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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(X) Annual Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1999; or
( ) Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to _________________
COMMISSION FILE NO. 000-24547
SCIENTIFIC LEARNING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-3234458
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number
1995 University Avenue, Suite 400
Berkeley, CA 94704
(Address of principal executive offices) (Zip Code)
Securities registered pursuant to Section 12 (b)
of the Act: NONE
Securities registered pursuant to Section 12 (g)
of the Act: COMMON STOCK, PAR VALUE
$0.001 PER SHARE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes : (X) No: ( )
Indicate by check mark 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 the Registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. ( )
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on February
29, 2000 as reported on the Nasdaq National Market, was approximately
$97,289,000. Shares of Common Stock held by each officer and director and by
certain persons who owned 5% or more of the registrant's outstanding Common
Stock on that date have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of Tuesday, February 29, 2000 Registrant had outstanding 10,591,468 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2000 Annual Meeting of
Stockholders to be held on May 18, 2000, at 1995 University Avenue, Suite 400,
Berkeley, California 94704 are incorporated by reference in Part III.
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TABLE OF CONTENTS
PART I PAGE NO
-------
Item 1. Business.................................................................... 3
Item 2 Properties.................................................................. 17
Item 3. Legal Proceedings........................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders......................... 17
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....... 21
Item 6. Selected Financial Data..................................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Item 7A Quantitative and Qualitative Disclosures about Market Risk.................. 27
Item 8. Financial Statements and Supplementary Data................................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................... 48
PART III
Item 10. Directors and Executive Officers of the Registrant.......................... 48
Item 11. Executive Compensation...................................................... 48
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 48
Item 13. Certain Relationships and Related Transactions.............................. 48
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............ 49
SIGNATURES ................................................................................... 50
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PART I
ITEM 1. BUSINESS
We develop, market and sell products and services that are based on more
than 25 years of brain and language research and are designed to increase
human learning and performance. Our goal is to become the leading provider
of software and other educational products and services based on the study
of how the brain learns. To date our primary focus has been on training
programs that build the language and reading skills that are the foundation
for learning. We have developed and introduced a suite of software training
programs designed to help children, adolescents and adults with language
comprehension, learning how to read and becoming better readers. In 1999,
we introduced skill-building and assessment software products. We also
recently launched BrainConnection.com, a comprehensive information source
about the brain and learning, which provides a wide range of written,
graphical, audio and interactive content, skill assessments and targeted
e-commerce resources for educators, parents, and others interested in the
learning process.
We assist educators, parents and speech and language and other
professionals with integrating our training programs and other products
into existing educational programs. We also provide professional training,
installation and implementation services and technical and other support.
We provide ongoing performance analysis to those supervising training
program participants through SLc Lesson.
We are a Delaware corporation. We incorporated in 1995 in California under
the name Scientific Learning Principles Corporation and reincorporated in
1997 in Delaware under our present name.
TRAINING PROGRAMS AND PRODUCTS
We combine more than 25 years of brain and language research with
technological advancements to create innovative learning products and
information services. Our current suite of products assess language
comprehension and reading skills, prepare individuals for reading, assist
in learning to read and aid in becoming better readers. Reading Edge is our
computer-based screening and assessment tool designed to evaluate language
comprehension and early reading skills. Our Away We Go! family of
skill-building software and storybooks helps children learn key language
and cognitive skills that are needed for success in pre-kindergarten
through grade 2. Our family of language and reading training programs uses
intensive, computer-controlled training exercises that automatically adapt
to each user's performance to modify the manner in which the brain
processes language. Our initial training program, Fast ForWord, focuses on
oral language comprehension and executive function skills critical to
learning how to read or becoming a better reader. Step 4word trains
critical reading skills as well as providing additional training on the
language comprehension skills addressed in Fast ForWord. We recently
launched 4wd, which uses a graphical user interface designed for middle and
high school students and adults to train language comprehension and
critical reading skills.
LANGUAGE AND READING TRAINING PROGRAMS
Our programs are based on more than 25 years of research on how the brain
learns and develops language and reading skills. In our current training
programs, we use intensive, adaptive computer-based training exercises to
enable an individual to build the skills that provide the foundation for
reading, particularly better oral language skills. In contrast to
traditional exercises, our programs combine acoustically modified speech to
train the brain to differentiate among sounds with cross-training in other
critical language skills. These skills include (1) vocabulary, (2) grammar,
(3) morphology, which is the system of word formation, (4) syntax, which is
the way in which words are put together to form phrases, clauses or
sentences, (5) semantics, which relates to meaning in language, and (6)
executive function skills, which are the organizational skills necessary
for thinking such as short-term memory and determining the sequence of
events.
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FAST FORWORD
Fast ForWord, launched in March 1997, is an intensive, computer-based
training program, which has the look and feel of a computer game. Fast
ForWord is designed to keep students engaged and entertained during the
thousands of repetitions necessary to improve a student's language skills.
The words and sentences used in the Fast ForWord exercises have been
electronically modified to expand and enhance the rapidly changing phonetic
elements within natural speech. As a student's skill level advances, the
exercises become increasingly difficult, driving the student to continually
increase his or her rate of oral language processing. At the most difficult
level of each exercise, the student is presented with natural, unmodified
speech. The exercises also cross-train the student in other critical
language skills and executive function skills. These skills are necessary
for a solid foundation for learning to read or becoming a better reader.
The program adjusts to the student's skill level and ongoing performance so
that the student is making correct responses approximately 80% of the time.
This adjustment is designed to keep the program challenging and engaging,
while allowing the student to generate a feeling of accomplishment and to
avoid failure, which can be discouraging and detrimental to learning.
The Fast ForWord program is designed to be used for 100 minutes per day,
five days a week for four to eight weeks. The professional supervising the
individual's use of the program can follow and analyze the student's data
through SLc Lesson, which uses our patented Internet and database
technology.
Field studies we conducted of Fast ForWord show that 90% of participants
identified as having language and reading problems showed statistically
significant gains in language comprehension skills, achieving, on average,
one to two years of improvement in language and related reading skills
after 4-8 weeks of Fast ForWord training. Recent independent and third
party studies have confirmed the positive impact of Fast ForWord. Based on
extensive interviews with parents and educators, students who have
completed the Fast ForWord program are generally reported to have shown
substantial improvements in both self-esteem and confidence as their
communication skills improved. We believe our training programs can improve
the language and related reading skills of most users.
STEP 4WORD
Step 4word (formerly Fast ForWord Two), launched in October 1998, is a
computer-based training program that trains reading and oral language
skills. Step 4word provides focused practice in language comprehension
skills for students who have basic oral language proficiency. Building on
that foundation, Step 4word also trains reading skills such as word
decoding, sound-letter recognition and visual tracking. Word decoding
enables a student to build associations between word sounds, written
representations of words and meaning. Sound-letter recognition is the
ability to translate letters into spoken words. We believe that being able
to process rapid sound-letter associations is critical to being able to
read. Step 4word also provides training exercises that reinforce
left-to-right reading patterns for students who may have visual tracking
problems.
The Step 4word program is designed to be used for 90 minutes per day, five
days a week for four to eight weeks. As with Fast ForWord, Step 4word
results can be monitored through SLc Lesson.
4WD
4wd, launched in November 1999, is a computer-based training program that
is designed specifically for middle and high school students and adults.
4wd offers the same benefits of Fast ForWord but with graphics, story lines
and content tailored for an older population. 4wd combines electronically
modified speech with cross-training in critical language and reading skills
in a manner that automatically adjusts to each user's performance. This
program enables participants to track their own cumulative progress without
connecting to the Internet as well as permitting results to be monitored
through SLc Lesson.
SLC LESSON
SLc Lesson employs our patented Internet and database technology to permit
the results from each participant's training program exercises to be
conveniently viewed and analyzed by the person overseeing the participant's
training. Training results are uploaded periodically via the Internet to
our proprietary database for analysis of the student's progress to date.
SLc Lesson then provides performance charts and templates in various
discrete learning areas which can be downloaded through the Internet,
enabling the training administrators to monitor compliance, track
performance and provide students and parents with measurable performance
results.
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AWAY WE GO! PRODUCT FAMILY (ALL LAUNCHED IN JUNE 1999)
The Away We Go! skill-building software is comprised of seven interactive
modules that each focus on key skills needed for success in grades pre-K
through 2, such as recognition of colors and shapes, and provides practice
in memory, using and manipulating phonemes, letter-name association, word
recognition, fine motor control, and hand-eye coordination. Its modular
format allows parents and professionals to choose which modules a child
will play, providing customized game sessions tailored to a child's
interests or needs. A professional version includes the same features as
the home version, and also allows multiple concurrent users, provides
printouts of performance data on each user and allows levels of difficulty
to be customized for individual users.
The Away We Go! Bookshelf is comprised of proprietary stories presented in
both an interactive CD ROM format and a four-color printed format. These
stories are designed as a companion to the Away We Go! skill-building
software and provide exposure to appropriate spoken and written language
content, thereby supporting the training related to phonemes in the Away We
Go! skill-building software games. A professional version has the same
features as the home version and also contains four different levels of
acoustically-modified speech.
ASSESSMENT: READING EDGE
Reading Edge, launched in August 1999, is a computer-based screening and
assessment product designed to evaluate early reading skills. Reading Edge
helps identify students who may be at risk for reading problems in K-2 and
provides later screening of older students who may be experiencing reading
difficulties. Reading Edge's animated games provide fast and reliable
measurements for evaluating proficiency in essential skill areas that are
strong predictors of future reading success, including phonological memory,
phonological awareness, phonemic decoding and letter identification. The
educator version of Reading Edge provides a rapid forward assessment tool.
The home version incorporates the assessment functionality with engaging
games that encourage practice of important reading skills. Reading Edge has
been tested with children in grades K-2. We acquired Reading Edge from the
successor to its developer.
ADMINISTRATOR TRAINING: CROSSTRAIN
CrossTrain, launched in November 1999, is a professional development
package for educators and speech and language and other professionals that
contains all the tools and information necessary to offer our family of
language and reading training programs. The package includes videos, CD
ROMs and printed materials. CrossTrain offers the same comprehensive
content as our professional development seminars but in a self-paced
tutorial that is more convenient.
SERVICES
BRAINCONNECTION.COM
In June 1999 we launched BrainConnection.com, a leading resource for
relevant, practical and easily understandable content about learning and
the brain. The web site includes (1) articles by and interviews with
leading authors and well-recognized experts in reading, education,
psychology and neuroscience; (2) education-oriented e-commerce purchasing
opportunities; (3) an Internet-based language assessment and related parent
and teacher questionnaires; (4) audio programming related to a variety of
mental health and other social issues; (5) learning-focused web site and
book reviews; (6) text and illustration databases regarding clinical
conditions, medical illustrations and optical illusions; (7) relevant news
articles; and (8) the capability for visitors to conduct customized
searches of the site and also to create a personalized home page that
allows access to, and interaction with, information that is tailored to
each visitor's particular interests and goals.
BrainConnection.com targets educators - school administrators, teachers and
opinion leaders - as well as parents, speech and language professionals and
others interested in learning and the brain. Its aim is to become the
premier source for those target groups for information about and products
and services related to learning and the brain. BrainConnection.com is both
a learning-focused on-line community and a vehicle to help build awareness
of the existence of neuroscience and other research-based programs,
products, services and curricula available to help school administrators,
teachers, parents, and others significantly impact the learning process.
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We recently announced our first BrainConnection.com conference - The Brain
Connection to Education, which is scheduled for May 2000 in San Francisco.
We expect this to be the first of a series of BrainConnection.com
conferences on brain research and its practical applications.
PROFESSIONAL DEVELOPMENT SEMINARS
To assist educators, parents and speech and language and other
professionals, we provide educational seminars on the latest in brain
research, the connection between oral language comprehension and learning
to read, and the practical application of Fast ForWord, Step 4word, and
4wd. Typically, workshops are either one- or two-day intensive training
seminars for educators and speech and language professionals. More than
5,000 individuals have been trained in administering Fast ForWord and other
programs and products through these seminars. Participants in our
professional development seminars are eligible to receive continuing
education credit to support the ongoing educational certification
requirements of teachers and educators.
SUPPORT SERVICES
SUPPORT FOR EDUCATORS, PARENTS AND PROFESSIONALS. We provide a number of
support services for educators, parents and speech and language and other
professionals involved in improving reading and language skills. We provide
two to three hour seminars for parents interested in learning more about
brain research, the connection between language comprehension skills and
learning to read, and the science behind our language and reading training
programs. In addition, we distribute a Fast ForWord newsletter that
contains items of interest on the program and language and reading problems
to the parents of participating students, as well as to educators and
speech and language professionals. We have a professional relations staff
dedicated to answering questions from and providing support to professional
providers and parents. Our professional relations staff provides support
over the Internet and a toll-free telephone information line.
TECHNICAL SUPPORT. We provide a variety of technical support services to
our customer base. We employ an experienced staff of technical service
representatives to answer technical questions regarding our programs,
computer hardware and networks. In addition, at large sites such as
schools, we provide on-site software installation, technical training and
technical support.
SCIENTIFICLEARNING.COM. We also maintain our company web site at
ScientificLearning.com. This site provides information about our company
and our products and services as well as extensive technical and customer
support resources.
SALES AND MARKETING
We market and sell our products through two primary channels of
distribution: public schools and speech and language professionals in
private practice. We also market directly to consumers, including through
our web site, but direct-to-consumer sales to date have been minimal.
We have recently expanded our outside sales force, and, as of December 31,
1999, had 30 sales representatives focused on the public school market and
three sales representatives focused on speech and language professionals in
private practice. Our hiring process has targeted experienced professionals
who have established relationships with prospective customers. During 1999,
our year-over-year retention rate for customers who purchased ten or more
copies of our training programs was over 90%.
PUBLIC SCHOOLS. As of December 31, 1999, we have sold our programs to
approximately 450 school districts in 49 states. The majority of our public
school sales have occurred since the formation in the fall of 1998 of a
dedicated sales force focused on that market. Our language and reading
training programs generally list for $850 per student and are typically
discounted for volume sales and in connection with the bundling of
different products or the purchase of our products together with
installation services or training programs. In addition, we market and sell
our Away We Go! and Reading Edge products to schools to use with their
students prior to, and as a complement to, the training programs. As
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we have expanded our suite of educational products, we have recently begun
to offer our products to schools on a site license basis as an alternative
to per program, per user licenses.
SPEECH AND LANGUAGE PROFESSIONALS. Speech and language professionals in
private practice recommend the use of our products to parents in
appropriate cases and then administer the program in connection with
providing traditional services. In such instances, Fast ForWord, Step 4word
and 4wd are typically sold to parents for a list price of $850 per student,
minimizing the administrative burden on the speech and language
professional, who charges separately for time spent supervising the
student. The fees charged by the speech and language professional generally
range from $2,000 to $5,000 per student. In addition, we market and sell
our Away We Go! family of products to private speech and language
professionals for use by their students prior to and as a complement to the
training programs.
We began marketing our Fast ForWord program to speech and language
professionals in March of 1997 and have developed a proprietary database of
information regarding thousands of speech and language professionals. We
contact speech and language professionals through telesales and other
direct marketing efforts to encourage them to attend our seminars and use
our training programs in their practices. In addition, speech and language
professionals learn of our programs through our participation in trade
conferences, publications in journals and the general press and the
distribution of our informational videos and practice kits.
TECHNOLOGY
Our training programs and products are cross-platform, software-based
programs available for a variety of hardware and software configurations.
Our products are designed to work with the computer technology widely
available in schools and homes, minimizing the need for users to purchase
new equipment. The programs can be used in a variety of ways, including an
on-site model where educators and speech and language and other
professionals supervise students in their offices, an off-site model where
students can train from their homes and a client/server-based model for
larger scale deployments. All of our existing training programs link to
Scientific Learning via standard Internet connections for data transfer and
updates. Using our patented Internet and database technology known as SLc
Lesson, program administrators can use any web browser to upload program
results to our database and monitor individuals under their supervision.
Products are typically delivered via a CD ROM. Our training programs can be
activated only by receiving a user access code. Continued access to the
training program requires periodic uploads of performance data over the
Internet. If users do not upload data within a required time period, access
to the program is denied.
We use an object-oriented authoring environment for all our software
products. New products and product extensions can be built off our core
object model, allowing all products to benefit from improvements in the
core code and reducing new product development time. The Scientific
Learning database maintains a performance history on every user of a
language and reading training program. The database is unique and highly
scalable, built on database technology from Oracle Corporation, and capable
of dynamic information queries. Using a proprietary set of analytical
tools, we automatically generate summaries and reports for use by the
educator, parent and speech and language or other professional. We can also
generate custom demographic reports from specific groups of users by
defining search characteristics such as school, classroom or common primary
language. The resulting reports show exactly how a given user is performing
and what challenges remain. The program databases at the client site are
tightly integrated with our databases to provide seamless service from
professional and technical support to accounting.
RESEARCH AND DEVELOPMENT
Approximately 20% of our employees are engaged in research and development
activities, which include both product development and outcomes research.
Our research and development organization includes neuroscientists,
psychologists, engineers, programmers, writers, statisticians, graphic
artists and animators.
Our research and development efforts are broad based, ranging from
development of additional language and reading programs for children to
research activities aimed at expanding application of our neuroscience
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expertise into areas that relate to language. As we have previously
announced, several computer-based training programs are in development with
launches scheduled during the year 2000. These include Fast ForWord Three,
which is intended to combine the essential components of word recognition
and decoding with reading comprehension skills; Fast ForWord for increased
English proficiency, which is planned to focus on training the language
skills found in English that are the most difficult for non-native English
speakers to learn; and Fast ForWord for language reacquisition, which is
being designed to provide individualized exercises that meet the specific
needs of individuals who have suffered a stroke or other brain injury.
Still in the research process is a potential computer-based training
program for remediation of certain types of stress injuries.
INTELLECTUAL PROPERTY
We have a broad intellectual property strategy addressing both product
technology and product concepts. We aggressively protect our proprietary
rights in our products and technology through a combination of patents,
trademarks, copyrights, trade secret laws, confidentiality procedures and
contractual provisions.
At December 31, 1999, we held 5 issued U.S. patents, 9 allowed U.S. patent
applications and 30 other pending U.S. applications. Of these applications,
7 are owned jointly with the University of California, and the remaining 32
are owned solely by us. We were the exclusive licensee under one issued
U.S. patent, 2 allowed U.S. patent applications and one other pending U.S.
application. The licensed patent and applications are licensed from the
Regents of the University of California and Rutgers, the State University
of New Jersey, and relate to the basic speech and sound modification and
adaptivity technology developed at those institutions. Our three language
and reading training products, as well as the professional version of Away
We Go! Bookshelf, incorporate this licensed technology. To date, more than
90% of our revenues are derived from selling products that use the licensed
inventions, and loss of this license agreement would cause material harm to
our business.
Under the terms of this license, we must pay royalties and milestone
payments based upon cumulative net sales of our products, subject to
certain minimum royalty amounts. In connection with the license, we issued
114,526 shares of Series A preferred stock, which were converted into
114,526 shares of our common stock upon completion of our July 1999 initial
public offering, to Rutgers and made other up-front payments. In 1999, we
had approximately $612,000 in royalty expense under the license. In 2000
and each year thereafter during the term of the license, the minimum
royalty expense necessary to maintain the license will be $150,000. We
expect royalties as a percentage of program revenues to decline over time
as additional programs are sold and, as a consequence, the royalty rate
under the license steps down. It may also decline to the extent that our
product mix becomes less reliant on licensed technology, although we cannot
predict our future product mix.
Unless otherwise terminated by operation of law or acts of the parties, the
license remains in effect until the later of the expiration of the
last-to-expire patent licensed or the abandonment of the last patent
application licensed. The Regents may terminate the license agreement if we
fail to perform or violate its terms without curing the violation within 60
days of receiving written notice of the violation.
COMPETITION
The educational technology market in which we operate is very competitive.
We believe that the principal competitive factors in the industry are
efficacy, ability to deliver measurable results, cost, efficiency of
delivery, ability to provide training to educators, parents and speech and
language and other professionals and ability to complement and supplement
public school curriculum. We believe that we compete favorably on the basis
of these factors. Particularly in the public school market, we compete
against other companies offering educational software and other language
and reading programs, as well as with providers of traditional methods of
teaching language and reading. Some of the other companies that provide
software and other programs are more established in the school market than
we are, offer a broader range of products to schools and have greater
technical, marketing and distribution resources than we do. In addition,
although the traditional approaches to language and reading are
fundamentally different from the approach we take, the traditional methods
are more widely known and accepted and, therefore, represent significant
competition.
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EMPLOYEES
As of December 31, 1999, we had 201 full-time and 12 part-time employees.
We believe our relations with employees are good. None of our employees is
represented by a union or subject to collective bargaining agreements.
RISK FACTORS
THE FOLLOWING FACTORS AS WELL AS OTHER INFORMATION CONTAINED IN THIS REPORT
ON FORM 10K SHOULD BE CONSIDERED IN MAKING ANY INVESTMENT DECISION RELATED
TO OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR
BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE MATERIALLY
AND ADVERSELY AFFECTED AND THE TRADING PRICE OF OUR COMMON STOCK COULD
DECLINE.
TO DATE WE HAVE RELIED PRIMARILY ON A SINGLE FAMILY OF PRODUCTS. ANY
FAILURE TO INCREASE OUR SALES OF OUR LANGUAGE AND READING TRAINING PROGRAMS
COULD CAUSE OUR BUSINESS TO SUFFER. Since our formation, sales of our
language and reading training programs have accounted for more than 85% of
our revenues. The remaining revenues are primarily from seminars regarding
how the brain works and how to administer our training programs. We
anticipate that most of our revenues will be related to our language and
reading training programs for at least the next 18 months. Our business
will suffer if we are unable to increase our sales of our language and
reading training programs.
WE HAVE ONLY A LIMITED HISTORY UPON WHICH YOU CAN GAUGE THE SUCCESS OF OUR
SOFTWARE PRODUCTS. We only recently expanded our family of language and
reading training programs beyond Fast ForWord, through the introduction of
Step 4word and 4wd. Additionally, we only recently released our Reading
Edge screening and assessment tool and our Away We Go! family of
skill-building products. Consequently, we only have a limited history upon
which you can gauge the success of our suite of software products. We
cannot assure you that new products we may release will receive the same or
greater level of commercial acceptance as our products that are currently
available.
OUR BUSINESS DEPENDS ON WHETHER WE CAN ACHIEVE AND MAINTAIN MARKET
ACCEPTANCE AND INCREASE THE NUMBER OF PROGRAMS WE COMMERCIALLY INTRODUCE
AND SELL. Our future success depends on acceptance of our language and
reading training programs and our other products by public schools,
administrators, educators, parents and speech and language and other
professionals. Sales of our products depend on many factors, including:
- our ability to incorporate our products into traditional school
programs;
- the willingness of educators and speech and language and other
professionals to adopt new teaching and training methods;
- the cost of our programs compared to other available programs;
- the availability of government funding;
- competitive developments;
- our ability to continue to demonstrate the efficacy and acceptance of
our programs;
- our ability to adapt to evolving technology and standards; and
- the public's ability and willingness to use the Internet.
Our business will suffer if we do not achieve and maintain market
acceptance for our existing products or if we fail to increase the number
of programs we commercially introduce and sell.
OUR RESULTS OF OPERATIONS WILL SUFFER IF EXPANSION OF BRAINCONNECTION.COM
DOES NOT INCREASE DEMAND FOR OUR PRODUCTS OR GENERATE OTHER REVENUE
OPPORTUNITIES. We plan to increase expenditures related to our
BrainConnection.com brand and web site. Our increased emphasis on
BrainConnection.com is a new and unproven strategy. If we fail to
successfully execute on our BrainConnection.com strategy, our results of
operations will suffer. In particular, if BrainConnection.com fails to
increase public awareness regarding practical applications of neuroscience
or if an increase in public awareness fails to result in increased demand
for our training programs and other products, our business will suffer.
Additionally, we plan to develop other revenue opportunities related to
BrainConnection.com, including e-commerce and conferences. We have limited
experience developing e-commerce and conferences as revenue opportunities
and we cannot assure you that we
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will be successful in developing these revenue opportunities. Our business
and results of operations will suffer if we are unable to successfully
develop revenue opportunities related to BrainConnection.com.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO INTRODUCE NEW PRODUCTS AS
SCHEDULED OR IF NEW PRODUCTS ARE UNSUCCESSFUL. Our future success will
significantly depend on whether we are able to enhance our existing
products and develop new products based on our proprietary technology.
While we recently launched 4wd, Reading Edge and the Away We Go! family of
skill-building software and storybooks and have more language and reading
training programs targeted for commercial launch in the year 2000, we
cannot assure you that we will be successful in developing and marketing
these or any other new products or that we will be able to introduce new
products as scheduled. We may not have sufficient resources to make the
investments to develop or acquire and market the products necessary to
maintain our competitive position. Our business will suffer if we are
unable to introduce new products as scheduled, or if new products are
unsuccessful.
ANY DIFFICULTY IN PENETRATING NECESSARY MARKETS COULD ADVERSELY AFFECT OUR
BUSINESS. Our target markets include public schools, speech and language
professionals in private practice and direct sales to parents. Any
difficulty in penetrating these markets could adversely affect our
business. We began selling Fast ForWord to public schools in April 1997 and
initiated our public schools sales force in the fall of 1998. We believe
that our success in the public school market will depend largely on the
following factors:
- our ability to effectively leverage our existing sales force, most
of whom joined us in the last six months;
- acceptance of our new site license sales approach, which offers our
products to schools bundled on a site license basis as an alternative
to per program, per user licenses;
- our ability to continue to hire and retain experienced sales
personnel;
- convincing educators and other key public school decision-makers to
use our products even though the learning methods required by our
products differ from the way schools have traditionally addressed
language and learning problems; and
- convincing schools and teachers to incorporate our intensive training
programs into their curriculum since our products are generally
designed to be used for 90 to 100 minutes per day, five days per week.
Our ability to penetrate the market of speech and language professionals in
private practice may not occur as quickly or as broadly as we would like,
for the following reasons:
- our programs require use of computers and other technology; and
- we may be unable to convince speech and language professionals that
our programs are tools that can be used in their practice and will
enable them to supervise multiple clients at a time.
We also have had limited experience selling our products directly to
parents and may have difficulty doing so for the following reasons:
- we may be unable to successfully establish BrainConnection.com as a
direct-to-consumer sales channel; and
- our ability to sell programs to parents and other private customers
depends upon word-of-mouth referrals which could take considerable
time to develop.
OUR QUARTERLY OPERATING RESULTS ARE SUSCEPTIBLE TO FLUCTUATIONS WHICH COULD
CAUSE OUR STOCK PRICE TO DECLINE. Since our formation, our quarterly
operating results have fluctuated significantly. For example, our revenues
for each fiscal quarter commencing September 30, 1997 and ending December
31, 1999, in sequence, have been approximately $1,398,000, $874,000,
$647,000, $1,153,000, $2,365,000, $1,001,000, $1,340,000, $2,051,000,
$3,901,000 and $2,960,000. We expect these fluctuations to continue for a
number of reasons, including factors described elsewhere in this "Risk
Factors" section of the prospectus. One reason we expect quarterly
operating results to fluctuate is the long sales cycle for our products,
which is the result of many factors, including the following:
- the nature of our products requires us to provide a significant level
of education to prospective educators, parents and speech and language
and other professionals regarding the use and benefits of our programs
and services;
- prospective purchasers need to consider that our programs involve a
significant commitment of time and resources;
- sales to schools are subject to budgeting constraints, which may
require schools to find available discretionary funds, obtain grants
or wait until subsequent budget cycles; and
- school-wide or district-wide sales can require multiple levels of
approval.
10
As a result, our sales cycle generally takes several months and in some
cases can take a year or longer.
An additional reason our quarterly operating results may fluctuate is that
demand for our programs and services may be subject to seasonal influences.
Demand for our programs from speech and language professionals in private
practice may be lower during the school year than in the summer, because
the intensive nature of our products may be more conducive to training
during school vacation. We also may experience seasonality in the public
school market due to public school calendars and budget cycles. We do not
have sufficient operating experience to predict the overall effect of
various seasonal factors and their effect on future quarterly operating
results.
Any significant shortfall of revenues in relation to our expectations could
cause significant fluctuations in quarterly operating results, and our
stock price could suffer. Prediction of future revenues and expenses is
difficult because of our limited operating history and the emerging nature
of our market. Our expense levels are based on our expectations of future
revenues and are primarily fixed in the short term. We cannot guarantee
that we will be able to predict our future revenues accurately or that we
will be able to adjust spending in a timely manner to compensate for any
unexpected revenue shortfall.
WE HAVE GENERATED LIMITED REVENUES TO DATE AND HAVE A HISTORY OF LOSSES. We
started operations in February 1996 and began generating revenues in the
first quarter of 1997. Because we have generated limited revenues to date,
we have incurred significant operating losses and negative cash flow since
inception. Our net losses were approximately $2.5 million for the year
ended December 31, 1996, $5.1 million for the year ended December 31, 1997,
$10.7 million for the year ended December 31, 1998 and $14.1 million for
the year ended December 31, 1999. Our cash flows used in operating
activities were approximately $1.7 million for the year ended December 31,
1996, $4.0 million for the year ended December 31, 1997, $6.8 million for
the year ended December 31, 1998 and $13.4 million for the year ended
December 31, 1999. We have an accumulated deficit of approximately $32.4
million from inception through December 31, 1999.
WE EXPECT TO INCUR ADDITIONAL LOSSES FOR AT LEAST THE NEXT 18 MONTHS. We
expect to incur additional losses for at least the next 18 months because
of increases in expenses relating to the expansion of BrainConnection.com,
as well as substantial increases in other sales and marketing and research
and development expenses. We cannot assure you that our cash resources
after this offering will be sufficient to fund our negative cash flow and
expected capital expenditures for this period.
WE CANNOT GUARANTEE THAT WE WILL EVER GENERATE SUFFICIENT REVENUES TO
ACHIEVE OR SUSTAIN PROFITABILITY. We cannot guarantee that we will ever
generate sufficient revenues to achieve or sustain profitability or
generate positive cash flow. As a result, we may need to obtain additional
equity or debt financing in the future, which may not be available on
acceptable terms, if at all.
OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR CURRENT
BUSINESS AND PROSPECTS. It is difficult for us to evaluate our current
business and prospects because we have a limited operating history of
approximately four years and limited experience penetrating necessary
markets and selling our products. Additionally, we have limited experience
developing opportunities related to BrainConnection.com. Companies with
limited operating histories, including ours, encounter high risks and
uncertainties, particularly in new and rapidly evolving markets such as
technology-based educational products and services. These risks include,
but are not limited to: (1) uncertain demand for technology-based learning
products and our products and services in particular; (2) attracting and
retaining key personnel and managing growth; (3) failure to select an
appropriate growth strategy; (4) institutions or other barriers that hinder
our ability to penetrate our target markets; and (5) competition. To
address these risks, we must, among other things:
- successfully gain market acceptance for our suite of software
products, particularly in the public school market;
- successfully introduce and gain market acceptance for related new
products and services;
- respond to competitive developments and execute our growth
strategy;
- attract, integrate, retain and motivate qualified personnel,
particularly sales and marketing professionals; and
- address new or evolving technologies and standards.
11
We cannot assure you that we will be successful in addressing the risks we
face and our failure to address those risks will materially and adversely
affect our business and financial condition.
OUR BUSINESS WILL SUFFER IF CUSTOMERS DELAY OR FOREGO PURCHASES OF OUR
PRODUCTS BECAUSE OF OUR PRODUCT ENHANCEMENTS OR NEW PRODUCTS OR BECAUSE OF
COMPETITORS' SUPERIOR PRODUCTS. The demand for our existing products may be
reduced or eliminated by our own enhancements or new products and any
resulting loss of revenues from our existing products may not be adequately
offset by the revenues generated from our enhancements or new products.
Customers may also delay their purchases of our products in anticipation of
the release of our product enhancements or new products. Finally, products
introduced by our competitors may be superior to the products we offer and
reduce the demand for our products. Our business will suffer if customers
delay or forego purchases of our products because of our own enhancements
or new products or because of our competitors' products.
OUR REVENUES DEPEND ON GOVERNMENT FUNDING AVAILABLE TO PUBLIC SCHOOLS AND
ANY SUBSTANTIAL DELAYS OR REDUCTIONS IN GOVERNMENT BUDGETS OR FUNDING FOR
EDUCATIONAL SOFTWARE OR TECHNOLOGY WOULD HARM OUR BUSINESS. Our future
revenues will depend, in part, on our ability to increase revenues from
public schools. This, in turn, depends largely on federal, state and local
government funding. Federal funding for educational technology is available
primarily through legislation, including Title I of the Elementary and
Secondary Education Act of 1965, the Individuals with Disabilities
Education Act, Goals 2000, Technology Literacy Challenge Grants and the
education rate discount authorized by the Telecommunications Act of 1996.
Many states have enacted similar legislation. Substantial delays or
reductions in government budgets or funding for educational software or
technology would have a material adverse effect on our business and
financial condition.
WE ARE GROWING RAPIDLY AND MAY BE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH.
We have recently experienced a period of significant expansion. We have
grown from five employees at April 1, 1996 to 201 full-time and 12
part-time employees at December 31, 1999. Our historical growth has placed,
and any further growth will place, a significant strain on our managerial,
operational, financial and other resources. Our future success will depend,
in part, upon whether our senior management can manage growth effectively.
This will require us to implement additional management information systems
and to develop additional operating, administrative, financial and
accounting systems and controls. We will also have to maintain close
coordination among our accounting, finance, marketing, sales, customer
support and professional service organizations. If we are unsuccessful in
managing growth, our business and financial condition will be materially
and adversely affected.
WE RELY ON OUR INTELLECTUAL PROPERTY RIGHTS AND MAY BE UNABLE TO PROTECT
THESE RIGHTS. Our ability to compete effectively will depend in part on
whether we are able to develop and maintain the proprietary aspects of our
technology and to operate without infringing on the proprietary rights of
others. We rely on a combination of patents, trademarks, copyrights, trade
secret laws, confidentiality procedures and contractual provisions to
protect our proprietary rights in our products and technology. At December
31, 1999, we were the assignee or exclusive licensee under 6 issued U.S.
patents, 11 allowed U. S. patent applications, and 31 other pending US
applications. We cannot assure you that our pending patent applications
will result in the issuance of any patents or that any issued patents will
offer protection against competitors with similar technology. In addition,
any patents issued to us or our licensors could be challenged, invalidated
or circumvented in the future.
It is possible we may become subject to patent infringement claims and
litigation or interference proceedings conducted in the USPTO to determine
the priority of inventions. Litigation may be necessary to enforce patents
issued to us, to protect trade secrets or know-how that we own or to
determine the enforceability, scope and validity of the proprietary rights
of others. Any litigation or interference proceedings will result in
substantial expense and significant diversion of effort by our technical
and management personnel. An adverse determination in litigation or
interference proceedings to which we may become a party could subject us to
significant liabilities to third parties or require us to seek licenses
from third parties which may not be available on commercially reasonable
terms or at all.
FAILURE TO MAINTAIN OUR EXCLUSIVE LICENSE WOULD MATERIALLY HARM OUR
BUSINESS BY DELAYING OR PREVENTING NEW PRODUCT INTRODUCTIONS AND
NECESSITATING PRODUCT RECALLS. We hold the exclusive license to develop
commercial products based on technology owned by The Regents of the
University of California and by Rutgers, the State
12
University of New Jersey, which technology is the subject of a patent
issued in September 1998, covering the basic speech and sound modification
and adaptivity technology developed at those institutions, and several
pending applications.
Our primary products, Fast ForWord, Step 4word and 4wd, incorporate this
licensed technology. In addition, the professional version of Away We Go!
Bookshelf incorporates this licensed technology. To date, more than 85% of
our revenues have come from selling programs using the licensed technology.
While our seminars and other services, Reading Edge and the other Away We
Go! products do not make use of this licensed technology, virtually all of
our revenues from programs and services relate to the base products which
do use the licensed technology and its loss would cause material harm to
our business.
In 1998, we had approximately $356,000 in royalty expense under the
license, on program revenues subject to royalties of approximately $4.5
million. In 1999, we had approximately $612,000 in royalty expense, on
program revenues of approximately $9.1 million, of which approximately $8.8
million was subject to royalties under the license. In 2000 and each year
thereafter during the term of the license, the minimum royalty expense
necessary to maintain the license will be $150,000. We expect royalties as
a percentage of program revenues to decline over time as additional
programs are sold and, as a consequence, the royalty rate under the license
steps down. It may also decline to the extent that our product mix becomes
less reliant on licensed technology, although we cannot predict our future
product mix.
If we lose or are unable to maintain the license agreement during the term
of the underlying patents, it would materially harm our business. It could
delay or prevent the introduction of new products and would likely require
the recall of most of our products from the market. Even if we could
identify and license or develop non-infringing equivalent technology, which
is far from certain, the cost and delays from such a changeover in our base
technology would cause material harm to our business.
The Regents may terminate the license agreement if we fail to perform or
violate its terms without curing the violation within 60 days of receiving
written notice of the violation. For example, The Regents could terminate
the agreement if we fail to perform any of the following obligations:
- make royalty and milestone payments;
- provide periodic progress reports;
- bear the costs to prepare, file and prosecute U.S. and foreign patent
applications;
- provide indemnification;
- insure our activities in connection with work under the agreement; and
- maintain the confidentiality of information received from The Regents
relating to the agreement.
WE COULD LOSE REVENUES AS A RESULT OF SOFTWARE ERRORS OR DEFECTS. Software
programs frequently contain errors or defects, especially when first
introduced or when new versions are released. We could, in the future, lose
revenues as a result of software errors or defects. We cannot assure you
that errors will not be found in new products or releases, even though
products are tested prior to release. Any errors could result in loss of
revenue or delay in market introduction or acceptance, diversion of
development resources, damage to our reputation or increased service and
warranty costs.
OUR REFUND POLICY COULD ADVERSELY AFFECT OUR REVENUES AND FINANCIAL
CONDITION. We have adopted a refund policy under which we provide a refund
if a child's performance on the purchased training program indicates, based
on criteria we set forth in the policy, that the program is too difficult
or too easy for the child or if technical problems prevent a child from
running the program. If an institution such as a school purchases multiple
licenses, the institution is entitled to enroll a new child in the program,
rather than receive a refund. Also, we allow refunds and cancellations from
time to time due to special circumstances such as inability to complete
training due to illness. We cannot guarantee that these policies will not
have a material adverse effect in the future on our business and financial
condition.
WE COULD BE SUBJECT TO PRODUCT AND PROFESSIONAL LIABILITY CLAIMS FROM THE
SALE OF OUR PRODUCTS AND SERVICES. Because we market products to the
public, we face an inherent business risk of financial exposure to product
liability claims. In addition, to the extent we provide professional or
similar services, we may also face a risk of exposure to professional
liability claims. As a publisher of online content, we face potential
liability for
13
defamation, negligence, copyright, patent or trademark infringement, or
other claims based on the nature and content of materials that we publish
or distribute. We currently carry product and professional liability
insurance that, in general, covers product and professional liability
claims up to the policy limits. We cannot assure you that we will continue
to have access to this insurance at a reasonable cost, if at all, or that
the insurance will be adequate to satisfy any liability or litigation
expenses. Any claim or claims against us, regardless of their merit or
eventual outcome, could materially and adversely affect our business.
THERE IS ACADEMIC DEBATE REGARDING THE SCIENTIFIC BASIS UNDERLYING OUR
PRODUCTS WHICH COULD SIGNIFICANTLY AFFECT THE MARKET FOR OUR PROGRAMS AND
SERVICES. Our training programs are based on particular theories of
neuroscience, the study of how the brain functions, and theories of
language acquisition. Our founders are actively involved in academic debate
about their own and opposing scientific theories of neuroscience and
language acquisition. As a result, the theories on which our suite of
software products are based have been, and are likely to be, subject to
public debate and challenges. Although we believe that our suite of
software products are based primarily upon non-controversial scientific
theories, some of the principles and methodologies underlying and
associated with our products are opposed by some academicians and
educators, any of whom could influence the market for our products and
services. Consequently, academic publications and debate challenging the
theories of neuroscience and language acquisition propounded by the
founders and others could adversely affect the market for our products and
services.
OUR BUSINESS WILL SUFFER IF INTERNET USE FAILS TO DEVELOP WITHIN SCHOOLS
AND AMONG SPEECH AND LANGUAGE PROFESSIONALS IN PRIVATE PRACTICE. One of the
key features of our training programs is the periodic uploading and
downloading of information to and from our proprietary database via the
Internet. If the use of the Internet, particularly within schools and among
speech and language professionals in private practice, fails to develop or
develops more slowly than expected, our business will suffer.
ANY DELAYS OR MALFUNCTIONS OF THE INTERNET ON WHICH WE RELY FOR THE
EFFECTIVE FUNCTIONING OF OUR PRODUCTS AND WEB SITES COULD ADVERSELY AFFECT
OUR BUSINESS. We depend on technology, particularly on the Internet, for
the effective functioning of our training programs and for implementation
of our BrainConnection.com strategy. One of the key features of our
training programs is the periodic uploading and downloading of information
to and from our proprietary database via the Internet. Additionally, our
ability to establish BrainConnection.com as a reputable and reliable source
for information and the revenues we expect to generate from e-commerce
depend on the availability of the Internet. If commercially available
browsers fail to provide access to the Internet due to unexpected user
demand or other delays or malfunctions, access to our web sites could be
harmed, our sites could lose credibility and e-commerce revenues, if any,
could suffer.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE EDUCATIONAL TECHNOLOGY
MARKET. The educational technology market in which we operate is very
competitive. We compete with other companies offering educational software
products and reading and language skill building programs to schools and to
speech and language professionals in private practice. Existing competitors
may continue to broaden their product lines, and potential competitors,
including large software developers and educational publishers, may enter
or increase their focus on the school market. Moreover, we expect that we
will face additional competition from new entrants into the market. Many
competitors have substantially greater technical, marketing and
distribution resources than we do. We cannot assure you that we will
continue to be able to compete effectively in the educational technology
market. We also compete with providers of traditional methods of
remediation for language and reading problems, which typically require
several years of one-on-one training for children with identified language
and reading problems.
IF WE FAIL TO RETAIN OUR KEY PERSONNEL OR ATTRACT AND RETAIN KEY EMPLOYEES,
OUR BUSINESS WILL SUFFER. Our success depends to a significant extent upon
the continued active participation of key members of our management,
including Sheryle J. Bolton, our Chief Executive Officer, Frank M. Mattson,
our Chief Operating Officer and Jane A. Freeman, our Chief Financial
Officer, as well as others identified in the management section of this
prospectus. While we do not believe that any of our employees are
irreplaceable, we recognize that we are in an extremely competitive market
for executives and the loss of one or more of these persons could have a
material adverse effect on our business, financial condition and results of
operations. We believe that our future success will depend upon our ability
to continue to attract, motivate and retain highly skilled managerial,
sales and marketing and product development personnel. Competition for such
personnel is intense. Our failure in attracting or retaining the necessary
personnel could materially and adversely affect our business.
14
A DISASTER OR MALFUNCTION THAT DISABLES OUR COMPUTER SYSTEMS COULD HARM OUR
WEB SITES AND DAMAGE THE CREDIBILITY OF BRAINCONNECTION.COM. Substantially
all of our communications hardware and computer hardware operations are
located in our facilities in Berkeley, California, where our web sites are
hosted. Our operations depend on our ability to protect these systems
against damage from fire, earthquakes, power loss, telecommunications
failures, break-ins and similar events. Additionally, computer viruses,
electronic break-ins or other similar disruptive problems could harm our
web sites. A disaster or malfunction that disables our hosting services
could cause an interruption in our ability to deliver up-to-date progress
reports on individuals currently using our training programs and could also
damage the credibility of our BrainConnection.com web site. Our insurance
policies may not adequately compensate us for any losses that may occur due
to any failures or interruptions in our systems.
WE HAVE LIMITED EXPERIENCE GENERATING REVENUES FROM ELECTRONIC COMMERCE,
AND WE MAY NOT BE ABLE TO DO SO IF WE ARE UNABLE TO SUCCESSFULLY ESTABLISH
BRAINCONNECTION.COM, EXPAND THE PRODUCTS AND SERVICES AVAILABLE THROUGH
BRAINCONNECTION.COM AND OVERCOME INTERNET SECURITY CONCERNS. A component of
our BrainConnection.com strategy includes expansion of our e-commerce
capabilities. We have very limited experience generating revenues from
e-commerce. Additionally, the e-commerce market is new and rapidly
evolving, and the extent of consumer acceptance is uncertain. The issues
concerning the commercial use of the Internet that we expect to affect the
development of our e-commerce distribution channel include security,
reliability, cost of access, ease of access, ease of use, speed and quality
of service. If we are unable to successfully establish BrainConnection.com,
expand the products and services available through BrainConnection.com or
overcome Internet security concerns, we may be unable to generate revenues
from e-commerce. The need to securely transmit confidential information
over the Internet has been a significant barrier to e-commerce and
communications over the Internet. Any compromise of security could deter
people from using the Internet and our web sites to conduct transactions
that involve transmitting confidential information. We may need to expend
significant resources to protect against security breaches or to address
problems caused by such breaches. Even if we are able to overcome Internet
security concerns, individuals may not buy our products, resulting in
revenues from e-commerce that fall short of the cost of our e-commerce
strategy. Many Internet companies engaged in e-commerce are losing money.
WE ARE SUBJECT TO GOVERNMENT REGULATIONS THAT COULD IMPOSE ADDITIONAL COSTS
ON THE CONDUCT OF OUR BUSINESS. Our business is potentially subject to or
affected by a variety of federal, state and local laws and regulations.
These include, without limitation, laws and regulations relating to:
- education;
- licensing of speech and language professionals in private practice and
delivery of speech and language testing and remediation services;
- consumer protection and anti-fraud and related protections, including
the regulation of referrals by professionals; and
- government funding.
Compliance with these and other laws and regulations impose additional
costs on the conduct of our business, and failure to comply with these laws
and regulations, changes in these laws and regulations, or in their
applicability to our business may impose additional costs.
Although we believe our existing products are educational training tools
not subject to regulation by the U.S. Food and Drug Administration, we
cannot assure you that the U.S. Food and Drug Administration will not make
a contrary determination in the future with respect to our existing
products or other products we may develop for persons experiencing the
effects of stroke, repetitive stress syndrome or other conditions. Our
business could suffer in the event we became subject to such regulation.
OUR BRAINCONNECTION.COM STRATEGY IS SUBJECT TO GOVERNMENT REGULATION OF THE
INTERNET AND OTHER LEGAL UNCERTAINTIES WHICH COULD NEGATIVELY IMPACT OUR
OPERATIONS. We are subject to the same federal, state and local laws as
other businesses on the Internet. Today there are relatively few laws
directed towards online services. However, due to the increasing popularity
and use of the Internet, it is possible that a number of laws and
regulations may be adopted with respect to the Internet. Changes in
regulation of the Internet could affect our results of operations. These
laws and regulations could cover issues such as user privacy, freedom of
expression, pricing, fraud, content and quality of products and services,
taxation, advertising, intellectual property rights and
15
information security. Applicability to the Internet of existing laws
governing issues such as property ownership, copyrights and other
intellectual property issues, taxation, libel, obscenity and personal
privacy is uncertain. The vast majority of these laws were adopted prior to
the advent of the Internet and related technologies and, as a result, do
not contemplate or address the unique issues of the Internet and related
technologies. Many laws that do reference the Internet, such as the
recently passed Digital Millennium Copyright Act, have not yet been
interpreted by the courts and their applicability and reach are therefore
uncertain.
Laws and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The United States Congress
recently enacted Internet laws, including laws relating to children's
privacy, the transmission of sexually explicit material, taxation of
Internet-based enterprises and taxation of Internet access. In addition,
the growth and development of the market for online commerce may prompt
calls for more stringent consumer protection laws. This occurrence may
impose additional burdens on companies conducting business online by
limiting how information can flow over the Internet and the type of
information that can flow over the Internet. The adoption or modification
of laws or regulations relating to the Internet could adversely affect our
business.
OUR INTERNET ACTIVITIES MAY BECOME SUBJECT TO ADDITIONAL TAXES, WHICH COULD
NEGATIVELY AFFECT OUR RESULTS OF OPERATIONS. Tax authorities in a number of
states are currently reviewing the appropriate tax treatment of companies
engaged in e-commerce. Therefore, our products and services may become
subject to additional sales and income taxes. If consumers of our products
and services are required to pay additional sales or other taxes, they
could reduce their purchases, which would negatively affect our results of
operations. Because BrainConnection.com is available over the Internet in
multiple states and foreign countries, these jurisdictions may claim that
we are required to qualify to do business as a foreign corporation. We are
qualified to do business in nineteen states in the United States, and
qualifying in additional states could subject us to additional taxes.
Additionally, failure by us to comply with foreign laws or to qualify as a
foreign corporation in a jurisdiction where we are required to do so could
subject us to taxes and penalties for the failure to qualify and could
result in the inability to enforce contracts in such jurisdictions.
OUR EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES EFFECTIVELY
CONTROL THE VOTING POWER OF OUR COMPANY. At February 29, 2000, our
executive officers and directors and their respective affiliates
beneficially owned approximately 65% of the outstanding common stock. As a
result, these stockholders, by acting in concert, will be able to exercise
significant influence over all matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. This concentration of ownership may also delay, prevent or
deter a change in control of our company. In addition, for so long as
Warburg Pincus Ventures LP continues to hold specified percentages of the
Company's stock, we are required to nominate up to two individuals
affiliated with Warburg, Pincus for election to the Board of Directors.
Warburg Pincus has also agreed with LF SL Holding LLC that so long as LF SL
continues to hold at least 50% of the shares it originally purchased,
Warburg Pincus will vote to elect a person nominated by LF SL to the Board.
THE MARKET PRICE OF OUR STOCK MAY BE HIGHLY VOLATILE. The market price of
our common stock has been highly volatile since our July 1999 initial
public offering and could continue to be subject to wide fluctuations for
the following reasons, among others:
- the fluctuation of our quarterly results for reasons including the
seasonal demand for our products and our long sales cycle;
- the release of (or the failure to release) product enhancements or new
products;
- the timing of our competitors' product releases or variations in their
quarterly financial results;
- conditions in the economy in general or in our industry in particular,
including conditions that affect the resources available to schools,
speech and language professionals, and private parties to purchase our
products;
- publicity regarding our products or those of our competitors,
including publicity relating to new scientific studies about how the
brain functions;
- general economic conditions that influence stockholder interest in
stocks of companies with Internet or technology applications;
- changes in applicable laws and regulations affecting us or the
educational technology industry; and
- changes by financial research analysts in their estimates of our
future earnings.
16
WE MAY BE SUBJECT TO LITIGATION IF OUR STOCK PRICE IS VOLATILE. Broad
market fluctuations or a downturn in our competitive prospects may
adversely affect the market price of our common stock and result in class
action litigation. This litigation could result in substantial costs and
would, at a minimum, divert our management's attention and resources, which
could materially and adversely affect our business. Any adverse
determination in this litigation could also subject us to significant
liabilities.
OUR CHARTER PROVISIONS COULD HAVE THE EFFECT OF DELAYING OR PREVENTING
CORPORATE TAKEOVERS. Our certificate of incorporation authorizes our board
of directors to issue up to 1,000,000 shares of preferred stock and to
determine the price, rights, preferences and privileges, including voting
rights, of those shares without any further vote or action by the
stockholders. The rights of the holders of common stock will be subject to,
and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The authority to issue
this preferred stock could enable our board of directors to deter
acquisitions of our company. Additionally, our certificate of incorporation
and bylaws also contain the following features which could have the effect
of delaying or preventing corporate takeovers:
- a board of directors classified into three classes, which makes it
more difficult to acquire immediate control of our board of directors
because only one third of the directors are elected each year;
- requiring stockholder actions to occur only at duly called meetings of
the stockholders, thereby reducing the ability of the stockholders to
act contrary to the interests of the board of directors;
- disallowing cumulative voting in the election of directors, which
means that the majority owner(s) of our voting common stock controls
the election of all directors; and
- requiring advance notice from stockholders for director nominations or
other stockholder proposals.
YOU SHOULD NOT RELY ON FORWARD-LOOKING STATEMENTS CONTAINED IN THIS REPORT.
This Report on Form 10K contains forward-looking statements. In some cases
you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of these
terms or other comparable terminology. The outcome of the events described
in these forward-looking statements is subject to known and unknown risks
and you should not rely on these forward-looking statements. These risks
include, among other things, those identified in this "Risk Factors"
section. Our actual results could differ materially from those discussed in
the forward-looking statements contained in this Report. We also undertake
no obligation to publicly update any forward-looking statement and the
forward-looking events discussed in this Report on Form 10K could change or
might not occur. This section, the remainder of this Item 1 and Item 7
("Management's Discussion and Analysis of Financial Condition and Results
of Operations") contain a discussion of some of the factors that could
contribute to those differences.
ITEM 2. PROPERTIES
We lease a 34,257 square-foot facility in Berkeley, California under a
five-year lease that expires in September 2002. We believe our facilities
are adequate for our current operations but expect to need additional space
within the next 12 months.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
17
EXECUTIVE OFFICERS
The following table sets forth various information concerning our executive
officers:
NAME AGE POSITION
- ------------------------- ----- -----------------------------------------------------
Sheryle J. Bolton 53 President, Chief Executive Officer and Member of the
Board of Directors
Dr. Michael M. Merzenich 57 Chief Scientific Officer and Member of the Board of
Directors
Dr. Paula A. Tallal 52 Executive Vice President and Chairman of the Board of
Directors
Frank M. Mattson 45 Chief Operating Officer, Executive Vice President and
Assistant Secretary
Jane A. Freeman 46 Chief Financial Officer
Linda L. Carloni 46 General Counsel and Secretary
Diane H. Church 53 Vice President, Sales
Bernard G. Fraenkel 41 Vice President, Engineering
Dr. William M. Jenkins 49 Vice President, Product Development
Dr. Steven L. Miller 36 Vice President, Research
James A. Mills 44 Vice President, Marketing
SHERYLE J. BOLTON has served as our Chief Executive Officer and as a
director since November 1996 and as our President since June 1997. From January
1994 to July 1995, Ms. Bolton served as President and Chief Operating Officer of
Physicians' Online, Inc., a physicians' online service provider. From June 1993
to December 1994 and from July 1995 to October 1996, Ms. Bolton consulted for a
number of international companies, including many in the Internet, healthcare
and technology sectors, specifically in the areas of strategy, operations and
finance. Ms. Bolton's experience also includes senior management positions at
Rockefeller & Co., Inc., a global investment management firm, and Merrill Lynch
Capital Markets, Investment Banking Division. Earlier in her career, she was a
teacher of English as a second language in Africa and a language arts teacher in
public schools in the State of Georgia. Ms. Bolton is a director or trustee of
several mutual funds of Scudder Kemper Investments, Inc. and is a director of
HealthCentral.com, an Internet consumer healthcare information company. Ms.
Bolton holds a B.A. in English and an M.A. in Linguistics from the University
of Georgia, and an M.B.A. from Harvard Business School.
DR. MICHAEL M. MERZENICH is one of our founders. He has served as our
Chief Scientific Officer since November 1996 and as a director since inception.
From January 1996 to November 1996, Dr. Merzenich served as the Chief Executive
Officer and President of the Company. During 1997, Dr. Merzenich worked
full-time with us during a sabbatical from his faculty position at UCSF. In
January 1998, Dr. Merzenich returned to his faculty position at UCSF, but
continues to direct our research and development activities under a consulting
agreement. Since 1971, Dr. Merzenich has been a member of the faculty, and since
1980 a full professor, in Neuroscience, Physiology, Biomedical Engineering and
Otolaryngology at UCSF. He is currently the Francis A. Sooy Professor of
Otolaryngology at UCSF. Dr. Merzenich has more than 25 years of experience in
managing large, multidisciplinary brain science/behavior/engineering research
projects that have led to commercial products and numerous publications
18
and awards. In May 1999, Dr. Merzenich was elected a member of the National
Academy of Sciences for distinguished and continuing achievements in original
research. Dr. Merzenich holds a B.S. in General Science from the University of
Portland and a Ph.D. in Physiology from The Johns Hopkins University, with
additional training from the University of Wisconsin.
DR. PAULA A. TALLAL is one of our founders. She has served as our
Executive Vice President and Chairman of the board of directors since January
1996 and as a director since our inception. During 1997, Dr. Tallal worked
full-time with us during a sabbatical from her faculty position at Rutgers. In
January 1998, Dr. Tallal returned to her faculty position at Rutgers, but
continues to consult with us pursuant to a consulting agreement. Since 1988, Dr.
Tallal has served as co-director of the Center for Molecular and Behavioral
Neuroscience at Rutgers. Dr. Tallal is an active participant in many scientific
advisory boards and governmental committees for both developmental language
disorders and learning disabilities. Dr. Tallal has over 20 years experience
managing multi-site, multi-disciplinary federally funded contracts and grants
that have resulted in over 150 publications, as well as national and
international honors. Dr. Tallal holds a B.A. in Art History from New York
University and a Ph.D. in Experimental Psychology from Cambridge University with
additional training from The Johns Hopkins University.
FRANK M. MATTSON became our Chief Operating Officer and Executive Vice
President in January 2000 and Executive Vice President in March 2000. He served
as our Chief Financial Officer from January 1997 to January 2000. Mr. Mattson
served as our Secretary from June 1997 through March 2000. From August 1994 to
January 1997, Mr. Mattson served as Vice President of Finance and Operations,
Executive Vice President, Chief Financial Officer and as a director of MNI
Interactive, Inc., a startup entertainment marketing company. From June 1992 to
August 1994, Mr. Mattson was Vice President of Distribution and Strategic
Planning for Ingram Entertainment, Inc. ("Ingram"), a unit of the Ingram
Distribution Group, one of the world's largest distribution companies. At
Ingram, Mr. Mattson directed the post-merger integration of Ingram and Commtron
Corporation ("Commtron"), the largest distributor in the home video industry
until its acquisition by Ingram in 1992. From 1986 to 1992, Mr. Mattson served
in a variety of management positions at Commtron, a publicly traded company,
most recently as Vice President of Operations and as a director of the company.
Mr. Mattson holds a B.S. in Business from Miami University (Ohio) and an M.A. in
Economics from the University of Wisconsin in Milwaukee. Mr. Mattson has also
served on the faculty of Drake University.
JANE A. FREEMAN joined us as Vice President, Finance and Business
Development and Treasurer in August 1999 and was named Chief Financial Officer
in January 2000. From April 1988 through December 1998, she was employed by
Rockefeller & Co., a global investment firm. Among her investment
responsibilities at Rockefeller & Co. were the leadership of the global asset
allocation process and the management of the U.S. Small Capitalization equity
product. She also served on the Management Committee of the firm. From January
1978 to March 1988, Ms. Freeman was employed by Scudder, Stevens and Clark as an
analyst and Manager of the Scudder Development Fund. She is a director of four
mutual funds managed by Harding Loevner, LLP. Ms. Freeman holds a B.A. in
Mathematics and Chemistry and an M.B.A. (with distinction) from Cornell
University and a License in Applied Economics from the University of Louvain in
Belgium.
LINDA L. CARLONI joined the Company as General Counsel in October 1999
and become our Secretary in March 2000. From April 1996 to September 1999, Ms.
Carloni was a founder and Vice President of Alere Medical Incorporated, a
healthcare services start-up. From May 1994 to April 1996, Ms. Carloni served as
a senior licensing officer for the University of California Office of Technology
Transfer. From April 1992 to April 1994, Ms. Carloni was a partner at the law
firm of Cooley Godward LLP. Earlier in her career, Ms. Carloni was the general
counsel of Nellcor Incorporated, a medical device company, and an associate and
a partner at Cooley Godward. She received her bachelor's degree in political
science from Case Western Reserve University and her law degree from Boalt Hall
School of Law at the University of California, Berkeley.
DIANE H. CHURCH has served as our Vice President, Sales since June
1999, having previously served as Vice President, Private Channel Sales since
August 1997. From February 1997 to August 1997, Ms. Church was Georgia Account
Team Manager with Compuware Corporation, an information systems software and
services company. Ms. Church was Mid-Atlantic Regional Director and Regional
Director for Telecommunications Accounts at Candle Corporation from April 1994
to September 1995 and at Legent Corporation Regional Director for Mid-Atlantic
and then South-Eastern Regional Director from April 1990 to April 1994, both of
which are information systems software and services companies. Prior to that
time, Ms. Church held senior management positions with Wang Laboratories, a
19
computer and office equipment company. Ms. Church also worked as an educator in
public schools in the State of Georgia. Ms. Church holds a B.A. in English and
Education from Georgia Southwestern College and an M.B.A. from Emory University.
BERNARD G. FRAENKEL has served as our Vice President, Engineering since
April 1999. From August 1996 until April 1999, Mr. Fraenkel served as Vice
President of Engineering at One Touch Systems, a joint venture of Hughes Network
Systems and Apollo Group, Inc., which is a leading provider of interactive
distance learning systems. From January 1996 until July 1996, he was a founder
of Pixel Engines, a developer of DVD authoring systems. From December 1993 until
December 1995, Mr. Fraenkel was Director of Research and Development with Sigma
Designs, a provider of MPEG products and integrated circuits for personal
computers. He previously served as Director of Engineering with Teknekron
Communications Systems, where he led an engineering team on consulting projects
in the areas of data and wireless communications, multimedia and VLSI design.
Mr. Fraenkel holds Graduate Engineer degrees from Ecole Polytechnique and Ecole
National Superieure des University Paris IX and an M.S. in Electrical
Engineering and Computer Science from the University of California at Berkeley.
DR. WILLIAM M. JENKINS is a founder and has served as our Vice
President, Product Development since June 1997. From March 1996 to June 1997,
Dr. Jenkins was our Vice President, Research and Development. Since 1990, Dr.
Jenkins has also served as an Adjunct Associate Professor at UCSF. Dr. Jenkins
has served on the editorial board in the Systems Plasticity section of
Restorative Neurology and Neuroscience. Dr. Jenkins is the principal developer
of our current training programs. Dr. Jenkins holds a B.S. in Psychology, an
M.A. in Psychobiology and a Ph.D. in Psychobiology from Florida State
University, with additional post-doctoral training from UCSF.
DR. STEVEN L. MILLER is a founder and has served as our Vice President,
Outcomes Research or Vice President, Research since June 1997. From May 1996 to
June 1997, Dr. Miller was our Vice President, Professional Relations and
Outcomes. From September 1991 to May 1996, he held research appointments at the
Center for Molecular and Behavioral Neuroscience at Rutgers. Dr. Miller has
extensive experience in organizing clinical research studies and conducting
longitudinal studies of children and adults who have language and reading
problems. Dr. Miller holds a B.A. in Psychology from Bloomsburg University of
Pennsylvania, an M.A. in Neuroscience from the University of Hartford and a
Ph.D. in Psychology from the University of North Carolina at Greensboro. He
received additional training in Clinical Neuropsychology at the Bowman Gray
School of Medicine at Wake Forest University.
JAMES A. MILLS has served as our Vice President, Marketing, since April
1999, having previously served as Director of Marketing since August 1998. He
joined our company in July 1997, as Director, Business Development. Prior to
joining our company, Mr. Mills was a consultant advising California-based
clients on financial and operational issues. From 1986 to 1996, Mr. Mills was
with Citibank, holding positions with various sales and marketing
responsibilities, most recently as a Vice President responsible for domestic and
overseas-based clients. Mr. Mills previously worked in cable television
marketing, promotion and public affairs for Viacom International, Inc., as well
as for a cable programming start-up venture and a national cable marketing trade
association. Mr. Mills holds a B.S. from Stanford University and an M.B.A. from
Harvard Business School.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHARE-
STOCKHOLDER MATTERS
(a) Our common stock is traded on the Nasdaq National Market under the symbol
"SCIL." The following table sets forth, for the periods indicated, the high and
low sales prices per share of our common stock as reported on the Nasdaq
National Market. Trading of our common stock started on July 22, 1999. Prior to
that, there was no public market for our common stock.
1999 High Low
---- ---- ---
Third quarter (from July 22, 1999) $19 5/8 $16
Fourth quarter $39 7/8 $16
2000
----
First quarter (through March 3, 2000) $36 1/4 $23 1/8
We have never declared or paid cash dividends on our Common Stock, and we
do not anticipate paying any cash dividends in the foreseeable future. As of
February 29, 2000, the approximate number of stockholders of record of the
Company's Common Stock was 200.
(b) The use of net proceeds of $33.1 million from our July 1999 initial public
offering does not represent a material change in the use of proceeds as
described in our prospectus dated July 21, 1999, comprising part of our
Registration Statement on Form S-1, as amended, filed with the Securities and
Exchange Commission, SEC File No. 333-77133.
ITEM 6. SELECTED FINANCIAL DATA
DECEMBER 31,
1999 1998 1997 1996
-----------------------------------------------------------------
(In thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Revenues:
Programs $ 9,110 $ 4,462 $ 2,249 $ -
Services 1,142 704 713 -
-------- -------- -------- --------
Total revenues 10,252 5,166 2,962 -
Cost of revenues:
Programs 1,451 784 481 -
Services 1,237 614 468 -
-------- -------- -------- --------
Total cost of revenues 2,688 1,398 949 -
-------- -------- -------- --------
Gross profit 7,564 3,768 2,013 -
Operating expenses:
Sales and marketing 12,930 6,057 2,646 164
Research and development 4,158 2,880 1,965 1,514
General and administrative 5,439 4,759 2,537 933
-------- -------- -------- --------
Total operating expenses 22,527 13,686 7,148 2,611
Operating loss $(14,963) $ (9,918) $ (5,135) $ (2,611)
Interest income (expense), net 892 (832) 162 70
Other income (expense), net (16) 2 (85) -
-------- -------- -------- --------
Net loss $(14,087) $(10,748) $ (5,058) $ (2,497)
-------- -------- -------- --------
-------- -------- -------- --------
21
DECEMBER 31,
1999 1998 1997 1996
-------------------------------------------------------------
(In thousands, except per share data)
Basic and diluted net loss per share $ (2.24) $ (3.87) $ (1.90) $ (1.02)
-------- -------- -------- --------
-------- -------- -------- --------
Shares used in computing basic and
diluted net loss per share 6,279 2,777 2,657 2,453
-------- -------- -------- --------
-------- -------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents $ 15,662 $ 6,362 $ 2,699 $ 3,822
Investments in government securities 13,903 - - -
Working capital 27,946 3,543 1,569 3,562
Total assets 36,324 9,121 4,456 4,306
Long-term debt, including current portion - 417 330 35
Redeemable convertible preferred stock - 18,940 8,002 4,002
Stockholders' equity (deficit) (1) 29,740 (14, 082) (5,064) (85)
(1) We have paid no cash dividends since our inception
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE STATEMENTS CONTAINED IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS THAT ARE NOT HISTORICAL IN NATURE ARE
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED. FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM THOSE INDICATED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH ARE INDICATED.
OVERVIEW
We develop, market and sell proprietary training software and other
educational products and services. Our programs, products and services are based
on research on how the brain works and are designed to increase human learning
and performance. Language and reading skills are the foundation for all
learning, and we have developed products to help children, adolescents and
adults learn how to read or become better readers. Our language and reading
programs, Fast ForWord, Step 4word and 4wd, are intensive, computer-based
training programs that focus on improving critical language and reading skills.
These training programs are based on scientific research and have been
extensively field-tested. In 1999, we began selling Reading Edge, a language and
reading assessment product, the Away We Go! family of software and storybooks,
and CrossTrain professional development software. We also offer professional
development seminars in which educators, speech and language professionals and
other professionals can learn about recent developments in brain research and
the practical application of our programs as well as earn continuing education
credit. Our products are delivered through a variety of distribution channels,
including sales to public schlools, referrals from speech and language
professionals in private practice and direct-to-consumer channels including
through our web sites. In 1999, sales to public schools represented
approximately one-third of total 1999 revenues compared to public school sales
in 1998, which represented less than 15% of total 1998 revenues.
In 1999, we launched BrainConnection.com, which provides easily
accessible information on brain research and its application to learning and
everyday life. It reaches its audience both through its web site and
BrainConnection.com conferences. We are also developing an e-commerce business
through the BrainConnection.com site.
We commenced operations in February 1996, and, until April 1997, we
devoted substantially all of our efforts to developing the Fast ForWord program,
performing a field trial, recruiting and training personnel, establishing
relationships with and training educators and speech and language professionals,
and raising capital. Since the commercial launch of Fast ForWord in April 1997,
we have also devoted efforts to sales and marketing activities. We have an
accumulated deficit of $32.4 million from inception through December 31, 1999.
We expect
22
to incur additional losses for at least the next 18 months, due primarily to
substantial increases in sales and marketing costs related to the expansion of
BrainConnection.com, increased personnel-related costs and expenditures for
travel, advertising, promotion, new product launches and other activities, and
increases in research and development expenses due to continued increases in
product development costs. We expect that losses will fluctuate from quarter to
quarter and that these fluctuations may be substantial.
REVENUES. We derive revenues from program and product sales and service fees.
Program revenues are derived from the sale of training programs including Fast
ForWord, Step 4word and 4wd, which generally list for $850 per child and are
typically discounted for volume sales and in connection with the bundling of
other products or services. Customers license the right to use our program
software during the program period and do not acquire or otherwise gain
unlimited rights to use the software. The total value of products and services
invoiced during a particular period is recorded as deferred revenues until
recognized.
Revenues on sales of our training programs are recognized over the period of
use.
In late 1999, we began selling our programs to schools on a site
license basis. These licenses offer unlimited use of specified programs to
students enrolled at the defined site for a specified period, typically 12
months. We recognize revenues from the training programs included in the site
license ratably over the life of the related site license. Revenues from site
licenses were minimal in 1999.
We only recently began offering our programs through our
direct-to-consumer channel and revenues to date have been minimal. Cancellations
and refunds are allowed in limited circumstances, and these amounts have not
been significant. Our policy is to grant refunds if the child's performance on
the purchased training program indicates, based on criteria we set forth in the
policy, that the program is too difficult or too easy for the child or if
technical problems prevent the child from running the program. If an institution
such as a school purchases multiple programs, the institution is entitled to
enroll a new child in the program, rather than receive a refund. Also, we allow
refunds and cancellations from time to time due to special circumstances such as
inability to complete training due to illness. Provisions are made for
cancellations and refunds as revenue is recorded.
Revenues from Reading Edge, Away We Go! and CrossTrain software
products are recognized when the product is shipped, collectibility is probable
and the fees are fixed or determinable. Service revenues are derived from
training seminars for learning facilitators, from software installation at large
sites such as schools and from services provided to consumers who buy directly
from us. Revenues from other services have not been significant.
Our revenues have been derived almost exclusively from the sale of
language and reading training programs and related seminars and services. While
we are developing additional products based upon our proprietary technology and
neuroscience expertise, there can be no assurance that we will be successful in
doing so. In addition, to date, the substantial majority of our sales of our
training programs have been through public schools and speech and language
professionals, with the majority of the public school revenues recorded in the
last year. Furthermore, due to the inherent complexity of selling to schools and
school districts, we expect that our sales cycle could be significantly longer
than that experienced historically as we increasingly focus on sales to this
market. As a result, we may have limited visibility on our future revenues, and
such revenues may fluctuate substantially.
COST OF REVENUES. Cost of revenues consists of program and product costs and
service costs. Program and product costs consist of costs associated with
program and product sales, including royalties, manufacturing, packaging,
documentation, fulfillment, amortization of capitalized software costs, Internet
hosting and technical support costs. Service costs consist primarily of the
costs of providing training seminars and installations and services to consumers
who buy directly from us, including personnel, materials, facilities and travel.
These costs of revenues are generally recognized as incurred. We generally
recognize significantly higher gross margins on our program revenues than on our
service revenues.
OPERATING EXPENSE. Our operating expenses consist of sales and marketing,
research and development and general and administrative expenses. Sales and
marketing expenses principally consist of salaries and compensation paid to
employees engaged in sales and marketing activities, advertising and promotional
materials, public relations costs and travel. Research and development expenses
principally consist of salaries and compensation paid to employees and
consultants engaged in research and product development activities, product
testing, and software and equipment costs. We expense all software development
costs associated with a product until technological
23
feasibility is established, after which time all these associated costs are
capitalized until the product is available for commercial release and are
amortized over the estimated lives of the related products. Technological
feasibility is deemed established upon completion of a working version. Only a
small portion of our research and development costs have been capitalized to
date. General and administrative expenses principally consist of salaries and
compensation paid to employees and consultants other than those engaged in
research and development and sales and marketing activities, facilities and
related depreciation, in-house and outside legal and accounting fees and related
costs, and travel.
We recorded deferred compensation of $2.1 million during the two years
ended December 31, 1998 and $278,000 during the year ended December 31, 1999,
representing the difference between the exercise price and the deemed fair value
of certain stock options granted to employees. These amounts are being amortized
by charges to operations over the vesting periods of the individual stock
options. This amortization amounted to $1.0 million for the year ended December
31, 1998 and $776,000 for the year ended December 31, 1999. The remaining
aggregate deferred compensation of $566,000 will be amortized over the remainder
of the vesting periods of the options (generally five years).
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, various
financial data expressed as a percentage of revenues (unless otherwise noted)
for the years ended December 31, 1999, 1998 and 1997.
YEARS ENDED DECEMBER 31,
1999 1998 1997
--------------------------------
Revenues
Programs and products 88.9% 86.4% 75.9%
Services 11.1 13.6 24.1
---- ---- ----
Total revenues 100.0% 100.0% 100.0%
Cost of revenues
Programs and products(1) 15.9% 17.6% 21.4%
Services(2) 108.3 87.2 65.6
----- ------ ----
Total cost of revenues 26.2% 27.1% 32.0%
Gross margin 73.8% 72.9% 68.0%
- -------------------------------------
(1) Program and product costs are expressed as a percentage of program and
product revenues.
(2) Service costs are expressed as a percentage of service revenues.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
REVENUES
Total revenues increased by $5.1 million, or 98.5%, to $10.3 million in
1999 compared to the prior year. Program revenues increased by $4.6 million, or
104.2%, to $9.1 million in 1999 compared to 1998 due to new product
introductions and increased sales to both public schools and private
professionals. Service revenues increased by $438,000, or 62.2%, to $1.1 million
in 1999 compared to 1998 due to an increased number of professional development
seminars for both public schools and speech and language professionals in
private practice and software installations in schools.
COST OF REVENUES
Total cost of revenues increased by $1.3 million, or 92.3%, to $2.7
million in 1999 compared to 1998. As a percentage of revenues, cost of revenues
decreased to 26.2% from 27.1%. Cost of program and product revenues decreased to
15.9% from 17.6% in 1999 compared to the prior year due to lower royalties and
because technical support and Internet hosting costs declined as a percentage of
revenues, reflecting growth in program volume. Cost
24
of services revenues increased to 108.3% from 87.2% in the current period
compared to 1998 due to administrator training and installation of our training
programs in public schools. To encourage schools to adopt our training programs,
we have offered discounts on administrator training and installation services.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased $6.9 million, or 113.5%, to
$12.9 million in 1999 compared to 1998. This increase was primarily attributable
to increased personnel, marketing and travel costs. We increased our quota
bearing sales force from 11 to 33 during the year. We expect further increases
in sales and marketing expenses in the future as we increase marketing efforts
for current and future products.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased $1.3 million, or 44.4%, to
$4.2 million in the current year compared to 1998. We expect to increase
research and development expenditures in the future as we continue to refine
current products and develop additional products based upon our proprietary
technology and our neuroscience expertise.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased $690,000, or 14.5%, to
$5.4 million in 1999 compared to 1998. This increase was primarily attributable
to increased personnel, consulting, legal and travel costs.
PROVISION FOR INCOME TAXES
We recorded no provision for income taxes in the years ended December
31, 1999 and 1998 as we incurred losses during such periods. At December 31,
1999, we had net operating loss carryforwards for federal income tax purposes of
approximately $28.0 million. The net operating loss carryforwards will expire in
years 2011 through 2019. Utilization of the net operating losses may be subject
to a substantial annual limitation due to the ownership change limitations
provided by the Internal Revenue Code of 1986. Previous or contemplated equity
transactions may result in such an ownership change. The annual limitation may
result in the expiration of net operating losses before becoming available to
reduce future tax liabilities. At December 31, 1999, we had approximately $11.7
million of deferred tax assets, comprised primarily of net operating loss
carryforwards. Realization of deferred tax assets is dependent upon future
earnings, if any, the timing and amount of which are uncertain. Accordingly, the
net deferred tax assets have been fully offset by a valuation allowance.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Revenues increased to $5.2 million in 1998 from $3.0 million in 1997,
an increase of 74.4%. Program and product revenues increased to $4.5 million
from $2.2 million, an increase of 98.4%, due to increased program activations in
speech and language professional and public school markets. Services revenues
were $704,000, a slight decrease from $713,000 in the prior year, reflecting a
planned decline in professional development seminars for speech and language
professionals in private practice, offset partially by growth in public school
services revenues.
25
COST OF REVENUES
Cost of revenues increased to $1.4 million in 1998 from $949,000 in
1997, an increase of 47.3%. As a percentage of revenues, cost of revenues
declined to 27.1% from 32.0%, due to growth in program and product revenues as a
percentage of total revenues. Cost of program and product revenues, as a
percentage of revenues, declined to 17.6% from 21.4%, due to a decline in costs
of materials, technical support and Internet hosting as a percentage of revenues
reflecting growth in program volume. Cost of services revenues, as a percentage
of revenues, grew to 87.2% from 65.6% in 1997, due to introductory pricing of
professional development and installation services offered to schools.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased to $6.1 million in 1998 from
$2.6 million in 1997, an increase of 128.9%. This increase was primarily
attributable to personnel, advertising and promotion, travel and public
relations costs.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased to $2.9 million in 1998
from $2.0 million in 1997, an increase of 46.6%. This increase was primarily
attributable to increased personnel and to a lesser extent to consulting,
software and equipment-related costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased to $4.7 million in 1998
from $2.5 million in 1997, an increase of 87.2%. This increase was primarily
attributable to fees and expenses related to a proposed initial public offering
withdrawn in 1998, personnel, facilities, legal and travel costs.
INTEREST INCOME (EXPENSE)
Interest expense, net of interest income, was $832,000 in 1998 compared
to interest income net of interest expense of $162,000 in 1997. Interest expense
in 1998 resulted principally from charges of $780,000 which represented the fair
value of warrants to acquire preferred and common stock issued to a significant
preferred stockholder in connection with a loan from the stockholder and a bank
loan guarantee provided by the stockholder.
PROVISION FOR INCOME TAXES
We recorded no provision for income taxes in 1998 or 1997 as we incurred losses
in both periods.
LIQUIDITY AND CAPITAL RESOURCES
From inception through December 31, 1999, we used approximately $25.9
million of cash for operating activities, resulting primarily from net losses of
$32.4 million and increases in accounts receivable of $3.5 million, partially
offset by increases in accounts payable and accrued liabilities of $2.2 million,
deferred revenue of $4.2 million, depreciation and amortization charges of $2.5
million and amortization of deferred compensation of $1.8 million.
During this same period, we used $17.6 million for investing
activities, consisting principally of the acquisition of government securities,
computer equipment, furniture and fixtures. These cash needs were primarily
financed through the sale of $15.8 million of convertible preferred stock in
December 1998 and January 1999, and the net proceeds of $33.2 million from our
initial public offering of common stock in July 1999. As of December 31, 1999,
we had cash and cash equivalents of $15.7 million. We also had $13.9 million in
U.S. Government securities. We believe that our cash and cash equivalents,
together with our investments in government securities, will be sufficient to
finance our presently anticipated operating losses, planned capital expenditure
requirements and internal growth for at least the next 18 months. However, we
cannot be certain that our cash resources will be sufficient to fund negative
cash flow and expected capital expenditures beyond that period. We therefore may
need
26
to obtain additional equity or debt financing in the future. We may not be able
to obtain the additional financing to satisfy our cash requirements on
acceptable terms or at all. To date the Company has paid no dividends. We have
no plans to initiate dividends in the next 18 months.
We currently have no significant long-term obligations, which extend
beyond 18 months except in connection with the lease of our corporate office
facility, which requires minimum lease payments of approximately $80,000 per
month through August 2002. See Note 7 of Notes to Financial Statements. During
the next 18 months, we may need to expand our corporate office facilities, which
would require us to commit to additional lease obligations.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income we can
earn on our investment portfolio. We do not use derivative financial instruments
in our investment portfolio. We ensure the safety and preservation of our
invested principal funds by limiting default risks, market risk and reinvestment
risk. We mitigate default risk by investing in safe and high-credit quality
securities. A hypothetical increase or decrease in market interest rates by 10%
from the market interest rates at December 31, 1999 would not cause the fair
value of our cash and cash equivalents to change by a material amount. Declines
in interest rates over time will, however, reduce our interest income.
YEAR 2000
Many computer programs have been written using two digits rather than
four to define the applicable year. In 2000, computer programs could pose
problems by not properly recognizing a year that begins with "20" instead of
"19". To date, we have not experienced any major system failures or
miscalculations that disrupted our business. We do not anticipate any future
significant problems or expense relating to Year 2000, or Y2K, compliance of our
computer systems. Additionally, we have not experienced any problems with
respect to Y2K compliance of our suppliers, service providers, contractors and
key business partners. To the extent that these suppliers, providers,
contractors, and partners have any problems with Y2K compliance of their
computer systems in the future and are unable to provide us with components,
materials or services that are necessary for our service and product offerings,
we intend to change to those that have demonstrated Y2K compliance. We cannot
assure you that we will be successful in finding such alternative suppliers,
providers, contractors and partners, and failure to do so could harm our
business.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
Scientific Learning Corporation
We have audited the accompanying balance sheets of Scientific Learning
Corporation (the "Company") as of December 31, 1999 and 1998, and the related
statements of operations, redeemable convertible preferred stock and
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the 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. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Scientific Learning Corporation
at December 31, 1999 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
ERNST & YOUNG LLP
Walnut Creek, California
January 31, 2000
28
Scientific Learning Corporation
Balance Sheets
(In thousands, except share and per share amounts)
DECEMBER 31,
1999 1998
--------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,662 $ 6,362
Investments in government securities 13,903 -
Accounts receivable, net of allowance for doubtful accounts of $271 and $33
at December 31, 1999 and 1998, respectively 3,472 799
Prepaid expenses and other current assets 1,282 307
--------------------------------
Total current assets 34,319 7,468
Restricted cash deposit - 280
Property and equipment, net 1,913 1,278
Other assets 92 95
--------------------------------
Total assets $ 36,324 $ 9,121
--------------------------------
--------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 802 $ 731
Accrued liabilities 1,366 1,249
Deferred revenue 4,205 1,649
Current portion of borrowings under bank line of credit - 278
Current portion of capital lease obligations - 18
--------------------------------
Total current liabilities 6,373 3,925
Borrowings under bank line of credit - 121
Other liabilities 211 217
---------------- ----------------
Total liabilities 6,584 4,263
Commitments
Redeemable convertible preferred stock, $0.001 par value, issuable in series:
Authorized shares- none in 1999 and 5,364,445 in 1998
Issued and outstanding shares-none in 1999 and 3,730,156 in 1998 - 18,940
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value:
Authorized shares-1,000,000 in 1999 and 1,533,333 in 1998
Issued and outstanding shares-none in 1999 and 946,435 in 1998 - 2,355
Common stock, $0.001 par value:
Authorized shares-40,000,000 in 1999 and 24,897,779 in 1998
Issued and outstanding shares-10,507,185 in 1999 and 2,795,781 in 1998 62,696 2,930
Deferred compensation (566) (1,064)
Accumulated deficit (32,390) (18,303)
--------------------------------
Total stockholders' equity (deficit) 29,740 (14,082)
--------------------------------
Total liabilities and stockholders' equity (deficit) $ 36,324 $ 9,121
--------------------------------
--------------------------------
SEE ACCOMPANYING NOTES.
Scientific Learning Corporation
Statements of Operations
(In thousands, except per share amounts)
YEARS ENDED DECEMBER 31,
1999 1998 1997
---------------------------------------------------
Revenues:
Programs and products $ 9,110 $ 4,462 $ 2,249
Services 1,142 704 713
---------------------------------------------------
Total revenues 10,252 5,166 2,962
Cost of revenues:
Programs and products 1,451 784 481
Services 1,237 614 468
---------------------------------------------------
Total cost of revenues 2,688 1,398 949
---------------------------------------------------
Gross profit 7,564 3,768 2,013
Operating expenses:
Sales and marketing 12,930 6,057 2,646
Research and development 4,158 2,880 1,965
General and administrative 5,439 4,749 2,537
---------------------------------------------------
Total operating expenses 22,527 13,686 7,148
---------------------------------------------------
Operating loss (14,963) (9,918) (5,135)
Interest income (expense), net 892 (832) 162
Other income (expense), net (16) 2 (85)
---------------------------------------------------
Net loss $ (14,087) $ (10,748) $ (5,058)
---------------------------------------------------
---------------------------------------------------
Basic and diluted net loss per share $ (2.24) $ (3.87) $ (1.90)
---------------------------------------------------
---------------------------------------------------
Shares used in computing basic and diluted net loss per share 6,279 2,777 2,657
---------------------------------------------------
---------------------------------------------------
Pro forma basic and diluted net loss per share (unaudited) $ (1.54)
-----------------
-----------------
Shares used in computing pro forma basic and diluted net loss
per share (unaudited) 9,175
-----------------
-----------------
SEE ACCOMPANYING NOTES.
30
Scientific Learning Corporation
Statements of Redeemable Convertible Preferred Stock
and Stockholders' Equity (Deficit)
(In thousands, except share amounts)
STOCKHOLDER'S EQUITY (DEFICIT)
--------------------------------------------------
REDEEMABLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balances at December 31, 1996 1,499,999 $ 4,002 963,101 $ 2,400 2,656,918 $ 12
Issuance of common stock under stock option
plan - - - - 870 -
Issuance of Series C preferred stock upon
exercise of warrant, net of issuance costs 952,380 4,000 - - - -
Reduction of Series A preferred stock issued
in connection with license agreement - - (16,666) (45) - -
Deferred compensation related to grant of
stock options - - - - - 508
Amortization of deferred compensation - - - - - -
Net loss and comprehensive loss - - - - - -
----------------------------------------------------------------------------
Balances at December 31, 1997 2,452,379 8,002 946,435 2,355 2,657,788 520
Issuance of common stock under stock option
plan - - - - 137,993 44
Issuance of Series D preferred stock, net of
issuance costs 1,277,777 10,938 - - - -
Issuance of common stock warrants to preferred
stockholder in connection with guarantee of
line of credit and loan obtained from
stockholder - - - - - 780
Deferred compensation related to grant of
stock options - - - - - 1,586
Amortization of deferred compensation - - - - - -
Net loss and comprehensive loss - - - - - -
----------------------------------------------------------------------------
Balances at December 31, 1998 3,730,156 18,940 946,435 2,355 2,795,781 2,930
Issuance of common stock under stock option
plan - - - - 179,258 164
Issuance of Series D preferred stock, net of
issuance costs 555,555 4,896 - - - -
Issuance of common stock in initial public
offering, net of offering costs - - - - 2,300,000 33,133
Conversion of preferred stock to common stock (4,285,711) (23,836) (946,435) (2,355) 5,232,146 26,191
Deferred compensation related to grant of
stock options - - - - - 278
Amortization of deferred compensation - - - - - -
Net loss and comprehensive loss - - - - - -
----------------------------------------------------------------------------
Balances at December 31, 1999 - $ - - $ - 10,507,185 $ 62,696
----------------------------------------------------------------------------
----------------------------------------------------------------------------
STOCKHOLDER'S EQUITY (DEFICIT)
-------------------------------------------------
TOTAL
DEFERRED ACCUMULATED STOCKHOLDERS'
COMPENSATION DEFICIT EQUITY (DEFICIT)
-------------------------------------------------
-------------------------------------------------
Balances at December 31, 1996 $ - $ (2,497) $ (85)
Issuance of common stock under stock option
plan - - -
Issuance of Series C preferred stock upon
exercise of warrant, net of issuance costs - - -
Reduction of Series A preferred stock issued
in connection with license agreement - - (45)
Deferred compensation related to grant of
stock options (508) - -
Amortization of deferred compensation 124 - 124
Net loss and comprehensive loss - (5,058) (5,058)
-------------------------------------------------
Balances at December 31, 1997 (384) (7,555) (5,064)
Issuance of common stock under stock option
plan - - 44
Issuance of Series D preferred stock, net of
issuance costs - - -
Issuance of common stock warrants to preferred
stockholder in connection with guarantee of
line of credit and loan obtained from
stockholder - - 780
Deferred compensation related to grant of
stock options (1,586) - -
Amortization of deferred compensation 906 - 906
Net loss and comprehensive loss - (10,748) (10,748)
-------------------------------------------------
Balances at December 31, 1998 (1,064) (18,303) (14,082)
Issuance of common stock under stock option
plan - - 164
Issuance of Series D preferred stock, net of
issuance costs - - -
Issuance of common stock in initial public
offering, net of offering costs - - 33,133
Conversion of preferred stock to common stock - - 23,836
Deferred compensation related to grant of
stock options (278) - -
Amortization of deferred compensation 776 - 776
Net loss and comprehensive loss - (14,087) (14,087)
-------------------------------------------------
Balances at December 31, 1999 $ (566) $(32,390) $ 29,740
-------------------------------------------------
-------------------------------------------------
SEE ACCOMPANYING NOTES.
31
Scientific Learning Corporation
Statements of Cash Flows
(In thousands)
YEARS ENDED DECEMBER 31,
1999 1998 1997
---------------------------------------------
OPERATING ACTIVITIES
Net loss $ (14,087) $ (10,748) $ (5,058)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 803 1,328 326
Loss on disposal of property and equipment - - 85
Preferred stock issued in connection with license agreement - - (45)
Amortization of deferred compensation 776 906 124
Changes in operating assets and liabilities:
Accounts receivable (2,673) (755) (44)
Prepaid expenses and other assets (972) (160) (225)
Accounts payable 71 312 304
Accrued liabilities 117 894 218
Deferred revenue 2,556 1,307 341
Other liabilities (6) 146 (29)
---------------------------------------------
Net cash used in operating activities (13,415) (6,770) (4,003)
INVESTING ACTIVITIES
Purchase of government securities (13,903) - -
Restricted cash deposit 280 70 (350)
Purchase of property and equipment, net (1,438) (700) (1,045)
---------------------------------------------
Net cash used in investing activities (15,061) (630) (1,395)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock, net 4,896 10,938 4,000
Proceeds from issuance of common stock, net 33,297 44 -
Borrowings under bank line of credit - 6,363 355
Repayments of borrowings under bank line of credit (399) (6,254) (65)
Repayments of capital lease obligations (18) (28) (15)
---------------------------------------------
Net cash provided by financing activities 37,776 11,063 4,275
---------------------------------------------
Increase (decrease) in cash and cash equivalents 9,300 3,663 (1,123)
Cash and cash equivalents at beginning of year 6,362 2,699 3,822
---------------------------------------------
Cash and cash equivalents at end of year $ 15,662 $ 6,362 $ 2,699
---------------------------------------------
---------------------------------------------
SUPPLEMENTAL DISCLOSURES
Interest paid $ 29 $ 142 $ 32
---------------------------------------------
---------------------------------------------
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligations incurred $ - $ 6 $ 20
---------------------------------------------
---------------------------------------------
Issuance of common stock warrants in connection with guarantee of line
of credit and loan obtained from stockholder $ - $ 780 $ -
---------------------------------------------
---------------------------------------------
Issuance of common stock in connection with conversion of redeemable
preferred stock and convertible preferred stock $ 26,191 $ - $ -
---------------------------------------------
---------------------------------------------
Deferred compensation $ 278 $ 1,586 $ 508
---------------------------------------------
---------------------------------------------
SEE ACCOMPANYING NOTES.
32
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Scientific Learning Corporation (the "Company") was incorporated on November 30,
1995 in the State of California and was reincorporated on May 2, 1997 in the
State of Delaware. The Company commenced operations in February 1996. The
Company operates in one business segment, which is the development and sale of
proprietary training software and other education products and services designed
to increase human learning and performance. The Company's revenues have been
derived primarily from 2 products, Fast ForWord and Step 4word, formerly known
as Fast ForWord Two, which are designed to improve language and reading skills.
The Company's products are delivered through a variety of distribution channels,
including sales to public schools, speech and language professionals in private
practice and direct-to-consumer channels.
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 accompanying notes.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid short-term
investments with original maturities of three months or less.
INVESTMENTS IN GOVERNMENT SECURITIES
The Company classifies all of its investments as available-for-sale securities.
Such investments consist of United States Government and Federal Agency
securities which are carried at amounts which approximate fair value, with
unrealized gains and losses on such securities reflected, net of tax, as other
comprehensive income (loss) in stockholder's equity (deficit) until disposition.
Realized gains and losses on investments in government securities, of which
there were none in the year ended December 31, 1999, are included in interest
income. At December 31, 1999, the amortized cost approximates the fair market
value of the available-for-sale securities.
33
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE LOSS
The Company has adopted the Financial Accounting Standards Board Statement No.
130, "Reporting Comprehensive Income" (FAS 130") in fiscal year 1999. FAS 130
establishes new standards for reporting and displaying comprehensive income and
its components. The adoption has no impact on the Company's consolidated
financial position, results of operations or cash flows.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's cash and cash equivalents, investments in
government securities, accounts receivable, and accounts payable approximate
fair value. The Company determines the fair value of its investments in
government securities based on quoted market prices.
ACCOUNTS RECEIVABLE
The Company conducts business with individuals and school districts primarily in
the United States. Ongoing credit evaluations are performed on customers and
collateral is generally not required. Allowances for uncollectible accounts are
made for potential credit issues and such allowances and issues to date have not
been material. Accounts receivable included unbilled amounts of $1,138,000 at
December 31, 1999. There were no unbilled amounts at December 31, 1998.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets which range
from three to five years.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs in accordance with Statement
of Financial Accounting Standards ("FAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed," under which certain
software development costs incurred subsequent to the establishment of
technological feasibility are capitalized and amortized over the estimated lives
of the related products. Technological feasibility is established upon
completion of a working version. In the year ended December 31, 1999, the
Company capitalized $629,000 of software development costs. Software costs are
amortized over the estimated useful life of the software, which is one year.
34
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE DEVELOPMENT COSTS (CONTINUED)
In February 1998, the Accounting Standards Executive Committee (AcSEC") issued
Statement of Position No. 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 establishes the
accounting for costs of software products developed or purchased for internal
use, including when such costs should be capitalized. The adoption of this
pronouncement did not materially impact the Company's results of operations for
the year ended December 31, 1999.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options using the intrinsic value method
in accordance with Accounting Principles Board Opinion No. 25 ("APB 25") and
makes the pro forma disclosures required by FAS No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123") (Note 6).
REVENUE RECOGNITION
Program revenues are derived from the sale of Fast ForWord, Step 4word, 4wd
training program and Away We Go!, Reading Edge, and CrossTrain software
products. Customers license the right to use Fast ForWord, Step 4word, and 4wd
during the training period and do not acquire or otherwise gain unlimited rights
to use the programs.
Revenues on sales of Fast ForWord, Step 4word, and 4wd are recognized over the
average duration of the program. Revenues on sales of Away We Go!, Reading Edge
and CrossTrain software products are recognized when the products are shipped,
collectibility is probable and the fees are fixed or determinable.
Service revenues are derived from the Company's training seminars for learning
facilitators and from services provided to customers. Revenues from seminars are
recognized when the seminar is held. Revenues from other services have not been
significant.
Cancellations and refunds are allowed in limited circumstances, and such amounts
have not been significant. Provisions are made for cancellations and refunds as
revenue is recorded. Costs of revenues are recognized as such costs are
incurred. Royalty costs are recorded over the period in which the related
program revenue is recorded.
35
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was $357,000,
$292,000 and $342,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.
INCOME TAXES
The Company uses the liability method to account for income taxes as required by
FAS No. 109, "Accounting for Income Taxes." Under this method, deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities. Deferred tax assets and
liabilities are measured using enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
NET LOSS PER SHARE
Basic and diluted net loss per share information for all periods is presented
under the requirement of FAS No. 128, "Earnings per Share" ("FAS 128"). Basic
earnings per share have been computed using the weighted-average number of
shares outstanding during the period and excludes any dilutive effects of stock
options, warrants, and convertible securities. Potentially dilutive securities
have been excluded from the computation of diluted net loss per share as their
inclusion would be antidilutive.
Pro forma net loss per share has been computed as described above and also gives
effect to the conversion of 5,232,000 preferred shares not included above that
converted upon completion of the Company's initial public offering (Note 6).
If the Company had reported net income, the calculation of diluted earnings per
share would have included approximately an additional 996,000, 955,000 and
906,000 common equivalent shares related to the outstanding options and warrants
not included above for the years ended December 31, 1999, 1998 and 1997,
respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
On December 3, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"). This summarizes certain areas of the
Staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company believes that its current
revenue recognition principles comply with SAB 101.
36
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
DECEMBER 31,
1999 1998
------------------------------------
Computer equipment $ 2,657 $ 1,707
Office furniture and equipment 954 466
Leasehold improvements 22 22
------------------------------------
3,633 2,195
Less accumulated depreciation (1,720) (917)
------------------------------------
$ 1,913 $ 1,278
------------------------------------
------------------------------------
3. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
DECEMBER 31,
1999 1998
------------------------------------
Accrued vacation $ 464 $ 185
Employee stock purchase plan 320 -
Accrued commission 246 64
Other accruals 336 1,000
------------------------------------
$ 1,366 $ 1,249
------------------------------------
------------------------------------
4. BANK LINES OF CREDIT
The Company had a $400,000 line of credit with a bank which was used to finance
equipment purchases during 1997. Borrowings under the line of credit were due in
equal monthly installments plus interest at the bank's prime rate plus 3% and
were secured by substantially all of the Company's assets, excluding
intellectual property. Borrowings under this line of credit were fully repaid in
June 1999.
In February 1998, the Company entered into an additional line of credit with the
same bank which provided for borrowings of up to $450,000 to finance equipment
purchases during the year ended December 31, 1998. Borrowings were due in
monthly installments plus interest at the bank's prime rate plus 3% and were
secured by substantially all of the Company's assets, excluding intellectual
property. Borrowings under this line of credit were fully repaid in September
1999.
37
4. BANK LINES OF CREDIT (CONTINUED)
In May 1999, the Company entered into a loan modification agreement to the
February 1998 line of credit providing for additional borrowings of up to
$1,000,000 to finance equipment purchases. Borrowings were due in monthly
installments plus interest at the bank's prime rate plus 3%. These additional
borrowings were fully repaid in September 1999.
In September 1997, the Company obtained a $350,000 irrevocable standby letter of
credit with the same bank as security for the lease agreement covering its
corporate office facility. A $350,000 certificate of deposit was pledged as
collateral for the standby letter of credit, which was subsequently reduced to
$280,000 in September 1998. The letter of credit was cancelled in September 1999
following the Company's initial public offering of common stock as provided for
in the lease agreement.
In June 1998, the Company obtained a $3.0 million unsecured line of credit from
another bank. Borrowings under the line of credit bore interest, at the election
of the Company, at the bank's base rate or the adjusted LIBOR plus 1.75%.
Borrowings were guaranteed by a significant preferred stockholder of the
Company. In connection with such guarantee, the Company issued to the
stockholder warrants to purchase 66,666 shares of the Company's common stock at
$9.00 per share. Such warrants expire on May 31, 2003. The Company estimated the
fair value of the warrants to be $650,000, which was amortized by charges to
interest expense during the year ended December 31, 1998. Additionally, the
stockholder agreed to purchase up to 333,333 shares of the Company's preferred
stock at $9.00 per share if requested by the Company. The Company's right to
require the stockholder to purchase such securities expired upon the closing of
the Series D preferred stock financing in January 1999. Borrowings under the
line of credit were repaid and the line of credit was terminated in December
1998.
In October 1998, the Company obtained a $3.0 million term loan from a
significant preferred stockholder of the Company. Borrowings under this loan
bore interest at 8% per annum. In connection with such loan, the Company issued
to the stockholder warrants to purchase 50,000 shares of the Company's common
stock at $9.00 per share. Such warrants expire on October 23, 2003. The Company
estimated the fair value of the warrants to be $130,000, which was amortized by
charges to interest expense during the year ended December 31, 1998. This loan
was repaid in December 1998.
38
5. INCOME TAXES
There has been no provision for U.S. federal, U.S. state or foreign income taxes
for any period as the Company has incurred operating losses in all periods and
for all jurisdictions.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows (in thousands):
DECEMBER 31,
1999 1998
----------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 10,461 $ 5,370
Capitalized research and development costs 358 -
Deferred revenue - 660
Research credits carryforwards 295 210
Other 591 360
----------------------------------------
Total deferred tax assets 11,705 6,600
Valuation allowance (11,705) (6,600)
----------------------------------------
Net deferred tax assets $ - $ -
----------------------------------------
----------------------------------------
Realization of deferred tax assets is dependent upon future earnings, if any,
the timing and amount of which are uncertain. Accordingly, the net deferred tax
assets have been fully offset by a valuation allowance. The valuation allowance
increased by $3,568,000 and $2,006,000 during the years ended December 31, 1998
and 1997, respectively.
As of December 31, 1999, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $28,000,000 which expire
in the years 2011 through 2019. The Company had net operating loss carryforwards
for state income tax purposes of approximately $13,450,000 expiring in 2003 and
2004.
Utilization of the Company's net operating loss carryforwards may be subject to
substantial annual limitation due to the ownership change limitation provided by
the Internal Revenue Code and a similar state provision. Such an annual
limitation could result in the expiration of the net operating loss
carryforwards before utilization.
39
6. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
On July 22, 1999, the Company issued 2,300,000 shares of common stock in an
initial public offering at a price of $16.00 per share. The net proceeds to the
Company from that offering were approximately $33.1 million after deducing the
underwriters' discount and offering expenses. In addition, upon completion of
the initial public offering, each outstanding share of the Company's convertible
preferred stock was automatically converted into one share of common stock.
COMMON STOCK
At December 31, 1999, the Company had reserved shares of common stock for future
issuance as follows:
Stock Option Plan:
Options outstanding 1,680,567
Options available for future grants 269,156
Common stock warrants 116,666
----------------
2,066,389
----------------
----------------
STOCK SPLIT
In May 1999, the Company's stockholders approved a two-for-three reverse stock
split of issued and outstanding common and preferred stock. All common and
preferred share prices, and amounts associated with rights, preferences,
dividends and privileges in the accompanying financial statements have been
retroactively adjusted to reflect the stock split. In connection with the
reverse stock split, the Board of Directors authorized a decrease in the number
of authorized shares of common stock to 35,500,000 and a decrease in the number
of authorized shares of preferred stock to 5,500,000 shares. Effective
immediately prior to the closing of the initial public offering of its common
stock, the Board of Directors authorized, and the stockholders approved, an
increase in the number of authorized shares of common stock to 40,000,000 and a
decrease in the number of authorized shares of preferred stock to 1,000,000.
40
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS
The Company's stock option plans provide for the issuance of incentive stock
options (ISO) or nonstatutory stock options (NSO) to eligible participants. The
ISOs may be granted at a price per share not less than the fair market value at
the date of grant. The NSOs may be granted at a price per share not less than
85% of the fair market value at the date of grant. Options granted to date can
be exercised immediately but, if so exercised, these unvested shares are subject
to repurchase by the Company. Options and unvested shares granted generally vest
over a period of up to five years. Options under the plan have a maximum term of
10 years. In the event optionholders cease to be employed by the Company, all
unvested options are forfeited and all vested options may be exercised within a
90-day period after termination; the Company also has the right to repurchase at
the original purchase price any unvested (but issued) shares if the holder is no
longer employed by the Company. At December 31, 1999, no outstanding common
shares are subject to such repurchase rights.
In May 1999, the Company's stockholders approved the 1999 Equity Incentive Plan
which amends and restates the Company's existing stock option plan. There are
2,192,666 shares of common stock authorized for issuance under the plan,
including shares originally authorized under predecessor plans. The plan became
effective upon completion of the Company's initial public offering of its common
stock.
In May 1999, the Company's stockholders approved the 1999 Non-Employee
Directors' Stock Option Plan and reserved an aggregate of 75,000 shares of
common stock for grants of stock options under the plan.
41
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
A summary of the Company's stock option activity under the plans is as follows:
OUTSTANDING OPTIONS
-----------------------------------------
WEIGHTED-AVERAGE
EXERCISE PRICE PER
NUMBER OF SHARES SHARE
-----------------------------------------
Outstanding at December 31, 1996 971,927 $ 0.27
Granted 232,632 0.55
Exercised (870) 0.26
Canceled (162,305) 0.28
-------------------
Outstanding at December 31, 1997 1,041,384 0.33
Granted 346,488 4.59
Exercised (137,993) 0.32
Canceled (61,923) 0.89
-------------------
Outstanding at December 31, 1998 1,187,956 1.54
Granted 814,587 12.65
Exercised (179,258) 0.59
Canceled (142,718) 5.35
-------------------
Outstanding at December 31, 1999 1,680,567 $ 6.72
-------------------
-------------------
Vested at December 31, 1999 663,371 $ 1.85
-------------------
-------------------
42
6. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable stock options at December 31, 1999:
VESTED AND
OUTSTANDING EXERCISABLE
------------------------------------------------- --------------------------------
WEIGHTED- WEIGHTED- WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE
NUMBER OF PRICE PER CONTRACTUAL LIFE NUMBER OF PRICE
PRICE RANGE SHARES SHARE (YEARS) SHARES PER SHARE
- --------------------------------------------------------------------------------- --------------------------------
$0.26 - $0.30 624,907 $ 0.28 6.49 513,208 $ 0.28
0.60 - 0.75 84,544 0.62 7.75 32,037 0.62
2.25 - 6.00 290,851 5.60 8.98 57,374 5.41
11.25 - 16.00 436,997 11.60 9.39 52,894 11.70
16.19 - 39.88 243,268 17.83 9.80 7,858 17.10
--------------- --------------
1,680,567 663,371
--------------- --------------
--------------- --------------
The Company recorded deferred compensation of $278,000 and $1,586,000 during the
years ended December 31, 1999 and 1998, respectively, representing the
difference between the exercise price and the deemed fair value of certain of
the Company's stock options granted to employees. These amounts are being
amortized by charges to operations over the vesting periods of the individual
stock options using a graded method. Such amortization amounted to $776,000,
$906,000 and $124,000 for the years ended December 31, 1999, 1998 and 1997,
respectively. The remaining aggregate deferred compensation of $566,000 will be
amortized over the remainder of the vesting periods of the options (generally
five years).
43
6. STOCKHOLDERS' EQUITY (CONTINUED)
PRO FORMA DISCLOSURES OF THE EFFECT OF STOCK-BASED COMPENSATION
Pro forma information regarding results of operations and net loss per share is
required by FAS 123, which also requires that the information be determined as
if the Company had accounted for its employee stock options under the fair value
method of FAS 123. The fair value for these options was estimated at the date of
grant using the Black-Scholes valuation model with the following
weighted-average assumptions: a risk-free interest rate of 6.0%, 6.0% and 6.3%
for the years ended December 31, 1999, 1998 and 1997, respectively, expected
volatility of 81.9%, 0% and 0% for 1999, 1998 and 1997, respectively, no
dividend yields, and a weighted-average expected life of the option of five
years.
The option valuation models were developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective
assumptions, including the expected life of the option. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined using the fair value at the grant dates for awards under those plans
calculated using the Black-Scholes valuation model, the Company's net loss and
pro forma basic and diluted net loss per share would have been increased to the
pro forma amounts indicated below:
YEARS ENDED DECEMBER 31,
1999 1998 1997
----------------------------------------------------
Pro forma net loss (in thousands) $ (14,824) $ (10,822) $ (5,092)
----------------------------------------------------
Pro forma basic and diluted net loss per share $ (2.36) $ (3.90) $ (1.92)
----------------------------------------------------
----------------------------------------------------
The weighted-average fair value of options granted, which is the value assigned
to the options under FAS 123, was $8.58, $6.44 and $1.25 for options granted
during the years ended December 31, 1999, 1998 and 1997, respectively.
The pro forma impact of options on the net loss for the years ended December 31,
1999, 1998 and 1997 is not representative of the effects on net income (loss)
for future years, as future years will include the effects of additional years
of stock option grants.
44
6. STOCKHOLDERS' EQUITY (CONTINUED)
1999 EMPLOYEE STOCK PURCHASE PLAN
In April 1999, the Company's Board of Directors adopted, and in May 1999 the
stockholders approved, the 1999 Employee Stock Purchase Plan which became
effective upon the completion of the initial public offering of the Company's
common stock. The Company has reserved a total of 350,000 shares of common stock
for issuance under the plan. Eligible employees may purchase common stock at 85%
of the lesser of the fair market value of the Company's common stock on the
first day of the applicable one-year offering period or the last day of the
applicable six-month purchase period. No shares were purchased in 1999.
7. COMMITMENTS
LEASES
The Company leases its corporate office facility under non-cancelable operating
lease, with an original term of five years. Future minimum payments under this
lease as of December 31, 1999 are as follows (in thousands):
2000 $ 982
2001 1,012
2002 671
------------------
Total minimum lease payments $ 2,665
------------------
------------------
Rent expense under all operating leases was $1,068,000, $974,000 and $418,000
for the years ended December 31, 1999, 1998 and 1997, respectively.
The Company has the option to extend the operating lease covering its corporate
office facility for an additional five years at the end of the lease term,
provided that certain conditions of the lease agreement are met.
45
7. COMMITMENTS (CONTINUED)
LICENSE AGREEMENT
In September 1996, the Company entered into a license agreement with a
university for the use of the intellectual property underlying its training
methods. In exchange for the license, the Company issued 131,192 shares of
Series A preferred stock and paid the university a license-issue fee of
$200,000. In March 1997, the number of shares of Series A preferred stock issued
under the agreement was reduced to 114,526.
Under the agreement, additional royalties and milestone payments are payable to
the university based upon revenues from products using the licensed technology.
Royalty and milestone expenses were $612,000, $415,000 and $202,000 for the
years ended December 31, 1999, 1998 and 1997, respectively, and are included in
cost of revenues.
8. EMPLOYEE RETIREMENT AND BENEFIT PLAN
The Company has a defined contribution retirement plan under Section 401(k) of
the Internal Revenue Code which covers substantially all employees. Eligible
employees may contribute amounts to the plan, via payroll withholding, subject
to certain limitations. The Company does not match contributions by plan
participants.
46
FINANCIAL STATEMENT SCHEDULE
As required under Item 8, Financial Statements and Supplementary Data, the
financial statement schedule of the Company is provided in this separate
section. The financial statement schedule included in this section is as
follows:
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
Valuation and Qualifying Accounts which are deducted in the Balance Sheet from
the assets to which they apply:
Charged to
Opening Operating Charged to Closing
Balance Expenses Revenue(1) Balance
------- -------- ---------- -------
Allowance for doubtful accounts, years ended December 31:
1999 $33 $40 $198 $ 271
1998 $ 5 $28 $ - $ 33
1997 $ - $ 5 $ - $ 5
- ----------------------------------
(1) The Company invoiced certain customers whose accounts were deemed
potentially uncollectible. As such, the accounts were entirely reserved
for and n amounts were recognized as revenue.
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The information required by this item with respect to our executive officers is
contained in Part I "Executive Officers".
Information respecting our directors is set forth under the caption "Election of
Directors" in our Proxy Statement relating to our 2000 Annual Meeting of
Stockholders and is incorporated by reference into this Form 10-K Report. The
Proxy Statement will be filed with the Securities and Exchange Commission in
accordance with Rule 14a-6(c) promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). With the exception of the foregoing
information and other information specifically incorporated by reference into
this Form 10-K Report, the Proxy Statement is not being filed as a part hereof.
Information respecting compliance with Section 16(a) of the Exchange Act is set
forth under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement and is incorporated by reference into this
Form 10-K Report.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is set forth under the captions
"Executive Compensation", "Stock Option Grants and Exercises", "Employment,
Severance and Change of Control Agreements" and "Compensation Committee
Interlocks and Insider Participation" in the Proxy Statement and is incorporated
by reference into this Form 10-K Report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement and is incorporated by
reference into this Form 10-K Report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is set
forth under the captions "Employment Agreements" and "Certain Transactions" in
the Proxy Statement and is incorporated by reference into this Form 10-K Report.
48
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
(1) Financial Statements
Independent Auditor's Report
Balance Sheets - December 31, 1999 and 1998
Statements of Operations - Years Ended December 31, 1999, 1998
and 1997
Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit) - Years Ended
December 31, 1999, 1998 and 1997
Statements of Cash Flows - Years Ended December 31, 1999, 1998
and 1997
Notes to Financial Statements
(2) Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
(3) Exhibits
EHXIBIT NO. DESCRIPTION OF DOCUMENT
----------- -------------------------------------------------------------------------
3.3* Restated Certificate of Incorporation.
3.4* Amended and Restated Bylaws.
4.1* Reference is made to Exhibits 3.3 through 3.4.
4.2 Amended and Restated Registration Rights Agreement,
dated as of December 30, 1998.
4.3* Specimen stock certificate.
10.1* Form of Indemnity Agreement with each of our directors and
executive officers, with related schedules.
10.2* 1999 Equity Incentive Plan.
10.3* Form of Stock Option Agreement under the Incentive Plan.
10.4* Form of Stock Option Grant Notice under the Incentive Plan.
10.5* 1999 Non-Employee Directors' Stock Option Plan.
10.6* Form of Non-statutory Stock Option Agreement under the Non-Employee
Directors' Stock Option Plan (Initial Grant).
10.7* Form of Non-statutory Stock Option Agreement under the Non-Employee
Directors' Stock Option Plan (Annual Grant).
10.8* 1999 Employee Stock Purchase Plan.
10.9* Form of Employee Stock Purchase Plan Offering under the Employee Stock
Purchase Plan.
10.10* Consulting Agreement, dated as of September 20, 1996, with
Dr. Michael M. Merzenich, as modified on January 19, 1998.
10.11* Consulting Agreement, dated as of September 19, 1996, with
Dr. Paula A. Tallal, as modified on January 22, 1998.
10.13*+ Exclusive License Agreement, dated September 27, 1996, with the Regents
of the University of California, as amended.
10.14* Lease Agreement, dated as of July 31, 1997, with GBC-University
Associates, L.P.
10.15* Securities Purchase Agreement, dated September 24, 1996, with Warburg,
Pincus Ventures, L.P.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule
-----------------------------------------------------------------
*Filed as an exhibit to our Registration Statement on Form S-1
(No. 333-77133) or amendments thereto and incorporated herein by
reference.
+Certain portions of this exhibit have been omitted based upon our
request for confidential treatment for portions of the referenced
exhibit.
49
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.
SCIENTIFIC LEARNING CORPORATION
By /s/ Sheryle J. Bolton March 23, 2000
----------------------
Sheryle J. Bolton
Chief Executive Officer
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 and on the dates indicated.
SIGNATURES TITLE DATE
/s/ Sheryle J. Bolton President, Chief Executive Officer March 23, 2000
- ------------------------------- and Director (Principal Executive
Sheryle J. Bolton Officer)
/s/ Jane A. Freeman Chief Financial Officer, Vice President March 23, 2000
- ------------------------------ Finance and Business Development and
Jane A. Freeman Treasurer (Principal Financial and
Accounting Officer)
/s/ Michael M. Merzenich
- ------------------------------
Dr. Michael M. Merzenich Chief Scientific Officer and Director March 23, 2000
/s/ Paula A. Tallal
- ------------------------------
Dr. Paula A. Tallal Executive Vice President and Chairman March 23, 2000
of the Board
/s/ Carleton A. Holstrom
- ------------------------------
Carleton A. Holstrom Director March 23, 2000
/s/ Rodman W. Moorhead
- ------------------------------
Rodman W. Moorhead, III Director March 23, 2000
/s/ James E. Thomas
- ------------------------------
James E. Thomas Director March 23, 2000
/s/ David A. Tanner
- ------------------------------
David A. Tanner Director March 23, 2000
50
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
------- -----------------------------------------------------------------------------------
3.3* Restated Certificate of Incorporation.
3.4* Amended and Restated Bylaws.
4.1* Reference is made to Exhibits 3.3 through 3.4.
4.2 Amended and Restated Registration Rights Agreement, dated as of December 30, 1998.
4.3* Specimen stock certificate.
10.1* Form of Indemnity Agreement with each of our directors and executive
officers, with related schedules.
10.2* 1999 Equity Incentive Plan.
10.3* Form of Stock Option Agreement under the Incentive Plan.
10.4* Form of Stock Option Grant Notice under the Incentive Plan.
10.5* 1999 Non-Employee Directors' Stock Option Plan.
10.6* Form of Non-statutory Stock Option Agreement under the Non-Employee
Directors' Stock Option Plan (Initial Grant).
10.7* Form of Non-statutory Stock Option Agreement under the Non-Employee
Directors' Stock Option Plan (Annual Grant).
10.8* 1999 Employee Stock Purchase Plan.
10.9* Form of Employee Stock Purchase Plan Offering under the Employee Stock
Purchase Plan.
10.10* Consulting Agreement, dated as of September 20, 1996, with Dr. Michael
M. Merzenich, as modified on January 19, 1998.
10.11* Consulting Agreement, dated as of September 19, 1996, with Dr. Paula A.
Tallal, as modified on January 22, 1998.
10.13*+ Exclusive License Agreement, dated September 27, 1996, with the Regents
of the University of California, as amended.
10.14* Lease Agreement, dated as of July 31, 1997, with GBC-University Associates, L.P.
10.15* Securities Purchase Agreement, dated September 24, 1996, with Warburg,
Pincus Ventures, L.P.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule
- -------------------------------------------------------------------------------
*Filed as an exhibit to our Registration Statement on Form S-1 (No. 333-77133)
or amendments thereto and incorporated herein by reference.
+Certain portions of this exhibit have been omitted based upon our
request for confidential treatment for portions of the referenced exhibit.