth within the initial notice of rejection, Vendor will promptly pay the warranty claim and service the customer as set forth within this Service Agreement and Attachment D. f. Store Stock Units. Notwithstanding any term to the contrary, Store Stock Units are entitled to Warranty Services. However, if a Store Stock Unit requires Warranty Services, Best Buy will forward a warranty claim to Vendor and will ship the damaged Store Stock Unit to Vendor. Within five days of its receipt of the damaged Store Stock Unit, Vendor will issue to Best Buy a credit in the amount of the purchase price of the Product. Additionally, Vendor will compensate Best Buy for Warranty Services Fees. 5. RISK OF LOSS. Vendor bears the risk of loss associated with the shipment of Defective Product, Refurbished Product, and/or Repaired Product. 6. ADDITIONAL VENDOR OBLIGATIONS. a. Return Upon Request. Under no circumstances may Vendor retain customers' Products or Best Buy's Confidential Information (including but not limited to customer information and status of repairs) or any Best Buy Products, following Best Buy's request for return of said Confidential Information and/or Products. This paragraph will survive the termination or expiration of this Service Agreement. b. Delete/Remove Information. Under the first Out to Vendor Service Model alternative (that is, when the customer is to receive a Refurbished Product instead of a Repaired Product), Vendor will delete or remove from the Defective Product prior to its transfer, disposal, or refurbishing: (i) all Best Buy customer information including, but not limited to, sales receipts, addresses, phone numbers, and credit card numbers; and (ii) all files and other information contained within the central processing unit of any Defective Products that are computers, except for the standard software programs or chips originally installed. Vendor agrees to indemnify and hold Best Buy harmless from and against any third party claims, demands, actions or causes of action arising out of or in connection with Vendor's subsequent disposal, transfer, or refurbishing of the Defective Product. This paragraph will survive the termination or expiration of this Service Agreement. 7. NON-WARRANTY SERVICE - REPLACEMENT PARTS. a. Generally. In performing Non-Warranty Services, Best Buy may acquire replacement parts for the Products ("Parts") from Vendor or from third party parts providers, subject to Section 4(B)(4) of the Service Agreement. Notwithstanding Section 13(b) of the Service Agreement, Vendor may sell Parts to third party parts distributors, and Best Buy may acquire Parts from such distributors. b. Quality; Inventory. Subject to Section 4(A)(9) of the Service Agreement, Vendor will ship Parts for the Products that (1) are the equivalent in specifications and quality to the original parts supplied with the Products, or (2) meet such other specifications agreed upon by the parties. Vendor will maintain an inventory of general replacement Parts and special parts as may from time to time be required by Best Buy for the longer of five years or the period prescribed by applicable law. Best Buy is not obligated to retain or store replaced Parts. c. Shipping; Universal Parts. Vendor will ship the Parts to Best Buy such that they are received by Best Buy within seventy-two hours of the time that Best Buy submits the order to Vendor. Vendor will ship all Parts via next day air parcel, next day air freight, or the best method for receipt at the Service Location within seventy two hours of Best Buy's order. Title and risk of loss passes to Best Buy upon receipt at the Service Location. If the Part is not received by Best Buy within seventy-two hours, Best Buy may acquire and use standardized parts which lack Vendor-specific insignia or grades ("Universal Parts") to perform the Services. Further, if Best Buy has not received the Part from Vendor within fourteen days of the date the Part was ordered by Best Buy and if Best Buy has not acquired and used Universal Parts within such fourteen days, then Best Buy may return the affected Product for a full credit or refund and may give the customer a new replacement Product (at Vendor's expense). Best Buy Product Service Agreement Master'6 Page 15 d. Pricing. Vendor guarantees that it will sell Parts to Best Buy at the lowest prices in effect for any similarly situated Vendor customer or the lowest prices available, whichever is lower. Subject to the preceding sentence, Vendor may reduce or increase prices to Best Buy at any time, upon at least thirty days prior written notice. Best Buy may audit Vendor's pricing to verify its receipt of the lowest pricing. If the audit reveals that Best Buy is not receiving the lowest pricing, then, in addition to Best Buy's other legal and equitable rights and remedies, Vendor will reimburse Best Buy for the reasonable costs of the audit. Best Buy does not guarantee any minimum number of Parts orders nor does it guarantee any amount of revenue to Vendor under this Service Agreement. e. Taxes. Unless otherwise stated, prices for Parts do not include sales, use, excise, or similar taxes. Consequently, Best Buy will pay the amount of any valid sales, use, excise, or other similar tax, attributable to Best Buy's purchase of Parts; or in lieu thereof, Best Buy will provide a tax exemption certificate acceptable to the taxing authorities. f. Payment for Replacement Parts. If Best Buy acquires Parts for Non-Warranty Services from Vendor, then Best Buy must pay all costs associated with the Parts, including cost for the Parts and shipping/handling costs, subject to subsection (g) below. If Best Buy timely disputes an invoice in good faith, Best Buy is entitled to receive the discount even if the good faith dispute is resolved beyond the discount date. If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. g. Defective Parts. For purposes of this Service Agreement, the term "defective" when referring to Parts means a Part that is visually or operationally defective. Best Buy may return to Vendor all defective Parts for full credit or refund, to be applied or paid to Best Buy within thirty (30) days of Vendor's receipt of the defective Parts. Further, Vendor will promptly pay all shipping/handling costs associated with the defective Parts. Vendor warrants its Parts for a minimum of 90 days from the date the Non-Warranty Services are complete. h. Discontinuation of Parts. Vendor will provide Best Buy with written notice of the discontinuation of any Parts not later than seven days following Vendor's knowledge of such discontinuation. Best Buy may return, at its own expense, the discontinued Parts inventory to Vendor for full credit. i. Return of Parts. Best Buy reserves the right to return, at Vendor's expense and for full credit (if there are sufficient funds to offset) or refund of the purchase price, any Parts for which a claim is made alleging that (1) the use of the Parts infringes any alleged patent, design, tradename, trademark, copyright, right of privacy or publicity, or any other tangible or intangible proprietary right; or (2) the Parts are not manufactured, packaged, and/or labeled in accordance with industry standards and/or all applicable laws; or (3) the use of the Parts has caused injury to person or property. In addition to any other return rights set forth in this Service Agreement, within sixty (60) days of receipt by Best Buy, Best Buy may return for an immediate full refund (or offset against amounts owed Best Buy) of Best Buy's costs, any of the Parts. Vendor will not apply any penalty, re-stocking, or other fees or liabilities to Parts returns. j. Repurchase of Parts. Upon the final termination or expiration of this Service Agreement, Vendor will submit a bid to repurchase the Parts remaining in Best Buy's possession. If Best Buy accepts such bid, Best Buy will ship the repurchased Parts to Vendor upon receipt of payment or credit or offset. Such payment, credit or offset must be received by Best Buy within sixty days of the date of the final termination or expiration of this Service Agreement. Best Buy will pay freight and shipment will be FOB Best Buy dock. Title and risk of loss will pass to Vendor upon delivery to the carrier at Best Buy's dock. IN WITNESS WHEREOF, the parties have executed this Attachment D as of the Effective Date of the Service Agreement. VENDOR Date: February 21, 2006 Sign: _____________________ Print: Steven Lamar Title: President Federal I.D.: 52-2258371 BEST BUY STORES, L.P. Date: _____ ____, 200__ Sign: _____________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 16 RETAIL EXCHANGE - ATTACHMENT E If Best Buy and Vendor select the "Retail Exchange Service Model" on page one of the Service Agreement, then this fully signed Attachment E is attached to and incorporated in this Service Agreement to specifically set forth each party's respective rights and obligations. Under this Retail Exchange Service Model, (1) a customer brings the in-warranty Product to Best Buy, (2) Best Buy determines that the customer's Product is defective/damaged ("Defective Product"), (3) Best Buy promptly gives the customer an in-store credit ("In-Store Credit"), and (4) Best Buy sends the Defective Product to Vendor. Best Buy submits a warranty claim to Vendor for the In-Store Credit, associated labor fees, and shipping/handling costs. All other terms of the Service Agreement, not specifically amended or modified by this Attachment E, are to remain in full force and effect. All capitalized terms not otherwise defined in this Attachment E will have the meaning ascribed in the Service Agreement. 1. PRODUCTS. Vendor appoints Best Buy as an Authorized Servicer to act in accordance with this Retail Exchange Service Model for the following Products ("Services"): -------------------------------------------------- PRODUCT DESCRIPTION -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- 2. SCOPE OF SERVICES; COMPENSATION. a. Non-Warranty Services. Best Buy may repair Products not under warranty ("Non-Warranty Services") for customers. Best Buy will establish the charges for the Non-Warranty Services, and Vendor is not obligated or responsible for any payment to Best Buy for such Non-Warranty Services. Best Buy is not obligated to return the Defective Product to Vendor when Best Buy performs Non-Warranty Services. b. Warranty Services. Best Buy may perform Services (defined above) on Products under warranty ("Warranty Services") without charge to customers provided that the Warranty Services are within the terms and guidelines of Vendor's Warranty. Vendor and Best Buy agree to the rates set forth below:
- ----------------------------------------------------- ------------------------------------------- SERVICE WARRANTY RATE - ----------------------------------------------------- ------------------------------------------- Labor, including No Apparent Defect $ - ----------------------------------------------------- ------------------------------------------- In-Store Credits (cost of Product plus shipping/handling) - ----------------------------------------------------- ------------------------------------------- Shipping $ - ----------------------------------------------------- ------------------------------------------- Return of Defective Product ("Return Fees") $ - ----------------------------------------------------- -------------------------------------------
3. SUBMISSION AND PAYMENT OF WARRANTY CLAIMS. a. Effective Warranty. Best Buy may perform Warranty Services on a Product after first obtaining acceptable proofs of purchase and then ascertaining that the Product is under warranty. Acceptable proofs of purchase include receipts issued to the customer at the time of sale from Best Buy (such as invoices or credit card receipts) or data retrieved from Best Buy's electronic records. Acceptable proofs of purchase must contain the date of purchase of the goods and a description of the goods. Notwithstanding any term to the contrary, those Products under warranty that are owned by Best Buy ("Store Stock Units") are entitled to Warranty Services. For so long as the Products are under the Vendor warranty, Best Buy's labor and costs, including In-Store Credits, will be paid by Vendor. b. Vendor's Payment Obligations. In accordance with Sections 2(b) and 3(d) of this Attachment E, Vendor will pay a labor fee to Best Buy for performing the Warranty Services, including instances in which Best Buy (using reasonable efforts) detects no apparent Product defect ("Labor Fees"). The Labor Fees may be revised periodically by mutual written agreement of the parties. Vendor will compensate Best Buy for Labor Fees, In-Store Credits, all associated shipping/handling costs and expenses, and other fees agreed upon by the parties (cumulatively referred to as "Warranty Services Fees"), and, per Section 5 below, Vendor will pay Best Buy for Best Buy's return of Defective Product ("Return Fees"). c. Submission and Conformation of Warranty Claims. Best Buy will submit all warranty claims (including Warranty Services Fees) to Vendor within thirty days of the completion of Warranty Services. Best Buy will submit each warranty claim using a properly completed NARDA form (or its electronic equivalent). Vendor will confirm its receipt of the warranty claim via fax or email within twenty-four hours (excluding weekends and national holidays) of Vendor's receipt of the claim. Vendor's confirmation must include the requisite return authorization numbers for Best Buy's return of the Defective Product. d. Satisfaction of Warranty Claims. Within thirty days of Vendor's receipt of a completed NARDA form, Vendor will (1) pay Warranty Services Fees (by check or via electronic funds transfer) to Best Buy and (2) pay Return Fees to Best Buy for its timely return of Defective Products to Vendor. Vendor will send all reimbursements and payments due Best Buy to the address designated by Best Buy. If the payments due Best Buy are not properly made, Best Buy may offset such amounts against amounts owed to Vendor by Best Buy, whether under this Service Agreement or otherwise. e. Rejection of Claims. Notwithstanding any provisions of any other agreements (whether presently existing or otherwise) to the contrary, the following procedure will apply regarding Vendor's rejection of warranty claims. If Vendor Best Buy Product Service Agreement Master'6 Page 17 rejects a warranty claim submitted or re-submitted by Best Buy, Vendor will give Best Buy a written notice of rejection of the claim within thirty days of Vendor's receipt of the claim from Best Buy. The notice of rejection must set forth, specifically and completely, the basis for rejection and the necessary action to be taken by Best Buy in order to make the claim valid and conforming. If Best Buy does not receive such a notice of rejection within such thirty days, the claim will be conclusively deemed valid and conforming, and Best Buy is entitled to full payment for the claim as prescribed above. Best Buy will then have sixty days from its receipt of the notice of rejection to cure the non-conforming claim and re-submit the claim to Vendor. Following Best Buy's re-submission and cure of the non-conformances set forth within the initial notice of rejection, Vendor will promptly pay the warranty claim. 4. TIMEFRAME FOR COMPLETION OF SERVICES. Best Buy will use commercially reasonable efforts to provide the customer with a In-Store Credit within twenty days of the date the customer requests Warranty Services. 5. THE DEFECTIVE PRODUCT. Best Buy will ship the Defective Product to Vendor within twenty-five days of the date the customer requests service, as long as Best Buy has received a return authorization number from Vendor. If Vendor does not timely provide a return authorization number to Best Buy for the return of the Defective Product to Vendor, then Best Buy is not obligated to retain or store the Defective Product beyond twenty-five days of the date the customer requests service from Best Buy. If Best Buy fails to timely ship the Defective Product to Vendor, then Vendor is not obligated to pay the relevant Return Fee to Best Buy (see Section 2(b)). 6. NON-WARRANTY SERVICE - REPLACEMENT PARTS. a. Generally. In performing Non-Warranty Services, Best Buy may acquire replacement parts for the Products ("Parts") from Vendor or from third party parts providers, subject to Section 4(B)(4) of the Service Agreement. Notwithstanding Section 13(b) of the Service Agreement, Vendor may sell Parts to third party parts distributors, and Best Buy may acquire Parts from such distributors. b. Quality; Inventory. Subject to Section 4(A)(9) of the Service Agreement, Vendor will ship Parts for the Products that (1) are the equivalent in specifications and quality to the original parts supplied with the Products, or (2) meet such other specifications agreed upon by the parties. Vendor will maintain an inventory of general replacement Parts and special parts as may from time to time be required by Best Buy for the longer of five years or the period prescribed by applicable law. Best Buy is not obligated to retain or store replaced Parts. c. Shipping; Universal Parts. Vendor will ship the Parts to Best Buy such that they are received by Best Buy within seventy-two hours of the time that Best Buy submits the order to Vendor. Vendor will ship all Parts via next day air parcel, next day air freight, or the best method for receipt at the Service Location within seventy two hours of Best Buy's order. Title and risk of loss passes to Best Buy upon receipt at the Service Location. If the Part is not received by Best Buy within seventy-two hours, Best Buy may acquire and use standardized parts which lack Vendor-specific insignia or grades ("Universal Parts") to perform the Services. Further, if Best Buy has not received the Part from Vendor within fourteen days of the date the Part was ordered by Best Buy and if Best Buy has not acquired and used Universal Parts within such fourteen days, then Best Buy may return the affected Product for a full credit or refund and may give the customer a new replacement Product (at Vendor's expense). d. Pricing. Vendor guarantees that it will sell Parts to Best Buy at the lowest prices in effect for any similarly situated Vendor customer or the lowest prices available, whichever is lower. Subject to the preceding sentence, Vendor may reduce or increase prices to Best Buy at any time, upon at least thirty days prior written notice. Best Buy may audit Vendor's pricing to verify its receipt of the lowest pricing. If the audit reveals that Best Buy is not receiving the lowest pricing, then, in addition to Best Buy's other legal and equitable rights and remedies, Vendor will reimburse Best Buy for the reasonable costs of the audit. Best Buy does not guarantee any minimum number of Parts orders nor does it guarantee any amount of revenue to Vendor under this Service Agreement. e. Taxes. Unless otherwise stated, prices for Parts do not include sales, use, excise, or similar taxes. Consequently, Best Buy will pay the amount of any valid sales, use, excise, or other similar tax, attributable to Best Buy's purchase of Parts; or in lieu thereof, Best Buy will provide a tax exemption certificate acceptable to the taxing authorities. f. Payment for Replacement Parts. If Best Buy acquires Parts for Non-Warranty Services from Vendor, then Best Buy must pay all costs associated with the Parts, including cost for the Parts and shipping/handling costs, subject to subsection (g) below. If Best Buy disputes an invoice in good faith and in a timely manner, Best Buy is entitled to receive the discount even if the good faith dispute is resolved beyond the discount date. If payment terms that are less advantageous to Best Buy are contained in invoices or other documents, the payment terms in this Service Agreement control. g. Defective Parts. For purposes of this Service Agreement, the term "defective" when referring to Parts means a Part that is visually or operationally defective. Best Buy may return to Vendor all defective Parts for full credit or refund, to be applied or paid to Best Buy within thirty (30) days of Vendor's receipt of the defective Parts. Further, Vendor will promptly pay all shipping/handling costs associated with the defective Parts. Vendor warrants its Parts for a minimum of 90 days from the date the Non-Warranty Services are complete. h. Discontinuation of Parts. Vendor will provide Best Buy with written notice of the discontinuation of any Parts not later than seven days following Vendor's knowledge of such discontinuation. Best Buy may return, at its own expense, the discontinued Parts inventory to Vendor for full credit. i. Return of Parts. Best Buy reserves the right to return, at Vendor's expense and for full credit (if there are sufficient funds to offset) or refund of the purchase price, any Parts for which a claim is made alleging that (1) the use of the Parts infringes any alleged patent, design, tradename, trademark, copyright, right of privacy or publicity, or any other tangible or intangible proprietary right; or (2) the Parts are not manufactured, packaged, and/or labeled in accordance with industry standards and/or all applicable laws; or (3) the use of the Parts has caused injury to person or property. In addition to any other return rights set forth in this Service Agreement, within sixty (60) days of receipt by Best Buy, Best Buy may return for an immediate full refund (or offset against amounts owed Best Buy) of Best Buy's costs, any of the Parts. Vendor will not apply any penalty, re-stocking, or other fees or liabilities to Parts returns. Best Buy Product Service Agreement Master'6 Page 18 j. Repurchase of Parts. Upon the final termination or expiration of this Service Agreement, Vendor will submit a bid to repurchase the Parts remaining in Best Buy's possession. If Best Buy accepts such bid, Best Buy will ship the repurchased Parts to Vendor upon receipt of payment or credit or offset. Such payment, credit or offset must be received by Best Buy within sixty days of the date of the final termination or expiration of this Service Agreement. Best Buy will pay freight and shipment will be FOB Best Buy dock. Title and risk of loss will pass to Vendor upon delivery to the carrier at Best Buy's dock. IN WITNESS WHEREOF, the parties have executed this Attachment E as of the Effective Date of the Service Agreement. VENDOR Date: February 21, 2006 Sign: _________________________ Print: Steven Lamar Title: President Federal I.D.: 52-2258371 BEST BUY STORES, L.P. Date: March 6, 2006 Sign: _________________________ Print: Rick Selvey Title: Vice President Best Buy Product Service Agreement Master'6 Page 19 EX-21 6 exh-21.txt SUBSIDIARIES OF THE REGISTRANT Exhibit 21 LIST OF SUBSIDIARIES -------------------- Name of Subsidiary State of Incorporation - ------------------ ---------------------- Evenstar Mergersub, Inc. Nevada EX-23 7 exh-23.txt CONSENTS OF EXPERTS AND COUNSEL Exhibit 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS --------------------------------------------------- As independent certified public accountants, we hereby consent to the incorporation of our report dated February 24, 2006 included in this Form 10-K into SLS International, Inc.'s previously filed Registration Statements on Form S-2 (File No. 333-122480), Form SB-2 (File No. 333-118346), Form SB-2 (file No. 333-108302), Form S-3 (File No. 333-128701), Form S-8 (File No. 333-129805), and Form S-8 (File No. 333-116621). /s/ WEAVER & MARTIN, LLC Kansas City, Missouri, March 31, 2006 EX-31.1 8 exh31-1.txt RULE 13A-14(A)/15D-14(A) CERTIFICATIONS Exhibit 31.1 CERTIFICATIONS I, John Gott, certify that: 1. I have reviewed this annual report on Form 10-K of SLS International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ John Gott - ---------------------------------- John Gott, Chief Executive Officer March 31, 2006 EX-31.2 9 exh31-2.txt RULE 13A-14(A)/15D-14(A) CERTIFICATIONS Exhibit 31.2 CERTIFICATIONS I, Michael L. Maples, certify that: 1. I have reviewed this annual report on Form 10-K of SLS International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Michael L. Maples - ------------------------------------------ Michael L. Maples, Chief Financial Officer March 31, 2006 EX-32 10 exh-32.txt SECTION 1350 CERTIFICATIONS Exhibit 32 Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-K of SLS International, Inc. (the "Company") for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of John Gott, Chief Executive Officer of the Company, and Michael L. Maples, Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John Gott - --------------------------- John Gott Chief Executive Officer March 31, 2006 /s/ Michael L. Maples - --------------------------- Michael L. Maples Chief Financial Officer March 31, 2006 This certification accompanies the Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss. 18 of the Securities Exchange Act of 1934, as amended. -----END PRIVACY-ENHANCED MESSAGE-----