SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark one)
[X] Annual report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended July 31, 1998
OR
[ ] Transition report under Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from -------- to --------
COMMISSION FILE NO. 1-13851
SONUS CORP.
(Name of small business issuer in its charter)
ALBERTA, CANADA NOT APPLICABLE
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
111 S.W. FIFTH AVENUE, SUITE 2390
PORTLAND, OREGON 97204
(Address of principal executive office) (Zip code)
(503) 225-9152
(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act:
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Title of Each Class Name of Each Exchange on Which Registered
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COMMON SHARES, WITHOUT NOMINAL OR PAR VALUE AMERICAN STOCK EXCHANGE
Securities registered under Section 12(g) of the Exchange Act: NONE
Check whether the issuer: (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 [ ]
Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation S-B contained herein, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State the issuer's revenues for its most recent fiscal year:
$22,368,000.
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the registrant, computed by reference to the
price at which the common equity was sold, or the average bid and asked price of
such common equity, as of October 1, 1998: $37,100,723
State the number of shares outstanding of each of the issuer's classes
of common equity: Common Shares, without nominal or par value, 6,119,707 shares,
as of October 1, 1998.
Transitional Small Business Disclosure. Format: Yes---- No X
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the issuer's definitive Management Information Circular and
Proxy Statement dated November 12, 1998, are incorporated by reference into Part
III of this Form 10-KSB.
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TABLE OF CONTENTS
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PART I .......................................................................................3
ITEM 1. Description of Business................................................................3
ITEM 2. Description of Property................................................................8
ITEM 3. Legal Proceedings......................................................................9
ITEM 4. Submission of Matters to a Vote of Security Holders....................................9
PART II ......................................................................................10
ITEM 5. Market for Common Equity and Related Stockholder Matters..............................10
ITEM 6. Management's Discussion and Analysis or Plan of Operation.............................13
ITEM 7. Financial Statements..................................................................18
ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..18
PART III......................................................................................19
ITEM 9. Directors, Executive Officers, Promoters, and Control Persons; Compliance
with Section 16(a) of the Exchange Act................................................19
ITEM 10.Executive Compensation................................................................20
ITEM 11.Security Ownership of Certain Beneficial Owners and Management........................20
ITEM 12.Certain Relationships and Related Transactions........................................20
ITEM 13. Exhibits and Reports on Form 8-K.....................................................20
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FORWARD-LOOKING STATEMENTS
Statements in this report, to the extent that they are not based on historical
events, constitute forward-looking statements. Forward-looking statements
include, without limitation, statements containing the words "believes,"
"anticipates," "intends," "expects," and words of similar import. Investors are
cautioned that forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance,
or achievements of Sonus Corp. (the "Company") to be materially different from
those described herein. Factors that may result in such variance, in addition to
those accompanying the forward-looking statements, include economic trends in
the Company's market areas, the ability of the Company to manage its growth and
integrate new acquisitions into its network of hearing care clinics, development
of new or improved medical or surgical treatments for hearing loss or of
technological advances in hearing instruments, changes in the application or
interpretation of applicable government laws and regulations, the ability of the
Company to complete additional acquisitions of hearing care clinics on terms
favorable to the Company, the degree of consolidation in the hearing care
industry, the Company's success in attracting and retaining qualified
audiologists and staff to operate its hearing care clinics, product and
professional liability claims brought against the Company that exceed its
insurance coverage, and the availability of and costs associated with potential
sources of financing. The Company disclaims any obligation to update any such
factors or to publicly announce the result of any revisions to any of the
forward-looking statements contained herein to reflect future events or
developments
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
The Company was incorporated under the laws of the Province of Alberta, Canada,
in July 1993, under the name "575035 Alberta Ltd." The Company changed its name
to HealthCare Capital Corp. in October 1994, when it acquired nine hearing care
clinics in British Columbia. The Company did not begin operating in the United
States until it purchased two hearing care clinics near Santa Maria, California,
in July 1996. By vote of the shareholders, the Company changed its name from
HealthCare Capital Corp. to Sonus Corp. on February 9, 1998. The Company,
through its subsidiaries Sonus-USA, Inc. ("Sonus-USA"), and Sonus-Canada Ltd.
("Sonus-Canada"), currently owns and operates a network of 89 hearing care
clinics in the United States and Western Canada. Clinics owned by the Company
are located in the states of Arizona, California, Illinois, Michigan, Missouri,
New Mexico, North Dakota, Oregon, and Washington and in the Canadian provinces
of British Columbia and Alberta. The Company intends to expand its network of
hearing care clinics by acquiring clinics in its existing as well as new
geographic markets.
Each of the Company's hearing care clinics provides its hearing impaired
patients with a full range of audiological products and services. During the
fiscal year ended July 31, 1998, approximately 84% of the Company's revenues
were derived from product sales, including hearing instruments, batteries, and
accessories, while 15% of the Company's revenues were derived from audiological
services. Substantially all of the Company's hearing care clinics are staffed by
audiologists. The Company's operating strategy is to provide patients with high
quality and cost-effective hearing care while at the same time increasing its
operating margins by attracting and retaining patients, recruiting qualified and
productive audiologists, achieving economies of scale and administrative
efficiencies, and pursuing large group and managed care contracts. The Company
believes that it is well positioned to provide retail hearing rehabilitative
services to consumers while simultaneously serving the diagnostic needs of
referring physicians and meeting the access and cost concerns of managed care
providers and insurance companies.
The Company, through its recently acquired subsidiary Hear PO Corp., operates as
an independent provider association and hearing care benefit administrator. Hear
PO Corp. obtains contracts to provide hearing care benefits to managed care
group and corporate health care organizations through its approximately 1,000
affiliated audiologists. It then processes claims under those contracts on
behalf of the audiologists in exchange for a fee.
The Company, through Sonus-USA, operates a franchise licensing program called
The Sonus Network. Licensees are entitled to use the Sonus name and receive
other benefits such as practice management advice and training, group buying
discounts, and marketing services. There are currently 9 licensees under the
licensing program located in 3 states.
INDUSTRY BACKGROUND
Professionals and Clinics. Hearing instruments may be dispensed by either a
dispensing audiologist or a hearing instrument specialist ("HIS"). Although both
audiologists and HISs may be licensed to dispense hearing instruments,
audiologists have advanced training in audiology and hold either a masters or
Ph.D. degree.
Overall, dispensing audiologists are much younger than HISs. The June 1998 issue
of The Hearing Review, a hearing industry trade journal, indicates that
approximately 24% of HISs in the U.S. are at least 61 years of age, 30% are
51-60 years of age, 33% are 41-50 years of age and only 13% are age 40 or under,
compared to 5%, 21%, 45% and 29%, respectively, for dispensing audiologists. The
Company believes that many HISs are facing retirement with no formal
"exit-strategy," a situation that creates an attractive investment opportunity
for the Company.
The typical hearing care practice wields little purchasing power with
manufacturers, and must spread overhead over a relatively small revenue base. In
addition, a typical hearing care practice often has insufficient capital to
purchase new technologies and lacks the systems and size necessary to develop
economies of scale. As a result, the Company believes that dispensing
audiologists and HISs will find it increasingly attractive to sell their
practices to or affiliate with larger organizations, such as the Company.
Another factor that may favor the consolidation of hearing care practices is
managed care. As managed care becomes more pervasive, hearing care professionals
will have an even greater need for the information resources, management
expertise, economies of scale, and access to managed care group contracts that
larger organizations such as the Company may be better able to provide. However,
managed care is not presently a large part of the hearing care market and
hearing care products and services are likely to continue to be provided
predominantly on a private pay basis for the next several years.
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Notwithstanding the factors favoring consolidation of hearing care practices,
there are currently only a few multiple clinic networks operating in more than
one state or province in the United States or Canada with combined annual
revenues in excess of $5 million.
Hearing Impaired Population. According to the 1996 edition of Communication
Facts, published by the American Speech-Language Hearing Association, the number
of persons in the United States who have hearing loss is estimated to be
approximately 28 million and the percentage of individuals with a hearing loss
relative to the general population is approximately 2% for those under 18 years
of age, 5% for those between 18 and 44 years of age, 14% for those between 45
and 64 years of age, 23% for those between 65 and 74 years of age and 32% for
those over 75 years of age. In addition, the American Tinnitus Association
estimates that approximately 12 million American adults have tinnitus (a ringing
sensation in the ears) that is severe enough to seek medical help.
The Company believes that the widely recognized demographic trend toward an
aging population will increase the demand for hearing instrument sales and
audiological services and that the demand for hearing instruments that are less
visible and for newer and superior hearing instrument technology, such as
digital and programmable hearing instruments, will also contribute to market
growth. In addition, the Company believes that some individuals forgo hearing
care because of the stigma of aging that can be associated with wearing a
hearing instrument and that the demand for hearing instrument sales and hearing
care services can be increased by marketing and education designed to reduce
that stigma.
Hearing Health Care Industry Segments. The hearing health care industry serving
patients with hearing and balance disorders is comprised of four distinct
service segments:
o hearing rehabilitation services, including the evaluation and
rehabilitation of persons with hearing impairments by assessing
communicative impairment and providing amplification;
o advanced audio-diagnostic services, including the
neuro-audiologic evaluation and non-medical diagnosis of hearing
and balance disorders;
o industrial and preventative audiological services, including
noise level measurements, dosimetry, and hearing screenings; and
o otolaryngologic services, including surgery and other medical
treatment.
The Company's clinics primarily provide hearing rehabilitation services. The
Company has one facility, the Rockyview Hearing and Balance Clinic located in
Calgary, Alberta, that provides advanced audio-diagnostic services and one
clinic located in San Diego, California, that provides evaluation and treatment
for patients with tinnitus.
Hearing rehabilitation services include the assessment and rehabilitation of
persons with hearing impairments through the use of hearing instruments and
counseling. Rehabilitation services, including amplification systems, are
provided by audiologists and HISs. The services offered include the diagnostic
audiological testing, fitting and dispensing of hearing instruments, follow-up
rehabilitative assistance, the sale of hearing instrument batteries, hearing
instrument repairs, and the sale of swim plugs, custom ear plugs, and assistive
listening devices.
Advanced audio-diagnostic services include the assessment and non-medical
treatment of vestibular and balance disorders and the evaluation of patients
with specific symptoms of an auditory or vestibular disorder, including hearing
loss, tinnitus, and balance problems. In order to make a differential diagnosis
of hearing disorders, an ear, nose and throat physician may employ or refer
patients to an audiologist to conduct special diagnostic hearing tests to
differentiate between conductive, sensory, and neural pathology. If the cause of
the hearing loss is a medical disorder in either the nervous system (neural) or
the middle ear (conductive), the physician proceeds with medical treatment.
However, if a non-treatable conductive or sensory loss is found, the physician
will generally refer the patient to an audiologist for rehabilitation.
GROWTH STRATEGY
The Company's growth strategy is to expand its operations by selectively
acquiring hearing clinics located in existing as well as new geographic markets
and by increasing the number of licensees under the Company's licensing program.
The Company believes that the fragmented nature of the hearing care industry,
the absence of industry-wide standards, and the inexperience and limited capital
resources of many hearing care providers, combine to provide an opportunity to
build an expanding network of Company-owned and licensed hearing care clinics
devoted to providing high-quality hearing health care services.
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The Company plans to expand its network of Company-owned clinics in each new
market by initially targeting for acquisition a significant hearing care
practice in order to secure a solid foundation upon which to build a regional
network of audiology practices. The Company will then seek to acquire additional
individual or group practices in order to realize economies of scale in
management, marketing, and administration, and hopes that its initial purchase
in the region will attract other practitioners interested in selling their
businesses. Due to the contacts of management with audiologists in the industry,
the Company is frequently presented with opportunities to acquire hearing care
clinics. From August 1, 1996, to September 30, 1998, the Company acquired 85
clinics, all located in the United States.
The Company looks at the following factors before acquiring clinics in a
particular geographic market: (a) population size and distribution; (b)
audiology practice density, saturation and average group size; (c) local
competitors; (d) level of managed care penetration; and (e) local industry and
economy. In acquiring particular clinics within a geographic market, the Company
seeks clinics with the following characteristics: (a) an established patient
base drawing from a substantial metropolitan population; (b) significant revenue
and profitability prior to acquisition; (c) above-average potential to enhance
clinic profitability after acquisition; and (d) if a clinic has an audiologist,
a willingness by the audiologist to enter into an employment agreement with the
Company in order to retain continuity in patient service and relationships and
maintain the identity of the clinic in the community where it is located.
Prior to acquiring a hearing care clinic, the Company conducts a due diligence
investigation of the clinic's operations that includes an analytical review of
the clinic's financial statements, tax returns, and other operating data, a
review of patient files on a random sample basis, a review of credit reports,
contracts, bank deposits, and other documents and information that the Company
deems significant, and the preparation of financial projections. Based on the
information collected and analyzed during the due diligence review, the Company
determines an appropriate purchase price for the acquisition.
The Company generally uses cash, its common shares, promissory notes, assumption
of debt, or a combination of the foregoing to fund acquisitions. The amount paid
for each practice varies on a case-by-case basis according to historical
revenues, projected earnings after integration into the Company, and transaction
structure. In connection with each acquisition, the Company acquires
substantially all of the assets of the practice, including its audiological
equipment and supplies, office lease and improvements, receivables and patient
files.
At the time a practice is acquired, the audiologist associated with the practice
typically becomes an employee of the Company and enters into an employment
agreement with the Company with an initial term of three years and annual
renewals thereafter. The employment agreement usually includes a three-year
non-compete provision following termination of employment. If the office of a
retiring HIS is acquired, a six- to 12-month transition plan is usually
negotiated with the HIS.
There can be no assurance that the Company will be able to complete acquisitions
consistent with its expansion plans, that such acquisitions will be on terms
favorable to the Company, or that the Company will be able to successfully
integrate the hearing care clinics that it acquires into its business.
Successful integration will be dependent upon maintaining payor and customer
relationships and converting the management information systems of the clinics
the Company acquires to the Company's systems. Significant expansion could place
a strain on the Company's managerial and other resources and could necessitate
the hiring of a number of new managerial and administrative personnel.
Unforeseen problems with future acquisitions or failure to manage expansion
effectively may have a material adverse effect on the business, financial
condition, and results of operations of the Company.
OPERATING STRATEGY
The Company's operating strategy is to provide its patients with high quality
and cost effective hearing care products and services while at the same time
increasing its operating margins by attracting and retaining patients,
recruiting qualified and productive audiologists, achieving economies of scale
and administrative efficiencies, and pursuing large group and managed care
contracts.
Attracting and Retaining Patients. The Company seeks to attract new patients and
retain existing patients at each clinic by providing patients with friendly,
comprehensive, and cost-effective hearing care at convenient times and
locations. In addition, by educating patients about hearing health issues and by
providing quality service during office visits and consistent patient follow-up
and support, the Company hopes to foster patient loyalty and increase the
likelihood of obtaining referrals and repeat visits for examinations and product
purchases.
Recruiting Qualified and Productive Audiologists. Audiologists employed by the
Company are primarily responsible for clinic profitability as well as for
attracting and retaining customers. The Company seeks to employ audiologists who
share the Company's goal of delivering high-quality hearing care service and who
are also dedicated to expanding and enhancing
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their practices. The Company believes that it can offer significant benefits to
audiologists by providing assistance in administrative tasks associated with
operating an audiology practice, thereby allowing them to focus on serving
patients and increasing productivity. The Company also believes that its size
and structure enable it to offer financial resources for practice development
and enhancement that solo and small group practitioners find difficult to obtain
independently. Achieving Economies of Scale and Administrative Efficiencies. A
key operating strategy of the Company is to achieve increased economies of scale
and administrative efficiencies at each of its clinics. When a clinic is
acquired by the Company, it immediately has available to it terms and discounts
with hearing instrument manufacturers that are generally more favorable than it
could negotiate independently. In addition, the Company believes that by
centralizing certain management and administrative functions such as marketing,
billing, collections, human resources, risk management, payroll, and general
accounting services, the profitability of a clinic can be improved by spreading
the cost of such functions over a larger revenue base. The Company has developed
an on-line management information system that links a substantial number of the
Company's clinics with the Company's corporate headquarters in order to provide
management with the ability to collect and analyze clinic data, control overhead
expenses, allow detailed budgeting at the clinic level, and permit effective
resource management.
Pursue Large Group and Managed Care Contracts. Although the Company intends to
continue to aggressively pursue private-payor business because it is presently
more pervasive and profitable than managed care business, the Company believes
that by providing comprehensive geographic coverage in a particular market
through its Company-owned clinics and through its licensees, it will be strongly
positioned to offer services to group hearing care plans in that market. Managed
care arrangements typically shift some of the economic risk of providing patient
care from the person who pays for the care to the provider of the care by
capping fees, requiring reduced fees, or paying a set fee per patient
irrespective of the amount of care delivered. With respect to hearing care, such
limits could result in reduced payments for services or restrictions on the
types of services for which reimbursement is available or the frequency of
replacements or upgrades of equipment. At the present time, managed care
penetration of the hearing care market is limited. However, if managed care
begins to play a larger role in hearing care, the Company plans to develop
information systems to improve productivity, manage complex reimbursement
methodologies, measure patient satisfaction and outcomes of care, and integrate
information from multiple sources.
Many third-party insurers impose restrictions in their health insurance policies
on the frequency with which hearing instruments may be upgraded or replaced on a
reimbursable basis. Such restrictions have a negative impact on hearing
instrument sales volume. There can be no guarantee that such insurers will not
implement other policy restrictions in the future in order to further minimize
reimbursement for hearing care. Such restrictions could have a material adverse
effect on the Company's business, financial condition, and results of
operations.
CLINIC STAFFING AND FACILITIES
Typically, each Company-owned hearing clinic is staffed with at least one
audiologist and one patient care coordinator, who handles reception, clerical,
and most bookkeeping functions. The Company currently employs approximately 135
audiologists. Where volume warrants, a clinic may also be staffed with
additional audiologists and patient care coordinators. An audiologist employed
by the Company has a masters or Ph.D. degree in audiology. The audiologist is
licensed by the appropriate state or province to dispense hearing instruments
and is a member of the Canadian Association of Speech/Language Pathologists and
Audiologists or the American Speech--Language Hearing Association.
Each of the Company's hearing clinics operates in leased space that ranges in
size from 800 to 3,000 square feet depending on patient volume and the extent of
services provided by the clinic. Clinics generally have a reception seating
area, a reception work and filing area, an office for the audiologist, a
laboratory for hearing instrument repairs and modifications, a technology
demonstration room and an evaluation room. A properly equipped office offering
only hearing rehabilitation services requires equipment that costs $50,000 to
$75,000. The cost of equipment for a clinic offering advanced audio-diagnostic
services is much greater and ranges from $225,000 to $250,000.
PRODUCTS AND SUPPLIERS
The hearing instrument manufacturing industry is highly competitive with
approximately 40 manufacturers serving the worldwide market. Few manufacturers
offer significant product differentiation. The Company currently purchases a
large percentage of its hearing instruments from five primary manufacturers
based upon criteria that include quality, price, and service. The Company
recently began offering a line of private-label hearing instruments that is
being marketed as the Sonus Digital Hearing System(TM). In addition to hearing
instruments, the Company's clinics also offer a limited selection of other
assistive listening devices and hearing instrument accessories.
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MARKETING
The Company's marketing program is designed to help its hearing care clinics
retain existing patients and expand the services they receive, attract new
patients, and develop contracts to serve large groups of patients.
The Company believes that patient satisfaction is the key to retaining and
expanding services to existing patients. The Company also believes that
delivering comfortable, high quality hearing care at times and locations that
are convenient for the patient will motivate patients to return to the Company's
clinics for their future hearing care needs. Educating patients about hearing
health, prescribing only necessary hearing enhancing products, ensuring that
each patient leaves a clinic with a future visit already scheduled, and
maintaining consistent patient follow-up and support are key elements of the
Company's plan to build patient loyalty and patronage.
After a patient has obtained a hearing instrument, ongoing revenues are
generated from battery purchases and routine maintenance of the instruments. The
Company believes that repeat revenues are attributable to the length of time
that a clinic has been established and the effectiveness of its patient
retention programs.
The Company believes that the same aspects of the Company's approach that earn
the loyalty of current patients will also generate new patients. The Company's
new patient marketing programs are designed to help the Company generate
referrals from physicians and existing patients and increase the Company's
visibility in the community. The Company seeks to foster such visibility by
developing marketing materials and information sources that communicate the
Company's philosophy of high quality patient-oriented hearing care.
The Company's large group marketing approach is designed to enable the Company
to develop contacts with self-insured employers and with health plans in the
metropolitan areas it serves and emphasizes the convenience, quality of care,
and wide range of services offered by the Company. The economies of scale
available to the Company may also allow health plans and self-insured employers
served by the Company to reduce administrative burdens they might otherwise
face. The Company believes that it is well positioned to respond to challenges
presented by the growth of managed care arrangements as they arise.
COMPETITION
The hearing care industry in the United States and Canada is highly fragmented
and intensely competitive. Many of the Company's competitors are small retailers
that focus primarily on the sale of hearing instruments. However, the Company
also competes with other networks of hearing care clinics and with large
distributors of hearing instruments such as Bausch & Lomb, a hearing instrument
manufacturer that distributes its products through a national network of over
1,000 franchised and company-owned stores (Miracle-Ear), and Beltone Electronics
Corp., a privately-owned hearing instrument manufacturer that distributes its
products primarily through its nationwide network of approximately 600
franchised dealers. These competitors are in many cases better known and owned
by companies having far greater financial and other resources than the Company.
There can be no assurance that one or more of these competitors will not seek to
compete directly in the markets targeted by the Company, nor can there be any
assurance that the largely fragmented hearing care market cannot be successfully
consolidated by other companies or through the establishment of co-operatives,
alliances, confederations or the like.
REGULATION
The sale of hearing instrument devices is regulated at the federal level in the
United States by the United States Food and Drug Administration ("FDA"), which
has been granted broad authority to regulate the hearing care industry. Under
federal law, hearing instruments may only be sold to individuals who have first
obtained a medical evaluation from a licensed physician, although a fully
informed adult may waive a medical evaluation in certain instances. Regulations
promulgated by the FDA also presently require that dispensers of hearing
instruments provide customers with certain warning statements and notices in
connection with the sale of hearing instruments and that such sales be made in
compliance with certain labeling requirements.
Most states in the United States and many provinces in Canada have established
formal licensing procedures that require the certification of audiologists
and/or HISs. Although the extent of regulation varies by jurisdiction, almost
all states and provinces engage in some degree of oversight of the industry. The
Company operates its hearing care clinics through its wholly owned subsidiaries,
Sonus-USA and Sonus-Canada. These subsidiary corporations employ licensed
audiologists and HISs who offer and perform audiology services and dispense
hearing instruments on behalf of the Company.
In certain states in the United States, business corporations such as Sonus-USA
may not be authorized to employ audiologists
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and offer audiology services. For example, in California, where the Company
operates 39 clinics, although the performance of audiology services by
professional corporations owned solely by licensed audiologists is expressly
authorized under California law, it is unclear whether general business
corporations such as Sonus-USA may employ licensed audiologists to perform
audiology services. However, the California Department of Consumer Affairs has
indicated by memorandum that speech-language pathologists, which are regulated
under statutes and regulations similar to those governing audiologists, may
practice in a general business corporation and that a general business
corporation may provide speech-language pathology services through licensed
speech pathologists. In Illinois, where the Company has seven hearing care
clinics, it is also unclear whether general business corporations may employ
licensed audiologists to perform audiology services. Under Illinois law, only
professional corporations and individuals are authorized to obtain licenses to
practice audiology.
The laws and regulations governing the practice of audiology are enforced by
regulatory agencies with broad discretion. If the Company were found to be in
violation of such laws and regulations in one or more states, the consequences
could include the imposition of fines and penalties upon the Company and its
audiologists as well as the issuance of orders prohibiting the Company from
operating its clinics under its present structure. In that event, among the
solutions the Company might consider would be the restructuring of all or a
portion of its operations in a manner similar to that used by certain medical
and dental clinic networks. Under such a structure, professional corporations
owned by licensed audiologists would contract with the Company to perform
professional services and the Company would contract with the professional
corporations to provide management services.
No assurance can be given that the Company's activities will be found to be in
compliance with laws and regulations governing the corporate practice of
audiology or, if its activities are not in compliance, that the operational
structure of the Company can be modified to permit compliance. In addition, no
assurance can be given that other states or provinces in which the Company
presently operates will not enact prohibitions on the corporate practice of
audiology or that the regulatory framework of certain jurisdictions will not
limit the ability of the Company to expand into such jurisdictions if the
Company is unable to modify its operational structure to comply with such
prohibitions or to conform with such regulatory framework. Additional laws and
regulations may be adopted in the future at the federal, state, or province
level that could have a material adverse effect on the business, financial
condition, and results of operations of the Company.
A portion of the revenues of the hearing care clinics operated by the Company
comes from Medicare and Medicaid programs. Federal law prohibits the offer,
payment, solicitation or receipt of any form of remuneration in return for, or
in order to induce, (i) the referral of a Medicare or Medicaid patient, (ii) the
furnishing or arranging for the furnishing of items or services reimbursable
under Medicare or Medicaid programs or (iii) the purchase, lease or order of any
item or service reimbursable under Medicare or Medicaid. Noncompliance with the
federal anti-kickback legislation can result in exclusion from Medicare and
Medicaid programs and civil and criminal penalties.
Because of its franchise licensing program, The Sonus Network, the Company is
subject to state and federal regulation governing franchising. Much of this
regulation involves providing detailed disclosure to a prospective franchisee
and periodic registration by the franchisor with state administrative agencies.
Additionally, some states have enacted, and others have considered, legislation
that governs the termination or non-renewal of a franchise agreement and other
aspects of the franchise relationship. The United States Congress has also
considered legislation of this nature. The Company believes that it has complied
with all applicable franchise laws and regulations.
PRODUCT AND PROFESSIONAL LIABILITY; PRODUCT RETURNS
In the ordinary course of its business, the Company may be subject to product
and professional liability claims alleging the failure of, or adverse effects
claimed to have been caused by, products sold or services provided by the
Company. The Company maintains insurance against such claims at a level that the
Company believes is adequate. A customer may return a hearing instrument to the
Company and obtain a full refund up to 60 days after the date of purchase. In
general, the Company can return hearing instruments returned by customers within
60 days to the manufacturer for a full refund. The Company maintains a reserve
based on estimated returns to account for returns that cannot be passed through
to the manufacturers and must be absorbed by the Company.
EMPLOYEES
At October 1, 1998, the Company had 263 full-time and 90 part-time employees, of
which 103 are audiologists practicing full time and 32 are practicing part-time.
None of the Company's employees are represented by a labor union. Management
believes it maintains good relationships with its employees.
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SERVICE AND ENFORCEMENT OF LEGAL PROCESS
The Company is incorporated under the laws of the Province of Alberta, Canada.
Some of the directors, controlling persons and officers of the Company, are
residents of Canada and all or a portion of the assets of such persons and of
the Company are located outside of the United States. As a result, it may be
difficult for holders of the Company's securities to effect service within the
United States upon those directors, controlling persons and officers who are not
residents of the United States, or to realize in the United States upon
judgments of courts of the United States predicated upon the civil liability
provisions of the United States federal securities laws to the extent such
judgments exceed such person's United States assets. The Company has been
advised by its Canadian counsel, Ballem MacInnes, that there is doubt as to the
enforceability in Canada against the Company or against any of its directors,
controlling persons or officers who are not residents of the United States, in
original actions or in actions for enforcement of judgments of United States
courts, of liabilities predicated solely upon United States federal securities
laws. The Company's agent for service of process in the United States is MN
Service Corp. (Oregon), 111 S.W. Fifth Avenue, Suite 3500, Portland, Oregon
97204, telephone (503) 224-5858.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's executive offices are located in approximately 12,400 square feet
of leased office space in downtown Portland, Oregon. The lease expires on
September 30, 2004 and provides for an annual base rent of $235,200 until
October 1, 2003, when the annual base rent increases to $273,060. Each of the
Company's hearing clinics operates in leased space that ranges in size from 800
to 3,000 square feet. All of the locations are leased for one to six-year terms
pursuant to generally non-cancelable leases (with renewal options in some
cases). The aggregate committed rental expense as of July 31, 1998, for the
subsequent five-year period is approximately $4.7 million.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
-9-
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON SHARES
The Company's common shares ("Common Shares") were traded on The Alberta Stock
Exchange until February 10, 1998, at which time they began trading on the
American Stock Exchange. The following table sets forth the reported high and
low sales prices in Canadian and United States dollars for the Common Shares for
the periods indicated:
<TABLE>
CANADIAN $ UNITED STATES $(1)
FISCAL YEAR PERIOD HIGH LOW HIGH LOW
<S> <C> <C> <C> <C> <C>
1997 First Quarter 14.25 10.00 10.40 7.30
Second Quarter 12.90 9.30 9.45 7.00
Third Quarter 12.25 6.25 8.95 4.45
Fourth Quarter 9.85 6.25 7.10 4.50
1998 First Quarter 10.75 7.75 7.75 5.60
Second Quarter 13.00 8.50 9.05 6.00
Third Quarter 13.64 10.84 9.50 7.63
Fourth Quarter 14.36 9.15 9.50 6.25
</TABLE>
(1) For reported prices prior to February 10, 1998, the high and low sales
prices were converted to United States dollars as of the date of sale.
HOLDERS AND DIVIDENDS
As of October 1, 1998, there were 67 holders of record of Common Shares.
For as long as Warburg, Pincus Ventures, L.P., beneficially owns at least
3,333,333 Series A Convertible Preferred Shares or the Common Shares into which
such shares are convertible, the Company may not, without such holder's consent,
pay any dividend or distribution on its Common Shares.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
Following is a summary of the principal Canadian federal income tax
considerations under the Income Tax Act (Canada) (the "Tax Act") and the
regulations thereunder generally applicable to a holder of Common Shares and
who, for purposes of the Tax Act, holds such shares as capital property and
deals at arm's length with the Company. Generally, Common Shares will be
considered to be capital property to a holder provided the holder does not hold
the Common Shares in the course of carrying on a business and has not acquired
them in one or more transactions considered to be an adventure in the nature of
trade. Special rules apply to non-resident insurers that carry on an insurance
business in Canada and elsewhere.
This summary is based upon the provisions of the Tax Act in force as of the date
hereof, all specific proposals to amend the Tax Act that have been publicly
announced prior to the date hereof (the "Proposed Amendments") and counsel's
understanding of the current published administrative and assessing policies and
practices of Revenue Canada, Customs, Excise and Taxation ("Revenue Canada").
For the purposes of this summary, it has been assumed that the Tax Act will be
amended as proposed, although no assurance can be given in this regard. This
summary is not exhaustive of all possible federal income tax consequences and,
except for the Proposed Amendments, does not anticipate any changes in the law,
whether by legislative, governmental or judicial decision or action, nor does it
take into account provincial, territorial or foreign tax considerations, which
may differ significantly from those discussed herein. This summary is not
applicable to subscribers who are traders or dealers in securities, a holder
that is a "financial institution" as defined in the Tax Act for purposes of the
mark-to-market rules, or to a holder of an interest which would be a "tax
shelter investment" as defined in the Proposed Amendments.
-10-
<PAGE>
THIS SUMMARY IS OF A GENERAL NATURE ONLY AND IS NOT INTENDED TO BE, AND SHOULD
NOT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULAR HOLDER.
ACCORDINGLY, HOLDERS SHOULD CONSULT THEIR INDEPENDENT TAX ADVISERS FOR ADVICE
WITH RESPECT TO THE INCOME TAX CONSEQUENCES RELEVANT TO THEIR PARTICULAR
CIRCUMSTANCES.
The following applies to holders of Common Shares who are not resident in Canada
for purposes of the Tax Act and who do not use or hold and are not deemed to use
or hold their Common Shares in, or in the course of, carrying on a business in
Canada.
Dispositions of Common Shares. A non-resident holder will, upon a disposition or
deemed disposition of Common Shares, not be subject to taxation in Canada on any
gain realized on the disposition unless the shares are "taxable Canadian
property" for the purposes of the Tax Act and no relief is afforded under an
applicable tax convention between Canada and the country of residence of the
holder. Since the Common Shares are listed on a prescribed stock exchange for
the purposes of the Tax Act, Common Shares held by a non-resident holder will
generally not be "taxable Canadian property" unless, at any time during the
five-year period immediately preceding the disposition, the non-resident holder,
persons with whom the non-resident holder did not deal at arm's length, or the
non-resident holder together with such persons, owned or had the right to
acquire 25% or more of the issued shares of any class of the capital of the
Company. Any interest in shares or options in respect of shares will be
considered to be the equivalent of ownership of such shares for purposes of the
definition of taxable Canadian property.
Subject to the comments set out below in respect of the application of the
Canada-United States Income Tax Convention, 1980 (the "Convention") to U.S.
resident holders, non-residents whose shares constitute "taxable Canadian
property" will be subject to taxation thereon on the same basis as Canadian
residents unless otherwise exempted by an applicable tax convention between
Canada and the country of residence of the holder.
Pursuant to the Convention, shareholders of the Company that are residents in
the U.S. for the purposes of the Convention and whose shares might otherwise be
"taxable Canadian property" may be exempt from Canadian taxation in respect of
any gains on the disposition of the Common Shares, provided the principal value
of the Company is not derived from real property located in Canada at the time
of disposition.
Non-resident holders who might hold their Common Shares as "taxable Canadian
property" should consult their own tax advisers with respect to the income tax
consequences of a disposition of their Common Shares.
Non-resident holders whose shares are repurchased by the Company, except in
respect of certain purchases made by the Company in the open market, will be
deemed to have received the payment of a dividend by the Company in an amount
equal to the excess paid over the paid-up capital of the Common Shares so
purchased. Such deemed dividend will be excluded from the holder's proceeds of
disposition of the Common Shares for the purposes of computing any capital gain
or loss but will be subject to Canadian non-resident withholding tax in the
manner described below under "--Dividends."
Dividends. Dividends received by a non-resident holder of Common Shares will be
subject to Canadian withholding tax at the rate of 25% of the amount thereof
unless the rate is reduced under the provisions of an applicable tax convention
between Canada and the country of residence of the holder. The provisions of the
Convention generally reduce the rate to 15%. A further reduction to 5% under the
Convention will be available if the recipient is a company which owns at least
10% of the voting shares of the Company.
INVESTMENT CANADA ACT
The Investment Canada Act (the "ICA") prohibits the acquisition of control of a
Canadian business by non-Canadians without review and approval of the Investment
Review Division of Industry Canada, the agency that administers the ICA, unless
such acquisition is exempt from review under the provisions of the ICA. The
Investment Review Division of Industry Canada must be notified of such exempt
acquisitions. The ICA covers acquisitions of control of corporate enterprises,
whether by purchase of assets, shares or "voting interests" of an entity that
controls, directly or indirectly, another entity carrying on a Canadian
business.
Apart from the ICA, there are no other limitations on the right of nonresident
or foreign owners to hold or vote securities imposed by Canadian law or the
Company's Articles. There are no other decrees or regulations in Canada that
restrict the export or import of capital, including foreign exchange controls,
or that affect the remittance of dividends, interest or other payments to
nonresident holders of the Company's Common Shares, except as discussed
elsewhere herein.
-11-
<PAGE>
SALES OF UNREGISTERED SECURITIES DURING FISCAL 1998
On October 8, 1997, the Company issued 25,925 Common Shares to a Canadian
resident pursuant to the conversion of a convertible note issued by the Company
in the amount of approximately $128,000. The Company issued 5,000 Common Shares
on November 5, 1997, and 5,000 Common Shares on January 15, 1998, to a Canadian
resident for a total of $8,700 in connection with the exercise of previously
granted stock options. On February 27, 1998, the Company issued 373,998 Common
Shares at $5.23 per share pursuant to the exercise of share purchase warrants
issued by the Company in February 1996. On March 31, 1998, the Company issued
22,936 Common Shares to the owner of Hearing and Speech Associates, Inc., and
Tri-County Hearing Aid Center, Inc., in connection with the acquisition of all
of the outstanding shares of these corporations. The shares are being held by
the Company and will be released over a three-year period if certain annual
revenue targets are met. On July 31, 1998, the Company issued 148,720 Common
Shares to Abbingdon Venture Partners L.P., 14,256 Common Shares to Abbingdon
Venture Partners L.P.-II, and 57,024 Common Shares to Business Development
Capital L.P. III as a result of the conversion to Common Shares of $1,430,000
aggregate principal amount of convertible subordinated notes due July 31, 1998.
The Company relied on the exemption provided by Section 4(2) of the Securities
Act of 1933 (the"1933 Act") with respect to the issuance of Common Shares
described above. On March 17, 1998, in reliance on Rule 701 under the 1933 Act,
the Company issued a total of 2,400 Common Shares to three employees upon
exercise of stock options granted under the Company's Stock Award Plan for an
aggregate exercise price of $17,400. There were no other securities of the
Company issued without registration under the 1933 Act during the fiscal year
ended July 31, 1998, except as previously reported in the Company's quarterly
reports on Form 10-QSB filed during the fiscal year.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
OVERVIEW
During the fiscal year ended July 31, 1998, the Company achieved significant
growth in revenues, primarily due to the acquisition and operation of additional
hearing care clinics. For the fiscal year ended July 31, 1998, the Company
generated total revenues of $22.4 million. As of July 31, 1998, the Company's
cumulative deficit was $6.7 million and its total shareholders' equity was $23.1
million. For the fiscal year ended July 31, 1998, the Company incurred a net
loss of $4.6 million, compared to a net loss of $1.7 million for the 1997 fiscal
year.
ACQUISITIONS
During the fiscal year ended July 31, 1998, the Company acquired 33 clinics and
one hearing care benefit administrator in 18 transactions for a total purchase
price of $6,409,000. The total purchase price consisted of cash payments of
$3,361,000, promissory notes issued by the Company of $1,781,000 generally
payable over three years, and $1,267,000 in assumed liabilities. In addition,
$1,405,000 will be paid in cash and 22,936 Common Shares that have been issued
and are held by the Company will be released over a three-year period if certain
annual net revenue targets are met. As a result of the acquisitions, the Company
recorded approximately $1,528,000 in accounts receivable, $942,000 in inventory,
property and equipment, $158,000 in other assets, $1,468,000 in current
liabilities and $6,508,000 in goodwill. The Company also recorded $623,000 for
covenants not to compete, of which $157,000 was paid in cash at the time of
closing, with the balance payable over three years.
The 34 hearing care businesses acquired by the Company during the fiscal year
ended July 31, 1998, have combined historical revenues for their immediately
preceding fiscal years of approximately $11.5 million. The Company expects these
clinics to contribute to the Company's future revenues consistent with their
historical revenues, as well as have a positive effect on cash flow and future
liquidity.
As of July 31, 1998, the Company had recorded $15,611,000 in goodwill and
$1,578,000 in covenants not to compete. The amortization of the unamortized
balance totaling $16,152,000 at July 31, 1998, which represented approximately
47% of the Company's total assets, will result in an annual non-cash charge to
earnings of approximately $854,000 in each of the next 20 years. If all of the
covenants not to compete referred to above were currently in effect, an
additional non-cash charge to earnings of approximately $500,000 in each of the
current and next two fiscal years would also be incurred.
RESULTS OF OPERATIONS
Year Ended July 31, 1998, Compared to Year Ended July 31, 1997
Revenues. Total revenues for the fiscal year ended July 31, 1998, were
$22,368,000, representing a 66% increase over revenues of $13,462,000 for the
prior fiscal year. Of this increase, $3,760,000 was attributable to the 34
businesses acquired during fiscal 1998. Product sales revenues were $18,792,000
for the 1998 fiscal year, up 64% from the $11,472,000 for
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<PAGE>
fiscal 1997. Audiological service revenues increased from $1,943,000, or 14% of
total revenues in fiscal 1997, to $3,311,000, or 15% of total revenues, for the
1998 fiscal year.
Gross Profit on Product Sales. Product gross profit for the fiscal year ended
July 31, 1998, was $11,080,000 compared to $6,642,000 for the prior fiscal year.
Gross profit percentage on product sales was 59% for fiscal 1998 versus 56% for
fiscal 1997. The increase in gross profit percentage on product sales was
primarily attributable to higher volume discounts, improved product sales
management, and an increase in the percentage of total revenues derived from the
Company's operations in the United States, where gross profit percentages are
higher than those for the Company's operations in Canada.
Clinical Expenses. Clinical expenses include all personnel, marketing, occupancy
and other operating expenses at the clinic level. Clinical expenses for the
fiscal year ended July 31, 1998, were $12,297,000, representing an increase of
105% over clinical expenses of $5,985,000 for the prior fiscal year. This
increase was primarily due to clinical expenses associated with the 34
additional businesses that were owned by the Company during the fiscal year
ended July 31, 1998, but not owned during the prior fiscal year and increased
marketing expenses designed to increase brand awareness of the Company within
the hearing health industry.
General and Administrative Expenses. General and administrative expenses
increased 73% from $3,410,000 for the fiscal year ended July 31, 1997, to
$5,896,000 for the fiscal year ended July 31, 1998, due to planned increases in
corporate staff and other corporate expenses related to the operation of a
larger organization as well as one-time expenses incurred in connection with the
implementation of the Company's franchise licensing program, consulting and
professional fees, and inventory revaluations. As a percentage of revenues,
general and administrative expenses rose to 26% for the fiscal year ended July
31, 1998, versus 25% for the prior fiscal year. Management anticipates that
general and administrative expenses will decrease as a percentage of revenues as
the Company establishes a larger revenue base through its strategic acquisition
program and enhanced marketing efforts.
Depreciation and Amortization Expense. Depreciation and amortization expense for
the fiscal year ended July 31, 1998, was $1,361,000, an increase of 72% over the
depreciation and amortization expense of $790,000 for the prior fiscal year. The
increase resulted from the depreciation of fixed assets and amortization of
goodwill and covenants not to compete associated with the 34 additional
businesses operated by the Company during the fiscal year ended July 31, 1998.
Interest Income and Expense. Interest income for the fiscal year ended July 31,
1998, increased to $452,000 from $76,000 for the prior fiscal year. The increase
was due to higher balances of cash and short-term investments held by the
Company as a result of the sale of preferred stock in December 1997 and the
exercise of warrants to purchase Common Shares in February 1998. Interest
expense for the fiscal year ended July 31, 1998, was $149,000 compared to
$47,000 for the fiscal year ended July 31, 1997, due to higher balances of
long-term debt incurred in connection with acquisitions.
LIQUIDITY AND CASH RESERVES
For the fiscal year ended July 31, 1998, net cash used in operating activities
was $2,203,000 compared to $606,000 for fiscal 1997. The Company invested cash
of $3,765,000 in business acquisitions, $1,414,000 in property and equipment,
and $6,408,000 in the purchase of short-term investments for the fiscal year
ended July 31, 1998, compared to $2,858,000, $1,191,000, and $0, respectively,
for the fiscal year ended July 31, 1997. During the fiscal year ended July 31,
1998, the Company received cash, net of costs, of $1,984,000 for the issuance of
Common Shares, primarily in connection with the exercise of warrants issued in
February 1996, and $15,701,000 for the issuance of 13,333,333 Series A
Convertible Preferred Shares together with warrants to purchase 2,000,000 Common
Shares for $12 per share, in a private placement. The Company also repaid
long-term debt of $1,625,000 and bank loans and short-term notes payable
totaling $39,000 during fiscal 1998.
Sonus-Canada, the Company's Canadian operating subsidiary, has a revolving
demand loan with a commercial bank, providing for borrowings up to $198,000 at
July 31, 1998. As of July 31, 1998, $46,000 was outstanding against this line.
Advances under the line of credit bear interest at 1% above the bank's prime
rate and are secured by all the assets of Sonus-Canada.
At July 31, 1998, the Company had working capital of $6,309,000 and cash and
short-term investments totaling $9,128,000. The Company believes that its cash
and short-term investments, along with cash generated from operations, will
provide it with sufficient capital to fund its operations over the next 12
months and to use up to $1,000,000 for acquisitions during that time period. The
Company's capital expenditures during fiscal 1999 are budgeted to be
approximately $1,700,000, with $533,000 committed as of October 1, 1998.
Additional funding will be needed to finance operations and planned capital
expenditure beyond that time period and to fund the Company's strategy to
acquire additional hearing care clinics. These funding requirements may result
in the Company incurring long-term and short-term indebtedness and in the public
or private issuance, from time to time, of additional equity or debt securities.
Any such issuance of equity may be dilutive to current shareholders and debt
financing may impose significant restrictive covenants on
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<PAGE>
the Company. There can be no assurance that any such financing will be available
to the Company or will be available on terms acceptable to the Company.
YEAR 2000
The "Year 2000 problem" refers to the possibility that computer and other
systems could fail or not work properly as a result of these systems using only
the last two digits of a year to refer to that year and therefore being unable
to properly recognize a year that begins with "20" instead of "19". The Company
has undertaken a review of the potential effects of the Year 2000 problem on its
business on a system by system basis.
With respect to its information technology ("IT") systems, the Company believes
that the computer hardware and system software of its IBM AS/400 computer, on
which its patient management system and accounting system operate, are Year 2000
compliant. Unrelated to Year 2000 issues, the Company is currently developing
new patient management system software that its development contractor has
represented will meet Year 2000 standards. Development of the software,
including related hardware upgrades, is expected to cost approximately $700,000
of which approximately $69,000 had been incurred as of July 31, 1998. The new
software is scheduled to be completed by the end of December 1998, with
implementation during the following six months. The Company will also be
installing a new release of its accounting and financial reporting software in
November 1998 that the vendor represents is Year 2000 compliant. The cost for
installing the new release is expected to be less than $10,000. In the first six
months of 1999, the Company will be surveying all of its servers, personal
computers, and network hardware to determine compliance with Year 2000
standards. All equipment found to be deficient will be replaced. The Company
estimates that the cost of replacement equipment will be less than $50,000.
The Company is currently reviewing its non-IT systems (primarily voice
communications) for Year 2000 compliance and expects that this review will be
completed by January 1999. The Company estimates that its cost to replace any
non-IT systems that are found to be non-compliant with Year 2000 standards will
not exceed $125,000.
The Company also faces the risk that vendors from which the Company purchases
goods and services, such as hearing instrument manufacturers, utility providers,
the banks that maintain the Company's depository accounts and process its credit
card transactions, and the Company's payroll processor, may have systems that
are not Year 2000 compliant. Significant disruptions in the operations of its
vendors may have a material adverse effect on the Company. The Company plans to
monitor the progress of its major vendors in achieving Year 2000 compliance.
However, the Company presently does not anticipate the occurrence of major
interruptions in its business due to Year 2000 issues.
The Company has not established a contingency plan to address potential Year
2000 noncompliance with respect to the Company's systems or those of its major
vendors and is currently considering the extent to which such a plan is
necessary. Due to the Company's dependence on systems outside its control, such
as telecommunications, transportation, and power supplies, there can be no
assurance that the Company will not face unexpected problems associated with the
Year 2000 issue that may affect its operations, business, and financial
condition.
ACCOUNTING PRONOUNCEMENTS
The Company will adopt Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," ("SFAS No. 130") for its fiscal year ending
July 31, 1999. SFAS No. 130 establishes requirements for disclosure of
comprehensive income. The objective of SFAS No. 130 is to report all changes in
equity that result from transactions and economic events other than transactions
with owners. Comprehensive income is the total of net income and all other
non-owner changes in equity. The Company does not anticipate any significant
impact on reported results of operations due to the adoption of SFAS No. 130.
The Company will also adopt Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information," ("SFAS No.
131") for its fiscal year ending July 31, 1999. SFAS No. 131 changes the way
segment information is reported for public companies and requires those
companies to report selected segment information in interim financial reports to
shareholders. Although the Company has not fully determined its complete impact,
the Company does not foresee any material change due to adoption of SFAS No. 131
on its financial presentation to shareholders.
In June 1998, Statement of Financial Accounting Standards No. 133 , "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS No. 133") was issued.
SFAS No. 133 standardizes the accounting for derivative instruments by requiring
that an entity recognize those items as assets or liabilities in the financial
statements and measure them at fair value. SFAS No. 133 is required to be
adopted for fiscal years beginning after June 15, 1999. Since the Company does
not hold any derivative instruments, SFAS No. 133 is not expected to have an
impact on the Company's financial statements.
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<PAGE>
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities"
("SOP 98-5") which requires that costs of start-up activities and organizational
costs be expensed as incurred. SOP 98-5 is effective for financial statements
for fiscal years beginning after December 15, 1998. Although the Company has not
fully determined its complete impact, the Company does not foresee any material
change due to adoption of SOP 98-5 on its financial presentation to
shareholders.
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<PAGE>
ITEM 7. FINANCIAL STATEMENTS
REPORT OF KPMG PEAT MARWICK LLP, INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS
SONUS CORP.:
We have audited the accompanying consolidated balance sheets of Sonus Corp.
(previously HealthCare Capital Corp.) and subsidiaries as of July 31, 1998 and
1997, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the two-year period ended July
31, 1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Sonus
Corp. and subsidiaries as of July 31, 1998 and 1997, and the consolidated
results of their operations and their cash flows for each of the years in the
two-year period ended July 31, 1998 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
Portland, Oregon
October 23, 1998
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<PAGE>
SONUS CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
July 31, July 31,
1998 1997
------------------ --------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 2,720 $ 1,099
Short-term investments 6,408 ---
Accounts receivable, net of allowance
for doubtful accounts
of $684 and $97, respectively 3,339 2,514
Other receivables 515 314
Inventory 967 425
Prepaid expenses 270 260
------------------ --------------
Total current assets 14,219 4,612
Property and equipment, net 3,607 2,277
Other assets 151 136
Goodwill and covenants not to compete, net 16,152 9,519
------------------ --------------
$ 34,129 $ 16,544
================== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank loans and short-term notes payable $ 46 $ 59
Accounts payable 2,879 2,260
Accrued payroll 1,110 486
Other accrued liabilities 2,595 649
Convertible notes payable --- 2,600
Capital lease obligation, current portion 120 101
Long term debt, current portion 1,160 357
------------------ --------------
Total current liabilities 7,910 6,512
Capital lease obligation, non-current portion 223 305
Long term debt, non-current portion 1,733 765
Convertible notes payable 1,170 127
------------------ --------------
Total liabilities 11,036 7,709
Commitments and contingencies (Note 12)
Shareholders' equity:
Series A convertible preferred stock, no par
value per share, 13,333,333 and 0 shares,
respectively, authorized, issued, and outstanding 15,701 ---
Common stock, no par value per share, unlimited
number of shares authorized, 6,079,908 and 5,427,657
shares, respectively, issued and outstanding 14,673 11,131
Notes receivable from shareholders (283) (124)
Accumulated deficit (6,711) (2,117)
Cumulative translation adjustment (229) (22)
Treasury stock, 6,960 and 3,960 shares, respectively, at cost (58) (33)
------------------ --------------
Total shareholders' equity 23,093 8,835
------------------ --------------
$ 34,129 $ 16,544
================== ==============
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
SONUS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended
July 31,
-----------------------------
1998 1997
------------ ------------
Net revenues $ 22,368 $ 13,462
Costs and expenses:
Cost of products sold 7,712 5,010
Clinical expenses 12,297 5,985
General and administrative expenses 5,896 3,410
Depreciation and amortization 1,361 790
------------ ------------
Total costs and expenses 27,266 15,195
------------ ------------
Loss from continuing operations (4,898) (1,733)
Other income (expense):
Interest income 452 76
Interest expense (149) (47)
Other, net 1 3
------------ ------------
Net loss $ (4,594) $ (1,701)
============ ============
Per share of common stock:
Basic $ (0.89) $ (0.42)
Diluted $ (0.89) $ (0.42)
Average shares outstanding:
Basic 5,167 4,010
Diluted 5,167 4,010
See accompanying notes to consolidated financial statements.
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<PAGE>
SONUS CORP.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
<TABLE>
Number of Number of Shareholder
Shares Shares Preferred Common Notes
Preferred Stock Common Stock Stock Stock Receivable
--------------- ------------ --------- ------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT JULY 31, 1996 -- 3,565,549 $ -- $ 1,925 --
Stock issued in connection
with receipt of tax credit -- 22,560 -- 38 --
Proceeds from exercise of stock options -- 155,000 -- 316 (124)
Stock issued in connection
with acquisitions -- 587,876 -- 3,291 --
Stock issued under private
placement (net proceeds) -- 1,093,482 -- 5,529 --
Proceeds from exercise of warrants -- 7,150 -- 32 --
Repurchase of common stock -- (3,960) -- -- --
Translation adjustment -- -- -- -- --
Net loss -- -- -- -- --
------ --------- ------- --------- ---------
BALANCE AT JULY 31, 1997 -- 5,427,657 $ -- $ 11,131 $ (124)
====== ========= ======= ========= =========
Stock issued upon conversion
of convertible note -- 25,925 -- 128 --
Stock issued in connection with acquisition
contingent upon satisfaction of certain
conditions (Note 2) -- 22,936 -- -- --
Repurchase of common stock -- (3,000) -- -- --
Proceeds from exercise of stock options -- 10,000 -- 9 --
Stock issued in connection with
Series A convertible preferred
stock, net of costs 13,333,333 15,701 -- --
Proceeds from exercise
of warrants -- 373,998 -- 1,957 --
Proceeds from exercise
of stock options -- 2,400 -- 18 --
Advance on shareholder notes -- -- -- -- (159)
Stock issued upon
conversion of convertible notes -- 220,000 -- 1,430 --
Payment of cash in lieu of fractional shares -- (8) -- -- --
Translation adjustment -- -- -- -- --
Net loss -- -- -- -- --
---------- --------- ------- ------- ----
BALANCE AT JULY 31, 1998 13,333,333 6,079,908 $15,701 $14,673 (283)
========== ========= ======= ======= ====
</TABLE>
<TABLE>
Cummulative Total
Accumulated Translation Treasury Shareholders'
Deficit Adjustment Stock Equity
----------- ------------ -------- -------------
<S> <C> <C> <C> <C>
BALANCE AT JULY 31, 1996 $ (416) $ 3 $ -- $ 1,512
Stock issued in connection
with receipt of tax credit -- -- -- 38
Proceeds from exercise of stock options -- -- -- 192
Stock issued in connection
with acquisitions -- -- -- 3,291
Stock issued under private
placement (net proceeds) -- -- -- 5,529
Proceeds from exercise of warrants -- -- -- 32
Repurchase of common stock -- -- (33) (33)
Translation adjustment -- (25) -- (25)
Net loss (1,701) -- -- (1,701)
------ ----------- ------- -------
BALANCE AT JULY 31, 1997 (2,117) $ (22) $ (33) $ 8,835
====== =========== ======= =======
Stock issued upon conversion
of convertible note -- -- -- 128
Stock issued in connection with acquisition
contingent upon satisfaction of certain
conditions (Note 2) -- -- -- --
Repurchase of common stock -- -- (25) (25)
Proceeds from exercise of stock options -- -- -- 9
Stock issued in connection with
Series A convertible preferred
stock, net of costs -- -- -- 15,701
Proceeds from exercise
of warrants -- -- -- 1,957
Proceeds from exercise
of stock options -- -- -- 18
Advance on shareholder notes -- -- -- (159)
Stock issued upon
conversion of convertible notes -- -- -- 1,430
Payment of cash in lieu of fractional shares -- -- -- --
Translation adjustment -- (207) -- (207)
Net loss (4,594) -- -- (4,594)
------- ----------- ------- -------
BALANCE AT JULY 31, 1998 $(6,711) $ (229) $ (58) $23,093
======= =========== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
-19-
<PAGE>
SONUS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
Years ended
July 31,
--------------------------
1998 1997
--------------------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $ (4,594) $ (1,701)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for bad debt expense 412 47
Depreciation and amortization 1,361 790
Changes in non-cash working capital:
Accounts receivable (51) (536)
Other receivables (181) (237)
Inventory (405) (61)
Prepaid expenses 24 (136)
Accounts payable and accrued liabilities 1,231 1,222
------------ -----------
Net cash used in operating activities (2,203) (606)
------------ -----------
Cash flows from investing activities:
Purchase of short-term investments (6,408) ---
Purchase of property and equipment (1,414) (1,191)
Additional costs related to acquisitions (198) (149)
Deferred acquisition costs and other, net (1) 177
Net cash paid on business acquisitions (3,765) (2,858)
------------ -----------
Net cash used in investing activities (11,786) (4,021)
------------ -----------
Cash flows from financing activities:
Net repayments of long-term debt
and capital lease obligations (1,625) (58)
Deferred financing costs, net (20) 42
Advances on (repayments of) bank loans and
short-term notes payable (39) 0
Advances to shareholders (159) (124)
Issuance of common stock for cash, net of costs 1,984 5,915
Issuance of preferred stock for cash, net of costs 15,701 ---
Acquisition of treasury stock (25) (33)
------------ -----------
Net cash provided by financing activities 15,817 5,742
------------ -----------
Net increase in cash and cash equivalents 1,828 1,115
Effect on cash and cash equivalents of changes
in foreign translation rate (207) (27)
Cash and cash equivalents, beginning of period 1,099 11
============ ===========
Cash and cash equivalents, end of period $ 2,720 $ 1,099
============ ===========
Supplemental disclosure of non-cash investing and financing activities:
Interest paid during the period 149 47
Non-cash financing activities:
Issuance and assumption of long-term debt in acquisitions 1,781 676
Issuance of convertible notes in acquisitions --- 2,600
Issuance of common stock in acquisitions --- 3,291
Issuance of common stock upon conversion of convertible note 1,557 ---
</TABLE>
See accompanying notes to consolidated financial statements
-20-
<PAGE>
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Company
----------------------
Sonus Corp. (formerly HealthCare Capital Corp.), an Alberta, Canada
corporation (the "Company"), through its primary operating subsidiaries,
Sonus-Canada Ltd., a British Columbia, Canada corporation, and Sonus-USA, Inc.,
a Washington corporation, currently owns and operates a network of 89 hearing
care clinics in the United States and Western Canada. The clinics are located in
the states of Arizona, California, Illinois, Michigan, Missouri, New Mexico,
North Dakota, Oregon, and Washington, and in the Canadian provinces of British
Columbia and Alberta. Each of the Company's hearing care clinics provides its
hearing impaired patients with a full range of audiological products and
services. The Company intends to expand its network of hearing care clinics by
acquiring clinics in its existing, as well as new, geographic markets. The
Company, through its recently acquired subsidiary Hear PO Corp., a New Mexico
corporation, also operates as an independent provider association and hearing
care benefit administrator, which obtains contracts to provide hearing care
benefits to managed care group and corporate health care organizations through
its approximately 1,000 affiliated audiologists and then processes claims under
those contracts on behalf of the audiologists in exchange for a fee.
Principles of Consolidation
---------------------------
The consolidated financial statements include the Company's wholly owned
subsidiaries. All significant inter-company accounts have been eliminated. The
functional currency of the Company's Canadian operations is the Canadian dollar
while the functional currency of the Company's U.S. operations is the U.S.
dollar. In accordance with Statement of Financial Accounting Standards No. 52,
"Foreign Currency Translation", assets and liabilities recorded in Canadian
dollars are remeasured at current rates in existence at the balance sheet date.
Revenues and expenses are remeasured using the weighted average exchange rate
for the period Exchange gains and losses from remeasurement of assets and
liabilities recorded in Canadian dollars are treated as unrealized gains and
losses and reported as a separate component of shareholders' equity
Revenue Recognition
-------------------
Revenues from the sale of hearing instrument products are recognized at
the time of delivery. Revenues from the provision of hearing care diagnostic
services are recognized at the time that such services are performed. Net
revenues consist of the following (in thousands):
July 31,
<TABLE>
1998 1997
---- ----
<S> <C> <C>
Product revenue $18,792 $11,472
Service revenue 3,311 1,943
Other revenue 265 47
------- -------
$22,368 $13,462
======= =======
</TABLE>
Income Taxes
------------
The Company accounts for income taxes under the asset and liability
method. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are
-21-
<PAGE>
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
Cash and Cash Equivalents
-------------------------
Cash equivalents consist of short-term, highly liquid investments with
original maturities of 90 days or less.
Short-term Investments
----------------------
Short-term investments consist of available-for-sale securities, as
defined by Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). Under SFAS
No. 115, unrealized holding gains and losses are reflected as a net amount in a
separate component of shareholders' equity until realized. At July 31, 1998,
there were no unrealized holding gains or losses as the market value of the
Company's available-for-sale securities approximated cost. Gross realized gains
and losses on sales of available-for-sale securities for fiscal 1998 and 1997
were nominal. Realized gains and losses are computed by determining cost on a
specific identification basis.
At July 31, 1998, the Company's short-term investments consisted of the
following debt securities which had maturities of less than six months and were
carried at cost which approximated market (in thousands):
Corporate Bonds $ 2,760
Discount Commercialal Paper 3,648
--------
$ 6,408
========
The Company did not have any short-term investments at July 31, 1997.
Gross proceeds from sales and maturities of available-for-sale
investments during fiscal 1998 and 1997 were $18,511,000 and $0, respectively.
Inventory
---------
Inventories are stated at the lower of cost (first in, first out) or net
realizable value.
Property and Equipment
----------------------
Property and equipment are recorded at cost and depreciated using the
straight-line method over the following useful lives:
Professional equipment Seven years
Office equipment Five years
Automotive equipment Five years
Leasehold improvements Five years
Computer equipment Five years
In the year of acquisition, depreciation is calculated at one-half the
above noted rates. Property and equipment purchased under capitalized leases are
amortized over the shorter of the lease term or their estimated useful life and
such depreciation is included with depreciation expense. On November 1, 1997,
the Company changed the method by which it calculates depreciation on property
and equipment to the straight-line method. Previously, professional equipment
was depreciated using the 20% declining balance method and office and computer
equipment and automobiles were depreciated using the 30% declining balance
method. The Company also adopted a useful life of seven years for professional
equipment and five years for office equipment and automobiles. The cumulative
effect of the changes adopted by the Company for the fiscal year ended July 31,
1998, was not material.
-22-
<PAGE>
Advertising Expenses
--------------------
The Company defers its advertising costs until the advertisement is
actually run, at which time the full expense is recognized. Deferred advertising
costs were $0 and $89,000 at July 31, 1998 and 1997, respectively. Advertising
expense was $2,786,000 and $786,000 for the years ended July 31, 1998 and 1997,
respectively.
Goodwill and Covenants Not to Compete
-------------------------------------
The unallocated purchase costs in excess of the net assets acquired
(goodwill) is being amortized on the straight-line basis over twenty years.
Non-compete agreements are amortized on the straight-line basis over the period
benefited. Goodwill and covenants not to compete are as follows (in thousands):
<TABLE>
July 31,
1998 1997
---- ----
<S> <C> <C>
Goodwill $15,611 8,966
Covenants not to compete 1,578 955
Less: Accumulated amortization (1,037) (402)
------- -----
$16,152 9,519
======= =====
</TABLE>
The Company assesses the recoverability of this intangible asset by
determining whether the amortization of the goodwill balance over its remaining
life can be recovered through undiscounted projected future cash flows of the
acquired businesses from which the goodwill arose. Amortization charged to
operations was $635,000 and $364,000 for the years ended July 31, 1998 and 1997,
respectively.
Deferred Acquisition and Financing Costs
----------------------------------------
Costs related to the acquisition of clinics are deferred and, upon
successful completion of acquisitions, are allocated to the assets acquired and
are subject to the accounting policies outlined above. Costs related to
potential acquisitions that are unsuccessful are expensed in the periods in
which it is determined that such acquisitions are unlikely to be consummated.
Costs related to issuing shares are deferred and upon the issuance of the
related shares, are applied to reduce the net proceeds of the issue.
Earnings Per Share
------------------
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
No. 128"). SFAS No. 128 supersedes APB Opinion No. 15, "Earnings Per Share" and
specifies the computation, presentation, and disclosure requirements for
earnings per share ("EPS") for entities with publicly held common stock or
potential common stock. It replaces the presentation of primary EPS with a
presentation of basic EPS and fully diluted EPS with diluted EPS. Basic EPS,
unlike primary EPS, excludes dilution and is computed by dividing income
available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that would then share in the earnings of the entity. Diluted EPS is
computed similarly to fully diluted EPS under APB Opinion No. 15. All prior
period EPS data have been restated to conform to SFAS No. 128. Common share
equivalents represented by convertible debt and convertible preferred stock have
not been included in the calculation of earnings per share as the effect would
be anti-dilutive.
Concentrations of Credit Risk
-----------------------------
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash, short-term
investments, and trade receivables. The Company places its cash with high credit
quality institutions. At times, such amounts may be in excess of the Federal
Deposit Insurance Corporation insurance limits. The Company's trade accounts
receivable are derived from numerous private payers, insurance carriers, health
maintenance organizations and government agencies. Concentration of credit risk
relating to trade accounts receivable is limited due to the diversity and number
of patients and payers.
-23-
<PAGE>
Fair Value of Financial Instruments
-----------------------------------
The carrying value of financial instruments such as cash and cash
equivalents, short-term investments, trade receivables, notes receivable, trade
payables, notes payable, and long-term debt approximate their fair value.
Use of Estimates
----------------
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
Reverse Stock Split
-------------------
Effective February 9, 1998, the Company effected a one-for-five reverse
stock split of its common shares ("Common Shares"). All share and per share
information appearing in the accompanying financial statements for the fiscal
year ended July 31, 1997, has been restated to give effect to the reverse stock
split.
Reclassifications
-----------------
Certain amounts in the 1997 financial statements have been reclassified
in order to conform to the 1998 presentation.
NOTE 2. ACQUISITIONS
During the fiscal year ended July 31, 1998, the Company acquired 33
clinics and one hearing care benefit administrator in 18 transactions. Each
transaction was accounted for as a purchase. The acquired assets and liabilities
were recorded at their estimated fair values at the date of acquisition, and the
unallocated excess purchase price (goodwill) is being amortized on a straight
line basis over 20 years. The operating results of each acquisition have been
included in the consolidated statements of operations from the respective
acquisition date. The aggregate purchase price for the acquisitions consisted of
cash payments of $3,650,000, promissory notes issued by the Company of
$1,781,000 generally payable over three years, and $3,072,000 in assumed
liabilities. In addition, $1,405,000 will be paid and 22,936 Common Shares that
have been issued but are being held by the Company will be released over a
three-year period if certain annual net revenue targets are met. As a result of
the acquisitions, the Company recorded approximately $1,186,000 in accounts
receivable, $137,000 in inventory, $629,000 in property and equipment, $96,000
in other assets, and $6,455,000 in goodwill, which included costs related to
acquisitions. In addition to the purchase price for the acquisitions, the
Company also recorded $623,000 for covenants not to compete, of which $157,000
was paid in cash at the time of closing, with the balance payable over three
years.
During the fiscal year ended July 31, 1997, the Company acquired 39
clinics in 12 transactions. Each transaction was accounted for as a purchase.
The acquired assets and liabilities were recorded at their book value at the
date of acquisition for stock purchases and mergers and at their estimated fair
market value for asset purchases. The unallocated excess purchase price
(goodwill) is being amortized on a straight line basis over 20 years. The
operating results of each acquisition have been included in the consolidated
statements of operations from the respective acquisition date. The aggregate
purchase price for the acquisitions consisted of cash payments of $2,091,000,
promissory notes issued by the Company of $3,277,000 generally payable over
three years, 587,876 Common Shares and $486,000 in assumed liabilities. As a
result of the acquisitions, the Company recorded approximately $1,629,000 in
accounts receivable, $220,000 in inventory, $916,000 in property and equipment,
$493,000 in other assets, $2,096,000 in current liabilities and $7,983,000 in
goodwill. In addition to the purchase price for the acquisitions, the Company
also recorded $940,000 for covenants not to compete, of which $792,000 was paid
in cash at the time of closing, with the balance payable over three years.
NOTE 3. PROPERTY, PLANT AND EQUIPMENT
Property and equipment consist of the following (in thousands):
-24-
<PAGE>
<TABLE>
July 31,
1998 1997
---- ----
<S> <C> <C>
Professional equipment $1,521 930
Office equipment 705 481
Automotive equipment 2 16
Leasehold improvements 760 405
Computer equipment 2,012 1,144
----- -----
5,000 2,976
Less accumulated depreciation (1,393) (699)
----- -----
$3,607 2,277
===== =====
</TABLE>
NOTE 4. FINANCING ARRANGEMENTS
Bank Loan
---------
Sonus-Canada Ltd. maintains a revolving bank demand loan bearing
interest at the bank's prime rate plus 1% per annum (8.5% and 5.75% at July 31,
1998 and 1997, respectively ), secured by a general security agreement covering
all assets of Sonus-Canada Ltd. The loan provided for a maximum credit limit of
$198,000 and $182,000 at July 31, 1998 and 1997, respectively, of which $46,000
and $0 were outstanding at July 31, 1998 and 1997, respectively.
Short-term Notes Payable
------------------------
At July 31, 1997, Sonus-USA, Inc., and Sonus-Canada had outstanding
short-term, non-interest bearing notes from certain hearing instrument
manufacturers totaling $59,000.
NOTE 5. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
July 31,
1998 1997
---- ----
<S> <C> <C>
Installment notes incurred in connection with acquisitions payable in
monthly installments due from 1998 to 2002 with a weighted
average interest rate of 6.5%........................................$ 322 $ 348
Installment notes incurred in connection with acquisitions payable
in quarterly installments due from 1999 to 2000 with a weighted
average interest rate of 6%.............................................150 133
Installment notes incurred in connection with acquisitions payable
in annual installments due from 1999 to 2003 with a weighted
average interest rate of 6.3%.........................................1,910 390
Non-interest bearing installment obligations for covenants not to compete
due from 1999 to 2001...................................................460 94
Equipment loan from a supplier bearing interest at 10% payable in monthly
installments due 2000....................................................51 75
Equipment loan from suppliers with interest rates from 0%to 9% per annum
due from 1999 to 2018...................................................--- 82
------- -------
-25-
<PAGE>
2,893 1,122
Less current portion................................................(1,160) (357)
------- -------
$ 1,733 $ 765
======= =======
</TABLE>
Annual maturities of long-term debt are as follows (in thousands): 1999 -
$1,160; 2000 - $908; 2001 - $598; 2002 - $115; 2003 - $112.
NOTE 6. CAPITAL LEASES
The following is a schedule by year of future minimum lease payments under
capital leases together with the present value of the net minimum lease payments
as of July 31, 1998 (in thousands):
<TABLE>
<S> <C>
1999............................................................................$ 144
2000..............................................................................142
2001.............................................................................. 98
-----
Total minimum lease payments......................................................384
Less: amount representing interest.............................................. (41)
-----
Present value of minimum lease payments...........................................343
Less current portion.............................................................(120)
-----
$ 223
=====
</TABLE>
Total assets under capitalized leases at July 31, 1998 and 1997, were $271,000
and $305,000, net of accumulated depreciation of $244,000 and $131,000,
respectively
NOTE 7. CONVERTIBLE NOTES PAYABLE
At July 31, 1997, the Company had outstanding non-interest bearing notes
in the amount of $2,600,000 convertible into 400,000 Common Shares at a rate of
$6.50 per share. During the fiscal year ended July 31, 1998, $1,430,000 of the
notes were converted into 220,000 Common Shares. At July 31, 1998, $1,170,000 of
the notes (convertible into 180,000 Common Shares) remained outstanding and
mature August 1, 1999. At July 31, 1997, the Company had outstanding a
non-interest bearing note in the amount of approximately $127,000 due on demand
and convertible into Common Shares at the rate of $5.00 per share. The note was
converted into 25,975 Common Shares during the fiscal year ended July 31, 1998.
NOTE 8. SHAREHOLDERS' EQUITY
Series A Convertible Preferred Shares
-------------------------------------
In December 1997, the Company issued 13,333,333 Series A Convertible
Preferred Shares (the "Convertible Shares") in a private placement. The
following summarizes certain terms of the Convertible Shares:
Voting Rights. Each Convertible Share is entitled to one-fifth of a vote
(or such other number of votes equal to the number of Common Shares into which
such Convertible Share shall be convertible from time to time) in the election
of directors and any other matters presented to the shareholders of the Company
for action or consideration.
Dividends. Each Convertible Share is entitled to receive, when, as and
if declared by the board of directors of the Company out of the Company's assets
legally available for payment, cumulative dividends from the date of original
issuance, payable annually at a rate of 5% per annum on a base amount of $1.35
per share (the "Base Amount"). All accrued and unpaid dividends will be
forfeited upon the conversion of the Convertible Shares. The dividend rate is
subject to increase on specified dates in the event that certain conditions (the
"Triggering Conditions") have not been met. The Triggering Conditions are as
follows:
(a) The Common Shares are listed on the New York Stock Exchange, the
American Stock Exchange, or the Nasdaq National Market (each a "U.S. Principal
Market");
-26-
<PAGE>
(b) The Common Shares are traded on a U.S. Principal Market at a daily
closing price greater than $12.00 per Common Share on each of the ten
consecutive trading days preceding the applicable date; and
(c) The Company's net income before income taxes, dividends on the
Convertible Shares, and amortization of goodwill and covenants not to compete
for the three consecutive fiscal quarters preceding the applicable date shall
have averaged at least $.35 per fully diluted Common Share per fiscal quarter
(for purposes of making this calculation, the Common Shares issuable upon the
exercise of warrants issued in connection with the Convertible Shares will not
be counted). If the Triggering Conditions have not been met by:
(x) January 1, 2003, the dividend rate will thereafter be 15% per annum
of the Base Amount;
(y) January 1, 2004, the dividend rate will thereafter be 18% per annum
of the Base Amount; or
(z) January 1, 2005, the dividend rate will thereafter be 21% per annum
of the Base Amount.
As soon as the Triggering Conditions have been satisfied, the dividend
rate will revert to 5% per annum of the Base Amount.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution, or winding up of the Company subject to the rights of
holders of any securities of the Company ranking senior to the Convertible
Shares upon liquidation, the holders of Convertible Shares will be entitled to
receive, out of the assets of the Company available for distribution to
shareholders, before any distribution of assets is made to holders of Common
Shares or any other securities ranking junior to the Convertible Shares upon
liquidation, a liquidating distribution in an amount equal to the greater of (i)
$1.35 per share plus any accrued and unpaid dividends or (ii) the amount that
would have been distributable to such holders if they had converted their
Convertible Shares into Common Shares immediately prior to such dissolution,
liquidation, or winding up, plus any accrued and unpaid dividends. The sale,
conveyance, mortgage, pledge or lease of all or substantially all the assets of
the Company will be deemed to be a liquidation of the Company for purposes of
the liquidation rights of the holders of Convertible Shares. After payment of
the full amount of the liquidating distribution to which they are entitled, the
holders of Convertible Shares will have no right to any of the remaining assets
of the Company.
Optional Redemption. The Convertible Shares may not be redeemed before
January 1, 2003. Thereafter, the Convertible Shares may be redeemed at the
option of the Company, in whole or in part. The redemption price will be an
amount equal to the greater of (i) $1.35 per share plus any accrued and unpaid
dividends or (ii) the fair market value of a Convertible Share as determined by
a nationally recognized independent investment banking firm selected by mutual
agreement of the Company and the holder of a majority of the outstanding
Convertible Shares. The Convertible Shares are not subject to mandatory
redemption or any sinking fund provisions.
Conversion Rights. The Convertible Shares may be converted at any time,
in whole or in part, at the option of the holder thereof, into Common Shares.
The conversion rate is presently equal to one Common Share for every five
Convertible Shares surrendered for conversion. The conversion rate is subject to
further adjustment for stock dividends, stock splits, recapitalizations, and
other anti-dilution adjustments. Upon the conversion of any Convertible Shares,
any accrued and unpaid dividends with respect to such shares will be forfeited.
The Company has the right to force conversion of the Convertible Shares, in
whole or in part, upon satisfaction of all the Triggering Conditions.
Release of Escrowed Shares
--------------------------
Effective with the listing of the Common Shares on the American Stock
Exchange on February 10, 1998, 850,000 common shares owned by certain members of
the Company's management were released from escrow by The Alberta Stock
Exchange. The shares, which had been excluded from the calculation of the
average shares outstanding during the fiscal year ended July 31, 1997, are
included in such calculation for the fiscal year ended July 31, 1998.
-27-
<PAGE>
Share Purchase Warrants
-----------------------
At July 31, 1998, the Company had the following share purchase warrants
outstanding:
(1) Share purchase warrants (the "September Warrants") to purchase 1,093,482
Common Shares at an exercise price of $10.00 per share. The September Warrants
expired on August 31, 1998, without being exercised.
(2) Share purchase warrants (the "Agent Warrants") to purchase 99,180 Common
Shares at an exercise price of $6.25 per share issued in connection with
placement of the September Warrants. The Company issued 39,799 Common Shares in
August 1998 in connection with the exercise of a portion of the Agent Warrants.
The remaining Agent Warrants expired on August 31, 1998.
(3) Share purchase warrants issued in connection with the Convertible Shares to
purchase 2,000,000 Common Shares at an exercise price of $12.00 per share
until December 24, 2002. The Company may force the exercise of the warrants
upon satisfaction of all the Triggering Conditions.
In February 1998, the Company issued 373,998 Common Shares at $5.23 per
share pursuant to the exercise of share purchase warrants issued by the Company
in February 1996.
Stock Option Plans
------------------
The Company has two stock option plans, the Stock Option Plan ("1993
Plan") and the Second Amended and Restated Stock Award Plan ("1996 Plan"). The
Company may grant to officers, directors, employees and consultants incentive
and non-qualified options to purchase up to 1,800,000 Common Shares under the
1996 Plan. There are options to purchase 245,000 Common Shares outstanding under
the 1993 Plan; no further options will be granted under the 1993 Plan. The
exercise price of options granted under the 1996 Plan may not be less than 75%
of the fair market value of the Company's Common Shares at the date of grant
(100% for tax-qualified incentive stock options). Options become exercisable at
the date of grant or in equal annual installments over a period of one to four
years from the date of grant. The options generally expire either five or ten
years after the date of grant.
The 1996 Plan also provides for the grant of stock appreciation rights,
restricted units, performance awards and other stock-based awards. The Company
had no such awards or rights outstanding at July 31, 1998 or 1997.
-28-
<PAGE>
The activity during the fiscal years ended July 31, 1998 and 1997 was as
follows:
<TABLE>
1998 1997
---- ----
Weighted- Weighted-
Average Average
Options Exercise Price Options Exercise Price
------- -------------- ------- --------------
<S> <C> <C> <C> <C>
Outstanding - beginning of 488,400 $6.41 340,000 $4.15
year
Granted 1,138,000 $8.12 368,400 $6.85
Exercised (12,400) $2.10 (155,000) $2.05
Canceled (54,000) $9.79 (65,000) $7.50
--------- -------
Outstanding - end of year 1,560,000 $7.54 488,400 $6.41
Exercisable at end of year ========= =======
363,200 $5.98 177,500 $5.95
Weighted-average fair value of
options granted during the year $8.38 $4.47
</TABLE>
The following table summarizes information about stock options
outstanding at July 31, 1998:
<TABLE>
Options Outstanding Options Exercisable
----------------------------------------------- -------------------------------
Weighted-
Number Average Weighted- Number Weighted -
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices as of Contractual Exercise as of Exercise
July 31, 1998 Life Price July 31, 1998 Price
- ----------------- --------------- ------------- -------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
$1.00-- $2.00 60,000 2.39 $1.26 60,000 $ 1.26
$2.01-- $3.50 25,000 2.55 $3.31 25,000 $ 3.31
$3.51-- $5.00 -- -- $ -- -- $ --
$5.01-- $6.50 166,000 3.34 $6.25 79,700 $ 6.28
$6.51-- $8.00 883,000 8.43 $6.95 158,500 $ 7.24
$8.01-- $9.50 120,000 7.32 $8.58 -- $ --
$9.51-- $12.00 306,000 9.52 $11.11 40,000 $ 9.10
- ----------------- --------------- ------------- -------------- --------------- -------------
$1.00-- $12.00 1,560,000 7.69 $7.54 363,200 $ 5.98
</TABLE>
The Company accounts for stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, no compensation cost has been recognized for its
stock option grants. Pro forma information regarding net income (loss) and net
income (loss) per share is required under Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and
has been determined as if the Company had accounted for all 1998 and 1997
stock option grants based on the fair value method. The pro forma information
presented below is not representative of the effect stock options will have on
pro forma net income (loss) or net income (loss) per share for future years.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes multiple option-pricing model. The following weighted
average assumptions were used for grants in 1998 and 1997: risk-free interest
rates of 5.5% and 5.94%, respectively, an expected option life of 7.69 years
and 4.92 years, respectively, expected volatility of 114% and 96%,
respectively, and dividend yield of zero.
-29-
<PAGE>
The Black-Scholes method is one of many models used to calculate the
fair value of options that are freely tradable, fully transferable and that
have no vesting restrictions. These models also require highly subjective
assumptions, including future stock price volatility and expected time until
exercise, which greatly affect the calculated values.
Had compensation cost for these plans been determined based on the fair
value of awards at the grant date, as prescribed by SFAS 123, net loss or net
loss per share would have been as follows:
<TABLE>
1998 1997
---- ----
(in thousands, except
per share data)
Net loss applicable to common shareholders:
<S> <C> <C>
As reported $(4,594) $(1,701)
Pro forma (1) $(5,988) $(3,276)
Net loss per share (basic and diluted):
As reported $(0.89) $ (0.42)
Pro forma (1) $(1.16) $ (0.82)
</TABLE>
(1) SFAS 123 applies to awards granted in fiscal years that begin after
December 15, 1994. Consequently, the effects of applying SFAS 123 shown here
are not likely to be representative of the effects in future years due to the
exclusion of awards granted in prior years but vesting (and therefore
expensed) in 1997 and 1998.
NOTE 9. INCOME TAXES
Sonus Corp. and its Canadian subsidiary file separate corporate income
tax returns on a stand-alone basis in Canada. Sonus-USA, Inc. files separate
corporate income tax returns in the United States.
There was no provision for income taxes for the years ended July 31,
1998 and 1997 as the Company incurred net operating losses.
The components of temporary differences that give rise to significant
portions of deferred income taxes are as follows (in thousands):
<TABLE>
July 31,
1998 1997
---- ----
Deferred tax assets:
<S> <C> <C>
Net operating losses carried forward $2,443 $ 839
Allowance for doubtful accounts 277 44
Other 14 --
----- ---
2,734 883
Deferred tax liabilities:
Goodwill and start-up costs (240) (54)
------ ----
2,494 829
Less valuation allowance (2,494) (829)
------ ----
$ --- $ ---
====== ======
A reconciliation of the Company's expected tax expense using the
statutory income tax rate to the actual effective rate is as follows:
1998 1997
---- ----
Tax benefit at statutory rate (34)% (34)%
Adjustment for higher Canadian tax rate (1) ---
Expenses not deductible for tax purpose 3 5
State taxes, net of federal (5) ---
Change in valuation allowance 37 29
---- ----
Tax rate per financial statements ---% ---%
==== ====
</TABLE>
At July 31, 1998, the Company had approximate net operating loss
carryforwards for tax purposes which, if not utilized, expire in the years
ended as follows (in thousands):
<TABLE>
UNITED
CANADA STATES TOTAL
<S> <C> <C> <C>
2001 $ 573 $ --- $ 573
2002 26 --- 26
2003 563 --- 563
2004 247 --- 247
2005 294 294
2011 --- 616 616
2012 --- 586 586
2013 3,599 3,599
------------- ---------- -------
$ 1,703 $4,801 $6,504
============= ======== =========
</TABLE>
NOTE 10. RELATED PARTY TRANSACTIONS
William DeJong is a partner in the Calgary, Alberta law firm of Ballem
MacInnes and is a director of the Company. Total fees, disbursements and
government sales tax paid to Ballem MacInnes by the Company for legal services
as of July 31, 1998 and 1997 were $196,000 and $168,000, respectively
(converted from Canadian dollars at July 31, 1998 and 1997).
In connection with the acquisition of the Midwest Division of Hearing
Health Services, Inc., Sonus-USA, Inc. assumed a promissory note with a
balance of $360,000 payable to Kathy A. Foltner, an officer of the Company.
The promissory note, which is payable in equal annual installments of $120,000
and bears interest at 6% per annum, has one payment remaining due July 1,
1999.
Gregory J. Frazer, Ph.D., an officer and director of the Company, was a
shareholder in certain Hearing Care Associates corporations that the Company
acquired during the fiscal years ended July 31, 1998 and 1997. For the fiscal
year ended July 31, 1998, the consideration paid to Mr. Frazer and his wife in
connection with the acquisitions and related non-competition agreements
consisted of $242,179 in cash and $80,520 payable in installments over three
years. The consideration paid to Mr. Frazer and his wife during the fiscal
year ended July 31, 1997, totaled $933,000 in cash and 294,071 Common Shares
at a price of $5.00 per share.
On May 8, 1997, Brandon M. Dawson, an officer and director of the
Company, exercised options for 50,000 Common Shares at $1.35 per share. In
connection with the exercise, the Company made loans of $67,500 and $91,000 to
Mr. Dawson on May 8, 1997, and April 24, 1998, respectively, to allow Mr.
Dawson to pay the aggregate exercise price of the options and taxes incurred
as a result of the exercise. The loans mature on November 1, 1999 and bear
interest at 10% and 7.75%, respectively. On October 5, 1997, the Company
loaned Mr. Dawson $85,000 in connection with the purchase of his residence.
The loan was repaid on April 10, 1998, along with interest at 10% per annum in
the amount of $4,308. On December 26, 1997, the Company loaned Mr. Dawson
$32,342 in order to allow Mr. Dawson to repay a loan obtained in connection
with the exercise of options to purchase 20,000 Common Shares. The loan
matures on November 1, 1999, and bears interest at 7.75% per annum. On March
19, 1998, the Company loaned Mr. Dawson $35,760, in order to pay taxes
incurred as a result of option exercises in April 1996. The loan matures on
November 1, 1999, and bears interest at 7.75% per annum. The loans to Mr.
Dawson are secured by 60,000 Common Shares.
-30-
<PAGE>
On May 19, 1997, Gene K. Balzer, Ph.D., a former director of the
Company, exercised options for 40,000 Common Shares at $1.40 per share. In
connection with such exercise, the Company loaned Mr. Balzer $56,000 to pay
the aggregate exercise price of the options. The loan is secured by the stock
underlying the exercised options and accrues interest at 10% per annum.
NOTE 11. 401(K) PLAN
The Company sponsors a 401(k) plan for all employees who have satisfied
minimum service and age requirements. Employees may contribute up to 20% of
their compensation to the plan. The Company does not match employee
contributions.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Operating Leases
The following is a schedule by year of future minimum lease payments
for non-cancelable operating leases at July 31, 1998 (in thousands):
1999 $1,393
2000 1,108
2001 913
2002 745
2003 519
Thereafter 605
------
Total minimum lease payments $5,283
======
Rental expense under operating leases was $1,426,000 and $810,000 for
the years ended July 31, 1998 and 1997, respectively.
Insurance
---------
In the normal course of business, the Company may become a defendant or
plaintiff in various lawsuits. Although a successful claim for which the
Company is not fully insured could have a material effect on the Company's
financial condition, management is of the opinion that it maintains insurance
at levels sufficient to insure itself against the normal risk of operations.
NOTE 13. SUBSEQUENT EVENTS
In August and September of 1998, the Company acquired 12 hearing care
clinics in 4 transactions for a total purchase price of $1,812,000. Each
transaction was accounted for as a purchase. The aggregate purchase price for
the acquisitions consisted of cash payments of $942,000 and promissory notes
issued by the Company of $870,000 payable over three years. In addition,
$100,000 will be paid in March 2000 if certain net revenue targets are met. As a
result of the acquisitions, the Company recorded $75,000 in accounts receivable,
$70,000 in inventory, property and equipment, $89,000 in other assets, $96,000
in current liabilities and $1,674,000 in goodwill. In addition to the purchase
price for the acquisitions, the Company also recorded $220,000 for covenants not
to compete payable over three years.
NOTE 14. CANADIAN VERSUS U.S. GAAP
As of July 31, 1998 and 1997, there were no material differences between
Canadian generally accepted accounting principles ("GAAP") and U.S. GAAP.
-31-
<PAGE>
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED - SEE ACCOMPANYING
ACCOUNTANTS' REPORT)
The following is a tabulation of the unaudited quarterly results of
operations for the years ended July 31, 1998 and 1997 (in thousands, except per
share data):
<TABLE>
Quarter ended
October 31, January 31, April 30, July 31,
1997 1998 1998 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $ 5,307 $ 4,109 $ 5,719 $ 7,233
Loss from continuing operations (79) (1,135) (778) (2,906)
Net loss (96) (1,085) (581) (2,832)
Earnings (loss) before interest,
depreciation and amortization (1) 198 (812) (429) (2,494)
Net loss per share (basic and diluted) $ (0.02) $ (0.24) $ (0.10) $ (0.49)
Quarter ended
October 31, January 31, April 30, July 31,
1996 1997 1997 1997
---- ---- ---- ----
Net revenues $ 1,268 $ 2,934 $ 4,355 $ 4,905
Loss from continuing operations (299) (657) (316) (461)
Net loss (298) (649) (290) (464)
Loss before interest,
depreciation and amortization (1) (247) (440) (123) (133)
Net loss per share (basic and diluted) $ (0.11) $ (0.16) $ (0.06) $ (0.09)
</TABLE>
- ---------------
(1) Earnings (loss) before interest, depreciation and amortization is provided
because it is a measure commonly used by acquisition companies. It is
presented to enhance an understanding of the Company's operating results and
is not intended to represent cash flow or results of operations in
accordance with generally accepted accounting principles for the periods
indicated.
NOTE 16. PRO FORMA FINANCIAL INFORMATION (UNAUDITED - SEE ACCOMPANYING
ACCOUNTANTS' REPORT)
The unaudited pro forma financial information set forth below reflects
the historical operations of the clinics acquired by the Company during the
fiscal year ended July 31, 1998 (the "Acquisitions"), from August 1, 1997, to
the date of acquisition. Such financial information .is not necessarily
indicative of the Company's combined financial position or the results of
operations that actually would have occurred if the Acquisitions had been
consummated on August 1, 1996, for the fiscal year ended July 31, 1997, and
August 1, 1997, for the fiscal year ended July 31, 1998. In addition, such
information is not intended to be a projection of results of operations that may
be obtained by the Company in the future. The unaudited pro forma combined
financial information should be read in conjunction with the consolidated
financial statements and related notes thereto included elsewhere herein.
-32-
<PAGE>
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JULY 31, 1998
<TABLE>
ACQUIRED PRO FORMA SONUS CORP.
SONUS CORP. CLINICS(A) ADJUSTMENTS(B) COMBINED (C)
----------- ---------- -------------- ------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net revenues $ 22,368 $ 10,467 $ $ 32,835
Costs and Expenses:
Cost of products sold 7,712 5,051 12,763
Operational expenses 18,193 4,826 23,019
Depreciation and
amortization 1,361 112 211 1,684
-------- -------- --------- --------
Total costs and expenses 27,266 9,989 211 37,466
-------- -------- --------- --------
Income (loss) from operations (4,898) 478 (211) (4,631)
Other income, net 304 15 - 319
Income (loss) before income taxes (4,594) 493 (211) (4,312)
Income tax expense - 23 - 23
-------- -------- --------- --------
Net income (loss) $ (4,594) $ 470 $ (211) $ (4,335)
======== ========= ========== ========
Pro forma:
Net loss per common share $ (0.84)
========
Weighted average number
of shares outstanding 5,167
=====
</TABLE>
-33-
<PAGE>
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JULY 31, 1997
<TABLE>
ACQUIRED PRO FORMA SONUS CORP.
SONUS CORP. CLINICS(A) ADJUSTMENTS(B) COMBINED (C)
----------- ---------- -------------- ------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net revenues $ 13,462 $13,430 $ $ 26,892
Costs and Expenses:
Cost of products sold 5,010 5,821 10,831
Operational expenses 9,395 6,567 15,962
Depreciation and
amortization 790 188 328 1,306
-------- ------- -------- --------
Total costs and expenses 15,195 12,576 328 28,099
-------- ------- -------- --------
Income (loss) from operations (1,733) 854 (328) (1,207)
Other income, net 32 21 - 53
Income (loss) before income taxes (1,701) 875 (328) (1,154)
Income tax expense - 19 - 19
-------- ------- -------- --------
Net income (loss) $ (1,701) $ 856 $ (328) $ (1,173)
======== ======= ======== ========
Pro forma:
Net loss per common share $ (0.29)
========
Weighted average number
of shares outstanding 4,010
========
</TABLE>
(a) Reflects the historical operations of the Acquisitions from August 1,
1997, to the date of acquisition.
(b) To record amortization of goodwill for the Acquisitions in the amount of
$211,000 and $328,000 for the fiscal years ended July 31, 1998, and
1997, respectively, as if the Acquisitions had occurred on August 1,
1997 and August 1, 1996, respectively.
(c) The "Sonus Corp. Combined" column set forth in the unaudited pro forma
statement of operations (i) for the year ended July 31, 1998, gives
effect to the Acquisitions as if they had occurred on August 1, 1997,
and (ii) for the year ended July 31, 1997, gives effect to the
Acquisitions as if they had occurred on August 1, 1996.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
-34-
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Information with respect to the directors and executive officers of the Company
and compliance with Section 16(a) of the Securities Exchange Act of 1934 is
incorporated herein by reference to the Company's definitive Management
Information Circular and Proxy Statement dated November 12, 1998 ("Proxy
Statement"), under the headings "Share Ownership By Principal Shareholders and
Management - Section 16(a) Beneficial Ownership Reporting Compliance" and " 3.
Election of Directors."
ITEM 10. EXECUTIVE COMPENSATION
The required information is incorporated herein by reference to the Proxy
Statement under the heading "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The required information is incorporated herein by reference to the Proxy
Statement under the heading "Share Ownership By Principal Shareholders and
Management."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The required information is incorporated herein by reference to the Proxy
Statement under the heading "Interests of Insiders in Material Transactions."
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits are listed in the Exhibit Index beginning on page 37 of this
report. Each management contract or compensatory plan or arrangement required to
be filed as an exhibit to this report is marked with an asterisk in the Exhibit
Index.
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during
the last quarter of the fiscal year ended July 31, 1998.
-35-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: October 29, 1998 SONUS CORP.
By /s/ Brandon M. Dawson
Brandon M. Dawson
President and Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated as of October 29, 1998.
Signature Title
PRINCIPAL EXECUTIVE OFFICER AND DIRECTOR:
/s/ Brandon M. Dawson
<TABLE>
<S> <C>
Brandon M. Dawson President and Chief Executive Officer and Director
PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:
/s/ Edwin J. Kawasaki
Edwin J. Kawasaki Vice President-Finance and Chief Financial Officer
</TABLE>
OTHER DIRECTORS:
*JOEL ACKERMAN Director
*WILLIAM DeJONG Director
*GREGORY J. FRAZER, Ph.D. Director
*DOUGLAS F. GOOD Director
*HUGH T. HORNIBROOK Director
/s/ Edwin J. Kawasaki
Edwin J. Kawasaki, as attorney-in-fact
-36-
<PAGE>
EXHIBIT INDEX
Exhibit Description of Exhibit
- ------- ----------------------
3.1 Articles of Incorporation of the Company. Incorporated by
reference to Exhibit 3.1 to Post-Effective Amendment No
1, filed March 5, 1998 (the "Amendment") to the Company's
Registration Statement on Form SB-2 filed March 12, 1997
(File No. 333-23137) (the "SB-2").
3.2 Bylaws of the Company. Incorporated by reference to
Exhibit 3.2 to the Amendment.
10.1 Securities Purchase Agreement between the Company and
Warburg, Pincus Ventures, L.P. ("Warburg") dated November
21, 1997. Incorporated by reference to Exhibit 99.2 to
the Company's current report on Form 8-K dated November
25, 1997.
10.2 Warrant Agreement between the Company and Warburg dated
December 24, 1997. Incorporated by reference to Exhibit
10.13 to the Amendment.
10.3 Stock Purchase and Sale Agreement dated as of February
28, 1997, between Gregory J. Frazer and Laurie Van
Duivenbode and SONUS-USA, Inc., a Washington corporation
("Sonus-USA"). Incorporated by reference to Exhibit 10.19
to the SB-2.
10.4 Merger Agreement dated as of October 1, 1996, among the
Company, Hearing Care Associates-Glendale, Inc., Hearing
Care Associates-Glendora, Inc., and Hearing Care
Associates-Northridge, Inc., and Gregory J. Frazer,
Carissa Bennett, and Jami Tanihana"). Incorporated by
reference to Exhibit 10.20 to the SB-2.
10.5 Asset Purchase Agreement effective as of October 31,
1996, among the Company, Sonus-USA and Hearing Health
Services, Inc., and Audio-Vestibular Testing Center, Inc.
(the "Midwest Division Agreement"). Incorporated by
reference to Exhibit 10.21 to the SB-2.
10.6 Stock Purchase and Sale Agreement dated as of January 9,
1997, by and between Gregory J. Frazer and Stephen
Martinez and Sonus-USA. Incorporated by reference to
Exhibit 10.24 to the SB-2.
10.7 Form of Convertible Subordinated Note relating to the
Midwest Division Agreement. Incorporated by reference to
Exhibit 10.25 to the SB-2.
10.8 1993 Stock Option Plan. Incorporated by reference to
Exhibit 10.26 to the SB-2.*
10.9 Second Amended and Restated Stock Award Plan (as amended
December 18, 1997). Incorporated by reference to Exhibit
10.27 to the Amendment.*
10.10 Employment Agreement dated October 1, 1996, between
Sonus-USA, and Gregory J. Frazer. Incorporated by
reference to Exhibit 10.28 to the SB-2.*
10.11 Employment Agreement dated as of November 1, 1996, among
the Company, Sonus-USA, and Kathy Foltner. Incorporated
by reference to Exhibit 10.29 to the SB-2.*
10.12 Employment Agreement dated December 24, 1997, between the
Company and Brandon M. Dawson. Incorporated by reference
to Exhibit 10.30 to the Amendment.*
10.13 Employment Agreement dated December 24, 1997, between the
Company and Edwin J. Kawasaki. Incorporated by reference
to Exhibit 10.31 to the Amendment.*
10.14 Employment Agreement dated December 24, 1997, between the
Company and Randall E. Drullinger. Incorporated by
reference to Exhibit 10.32 to the Amendment.*
-37-
<PAGE>
10.15 Consulting Agreement effective as of January 1, 1997,
between the Company and Hugh T. Hornibrook. Incorporated
by reference to Exhibit 10.33 to the SB-2.*
10.16 Stock Purchase and Sale Agreement dated as of March 6,
1997, between Gregory J. Frazer, Alfred S. Gaston and
Sonus-USA. Incorporated by reference to Exhibit 10.34 to
the SB-2.
10.17 Stock Purchase and Sale Agreement dated as of March 14,
1997, by and between Gregory J. Frazer, David N. Jankins,
and Jami Tanihana and Sonus-USA. Incorporated by
reference to Exhibit 10.35 to Amendment No. 1 to the SB-2
filed May 19, 1997.
10.18 Stock Purchase and Sale Agreement dated as of April 6,
1997, by and between Susan Diaz, Gregory J. Frazer, and
Jami Tanihana and Sonus-USA. Incorporated by reference to
Exhibit 10.36 to Amendment No. 1 to the SB-2 filed May
19, 1997.
10.19 Promissory Notes of Brandon M. Dawson dated May 8, 1997,
December 26, 1997, March 19, 1998, and April 24, 1998,
and related Pledge Agreement between the Company and Mr.
Dawson, dated May 1, 1998. Incorporated by reference to
Exhibits 10.1, 10.2, 10.3, 10.4, and 10.5 to the
Company's Quarterly Report on Form 10-QSB for the quarter
ended April 30, 1998.*
10.20 Amended and Restated Promissory Note of Gene K. Balzer,
Ph.D., dated as of May 19, 1998, and related Pledge
Agreement between the Company and Mr. Balzer, dated as of
May 19, 1997.*
10.21 Stock Purchase Agreement dated August 27, 1997, by and
between Carissa D. Bennett, Gregory J. Frazer, and Evelyn
L. Gong and Sonus-USA, Inc. Incorporated by reference to
Exhibit 10.35 to the Company's Annual Report on Form
10-KSB for the fiscal year ended July 31, 1997.
10.22 Stock Purchase Agreement dated January 5, 1998, by and
between Gregory J. Frazer, Rhonda Jesperson and
Sonus-USA. Incorporated by reference to Exhibit 10.41 to
the Amendment.
10.23 Stock Purchase Agreement dated February 12, 1998, by and
between Gregory Frazer, Donald M. Welch and Sonus-USA.
Incorporated by reference to Exhibit 10.42 to the
Amendment.
21 The Company's subsidiaries are SONUS-USA, Inc., a
Washington corporation, Sonus-Canada Ltd., a British
Columbia (Canada) corporation, and Hear PO Corp., a New
Mexico corporation.
23.1 Consent of KPMG Peat Marwick LLP.
24 Power of attorney of certain officers and directors.
27 Financial Data Schedule.
- ----------------------------
* Management contract or compensatory plan or arrangement.
-38-
$56,000.00 Dated May 19, 1998
AMENDED AND RESTATED PROMISSORY NOTE
The undersigned ("Maker") executed a promissory note dated May 19, 1997 (the
"Initial Note"), payable to Health Care Capital Corp, now known as Sonus Corp
("Holder"). Holder has agreed to extend the maturity date of the Initial Note to
November 1, 1999. The Initial Note shall therefore be replaced in its entirety
by this Amended and Restated Promissory Note.
For value received, the undersigned promises to pay to the order of Holder, the
principal sum of Fifty-Six Thousand and no/100 Dollars ($56,000.00) with
interest thereon at ten percent (10%) per annum from May 19, 1997. Principal and
interest shall be payable in lawful money of the United States of America at 111
SW Fifth Avenue, Suite 2390, Portland, Oregon 97204 or at such other place as
Holder may designate in writing. Principal and interest shall become due and
payable on November 1, 1999.
Maker agrees to pay all costs of collection of any amounts due hereunder when
incurred, including, without limitation, attorney's fees and expenses, including
on any appeal. Such costs shall be added to the balance of principal and
interest then due.
Maker, for himself and his successors and assigns, hereby waives presentment,
demand, notice and protest and any defense by reason of extension of time for
payment or other indulgences. Failure of the Holder to assert any right herein
shall not be deemed to be a waiver hereof.
This Amended and Restated Promissory Note is secured. The Maker has executed a
Pledge Agreement dated May 19, 1997, which describes the collateral and the
process for realization on the security in the event of a default hereunder.
This Amended and Restated Promissory Note shall be governed by and construed and
enforced in accordance with the laws of the State of Oregon.
Maker:
/s/ Gene K. Balzer, Ph.D.
Gene K. Balzer, Ph.D., an individual
<PAGE>
PLEDGE AGREEMENT
DATE: May 19, 1997
PARTIES: HEALTHCARE CAPITAL CORP., an Alberta, ("Lender")
Canada corporation
AND: GENE K. BALZER, Ph.D., an individual ("Borrower")
RECITAL:
Contemporaneous with this Agreement, Borrower has exercised stock options from
Lender for Two Hundred Thousand (200,000) Shares of Common Stock of HEALTHCARE
CAPITAL CORP., an Alberta, Canada corporation and issued Lender a promissory
note of even date herewith in the amount of $56,000.00 (the "Note"). To secure
all amounts due now or later from Borrower to Lender under the Note, Borrower
hereby pledges to Lender a security interest in the following described
property:
One Hundred Thousand (100,000) shares of the common stock of Lender as
evidenced by stock certificate no. , endorsed in the blank by Borrower
(the "Shares").
AGREEMENT:
SECTION 1. POSSESSION
Lender shall retain possession of the Shares until all amounts due from Borrower
to Lender are paid in full.
SECTION 2. DEFAULT
Borrower shall be in default under this Agreement if Borrower fails to make any
payment to Lender when due, or if borrower violates any terms of this Agreement
or the Note. Upon default, Lender shall have all the rights of a secured party
under the Oregon Uniform Commercial Code, including, subject to Section 3, the
right to sell the Shares at either a private or public sale.
SECTION 3. SECURITIES LAWS
Borrower acknowledges that the sale of the Shares by Lender may be subject to
certain securities laws, and Borrower agrees that Lender may take any action
necessary in order to comply with such laws, including any and all necessary
restrictions with respect to the time, place, manner and conditions of sale.
IN WITNESS WHEREOF, Borrower has executed this Pledge Agreement on the day and
year first written above.
Borrower:
/s/ Gene K. Balzer, Ph.D.
Gene K. Balzer, Ph.D.
an individual
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Sonus Corp.:
We consent to incorporation by reference in the Registration Statement on Form
S-8 No. 333-57673 of Sonus Corp. of our report dated October 23, 1998, relating
to the consolidated balance sheets of Sonus Corp. and subsidiaries as of July
31, 1998 and 1997, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the years in the two-year period
ended July 31, 1998, which report appears in the July 31, 1998 annual report on
Form 10-KSB of Sonus Corp.
/s/ KPMG PEAT MARWICK LLP
Portland, Oregon
October 23, 1998
POWER OF ATTORNEY
Each person whose signature appears below designates and appoints
Brandon M. Dawson and Edwin J. Kawasaki, or either of them, such person's true
and lawful attorneys-in-fact and agents, to sign the annual report on Form
10-KSB of Sonus Corp., an Alberta, Canada, corporation, for the fiscal year
ended July 31, 1998, and to file said report, with all exhibits thereto, with
the Securities and Exchange Commission under the Securities Exchange Act of
1934. Each person whose signature appears below also grants full power and
authority to these attorneys-in-fact and agents to perform every act and execute
any instruments that they deem necessary or desirable in connection with said
report, as fully as he or she could do in person, hereby ratifying and
confirming all that the attorneys-in-fact and agents or their substitutes may
lawfully do or cause to be done.
IN WITNESS WHEREOF, this power of attorney has been executed by each of
the undersigned as of the 26th day of October, 1998.
Signature Title
--------- -----
/s/ Brandon M. Dawson President and Chief Executive Officer and
Brandon M. Dawson Director (Principal Executive Officer)
/s/ Edwin J. Kawasaki Vice President-Finance and Chief Financial
Edwin J. Kawasaki Officer (Principal Financial and Accounting
Officer)
/s/ Gregory J. Frazer, Ph.D. Vice President-Business Development and
Gregory J. Frazer, Ph.D. Director
/s/ Douglas F. Good Chairman of the Board and Director
Douglas F. Good
/s/ Joel Ackerman Director
Joel Ackerman
/s/ William DeJong Director
William DeJong
/s/ Hugh T. Hornibrook Director
Hugh T. Hornibrook
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule constains summary financial information extracted from the
financial statements for Sonus Corp. and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<CIK> 0001029260
<NAME> Sonus Corp.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<CASH> 2,720
<SECURITIES> 6,408
<RECEIVABLES> 4,023
<ALLOWANCES> (684)
<INVENTORY> 967
<CURRENT-ASSETS> 14,219
<PP&E> 5,000
<DEPRECIATION> 1,393
<TOTAL-ASSETS> 34,129
<CURRENT-LIABILITIES> 7,910
<BONDS> 3,126
0
15,701
<COMMON> 14,673
<OTHER-SE> (7,281)
<TOTAL-LIABILITY-AND-EQUITY> 34,129
<SALES> 18,792
<TOTAL-REVENUES> 22,368
<CGS> 7,712
<TOTAL-COSTS> 27,266
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 789
<INTEREST-EXPENSE> 149
<INCOME-PRETAX> (4,594)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,594)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,594)
<EPS-PRIMARY> (0.89)
<EPS-DILUTED> (0.89)
</TABLE>
