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, 2000
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM TO
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Commission File No. 1-13851
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SONUS CORP.
(Name of small business issuer in its charter)
YUKON TERRITORY, CANADA NOT APPLICABLE
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
111 S.W. FIFTH AVENUE, SUITE 1620 97204
PORTLAND, OREGON (Zip code)
(Address of principal executive offices)
(503) 225-9152
(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
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COMMON SHARES, WITHOUT NOMINAL AMERICAN STOCK EXCHANGE
OR PAR VALUE
Securities registered under Section 12(g) of the Exchange Act: NONE
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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 no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is 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. [X]
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State the issuer's revenues for its most recent fiscal year:
$43,959,000.
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 November 10, 2000: $17,029,169.
State the number of shares outstanding of each of the issuer's classes
of common equity: Common Shares, without nominal or par value, 6,095,706 shares,
as of November 10, 2000.
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 16, 2000, are incorporated by reference into Part
III of this Form 10-KSB.
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TABLE OF CONTENTS
PAGE
PART I........................................................................3
ITEM 1. Description of Business..............................................3
ITEM 2. Description of Property..............................................9
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...........12
ITEM 7. Financial Statements................................................15
ITEM 8. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure.................33
PART III.....................................................................34
ITEM 9. Directors, Executive Officers, Promoters, and Control Persons;
Compliance with Section 16(a) of the Exchange Act.................34
ITEM 10. Executive Compensation..............................................34
ITEM 11. Security Ownership of Certain Beneficial Owners and Management......34
ITEM 12. Certain Relationships and Related Transactions......................34
ITEM 13. Exhibits and Reports on Form 8-K....................................34
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FORWARD-LOOKING STATEMENTS
Statements in this report, to the extent 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 centers, 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 centers 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
centers, the ability of the Company to attract audiology centers as franchise
licensees under The Sonus Network, product and professional liability claims
brought against the Company that exceed its insurance coverage, the Company's
ability to collect its accounts receivable in a timely manner, 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.
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 centers in British Columbia. The Company did not begin operating in
the United States until it purchased two hearing care centers near Santa Maria,
California, in July 1996. By vote of the shareholders, the Company changed its
name from HealthCare Capital Corp. to Sonus Corp. in February 1998, and changed
its jurisdiction of incorporation from Alberta, Canada, to Yukon Territory,
Canada, in December 1998. The Company, through its subsidiaries Sonus-USA, Inc.
("Sonus-USA"), Sonus-Texas, Inc. ("Sonus-Texas"), and Sonus-Canada Ltd.
("Sonus-Canada"), currently owns and operates 106 hearing care centers in the
United States and Western Canada. Centers owned by the Company are located in
the states of Arizona, California, Illinois, Michigan, Missouri, New Mexico,
Oregon, Texas, and Washington and in the Canadian provinces of British Columbia
and Alberta.
In addition to its company-owned hearing centers, the Company operates,
through Sonus-USA, a franchise licensing program called The Sonus Network, with
442 current locations. 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 281 Sonus Network
licensees located in 43 states and the District of Columbia.
The Company, through its subsidiary Hear PO Corp. ("Hear PO"), also
operates as an independent provider association and hearing care benefit
administrator. Hear PO obtains contracts to provide hearing care benefits to
managed care group and corporate health care organizations through its
approximately 1,400 affiliated audiologists and sells Hear PO brand private
label hearing instruments. Hear PO currently has contracts to provide hearing
care benefits to over 57 million covered lives.
Each of the hearing care centers owned by the Company provides a full
range of audiological products and services to hearing impaired individuals.
During the fiscal year ended July 31, 2000, approximately 85% of the Company's
revenues were derived from product sales, including hearing instruments,
batteries, and accessories, 8% were derived from audiological services, and 7%
were from other sources, including The Sonus Network and Hear PO. Substantially
all of the Company's hearing care centers are staffed with 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 and hearing instrument dispensers, 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 sells products through its internet site at www.sonus.com.
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Products that can be purchased through www.sonus.com include gift certificates,
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hearing instrument batteries, assistive listening devices, hearing protection
items, educational materials, and audiology equipment, supplies and accessories.
Audiologists and hearing instrument dispensers can also purchase hearing
instruments for resale to their patients. The Company believes that e-commerce
poses substantial opportunities for revenue growth and
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intends to continue to devote resources to enhancing its web site and increasing
product availability and differentiation.
INDUSTRY BACKGROUND
PROFESSIONALS AND CENTERS. 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.
The June 2000 issue of THE HEARING REVIEW, a hearing industry trade
journal, indicates that approximately 31% of HISs in the U.S. are at least 61
years of age, 33% are 51-60 years of age, 25% are 41-50 years of age and only
11% are age 40 or under, compared to 8%, 30%, 46% and 16%, 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.
Managed care arrangements may also favor the consolidation of hearing
care practices. Managed care organizations contract with health care providers
such as the Company to provide health care services and products to their
members. These organizations seek to establish relationships with providers
whose offices are convenient for the organization's members and that can offer
quality services and products at very competitive prices. Managed care
organizations also typically seek to shift some of the economic risk of
providing health care to the provider of the care. This shifting of risk is
accomplished in a number of ways, including capping fees, requiring discounted
fees, or paying a set fee per patient irrespective of the amount of care
delivered to that patient. As managed care arrangements become more pervasive,
the Company believes that hearing care professionals will have an even greater
need for the geographic reach, economies of scale, information resources, and
management expertise that larger organizations such as the Company can 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.
HEARING IMPAIRED POPULATION. 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:
- hearing rehabilitation services, including the evaluation and
rehabilitation of persons with hearing impairments by assessing
communicative impairment and providing amplification;
- advanced audio-diagnostic services, including the neuro-audiologic
evaluation and non-medical diagnosis of hearing and balance disorders;
- industrial and preventative audiological services, including noise
level measurements, dosimetry, and hearing screenings; and
- otolaryngologic services, including surgery and other medical
treatment.
The Company's hearing centers primarily provide hearing rehabilitation
services, which 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
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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 involves expanding its operations by
selectively acquiring hearing centers located in existing as well as new
geographic markets, increasing the number of licensees under the Company's
franchise licensing program, and increasing the number of covered lives served
by the Company under managed care contracts. 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 centers devoted to providing
high-quality hearing health care services.
ACQUISITIONS. The Company works to expand its network of Company-owned centers
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 then seeks to acquire
additional individual or group practices in order to realize economies of scale
in management, marketing, and administration. Due to the contacts of management
with audiologists in the industry, the Company is frequently presented with
opportunities to acquire hearing care centers. From August 1, 1996, to September
30, 2000, the Company acquired 122 centers, all located in the United States.
The Company looks at the following factors before acquiring centers 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 centers within a geographic market, the Company
seeks centers with the following characteristics: (a) an established patient
base drawing from a substantial metropolitan population; (b) significant revenue
and profitability prior to acquisition; and (c) above-average potential to
enhance center profitability after acquisition.
Prior to acquiring a hearing care center, the Company conducts a due
diligence investigation of the center's operations that includes an analytical
review of the center'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, 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, and patient files. At the
time a practice is acquired, the audiologists and hearing instrument dispensers
associated with the practice typically become employees of the Company.
There can be no assurance that the Company will be able to continue to
complete acquisitions consistent with its expansion plans, that such future
acquisitions will be on terms favorable to the Company, or that the Company will
be able to successfully integrate the hearing care centers that it acquires into
its business. Successful integration is dependent upon maintaining payor and
customer relationships and converting the management information systems of the
centers the Company acquires to the Company's systems. Significant expansion
could place excessive strain on the Company's managerial and other resources and
could necessitate the hiring of additional 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.
THE SONUS NETWORK. The Sonus Network was established in August 1998 to
complement the Company's internal growth and acquisition strategy and allow
additional national growth without incurring the added capital costs and
management resources necessary for Company-owned centers. There are currently
281 members of The Sonus Network representing 442 locations in 43 states and the
District of Columbia. The Company plans on adding 240 new franchisees in the
next fiscal year. Unlike many traditional franchise systems, the Company allows
its franchisees maximum flexibility in the day-to-day operation of their
businesses, including the extent to which the
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franchisees wish to adopt the Sonus name and trademarks. The Company believes
that the primary benefits of joining the Sonus Network are reduced pricing on
hearing instruments and related products, access to quality marketing materials
and national advertising programs developed by Sonus, the ability to offer Sonus
private-label products, and exclusive protected territories for franchisees.
Additional benefits include recruiting, training, and operational consulting
services and on-line ordering of hearing instruments and related products.
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 center 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 center 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 their practices. The Company has
developed an intensive six-week training course called the Greenhouse Program(R)
for its audiologists that focuses on clinical audiology skills as well as
private practice business management. Greenhouse participants are instructed by
some of the hearing health industry's most accomplished and experienced
professionals. The Company believes that the Greenhouse Program(R) can
significantly increase employee performance and improve customer service.
Greenhouse Program(R) graduates consistently rank among the Company's top
performers. The Company also believes that it can offer significant benefits to
private practice audiologists by providing assistance in administrative tasks
associated with operating an audiology practice, thereby allowing them to focus
on serving patients and increasing productivity.
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 centers. When a center 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 center 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 the Company's centers located in the
United States with the Company's corporate headquarters in order to provide
management with the ability to collect and analyze center data, control overhead
expenses, allow detailed budgeting at the center 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 and franchised centers and the over 1,400 audiologists
affiliated with its Hear PO subsidiary, it is well positioned to offer hearing
care services to managed care group and corporate health care organizations 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.
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CENTER STAFFING AND FACILITIES
Typically, each Company-owned hearing center is staffed with at least
one audiologist and one patient care coordinator, who handles scheduling and
clerical functions. Where volume warrants, a center may also be staffed with
additional audiologists, hearing instrument dispensers, 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 American
Speech-Language Hearing Association or the Canadian Association of
Speech/Language Pathologists and Audiologists.
Each of the Company's hearing centers 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 center. Centers generally have a reception
seating area, a reception work and filing area, an office for the audiologist or
hearing instrument dispenser, 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 center
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 six primary
manufacturers based upon criteria that include quality, price, and service. The
Company uses four top hearing instrument manufacturers to produce its Sonus
Solution(TM) line of private-label digital hearing instruments. Hearing
instruments in the Sonus Solution(TM) line come with a three-year warranty, a
three-year supply of batteries, and a 75-day return policy. The Sonus
Solution(TM) line is available only at Company-owned and franchised locations.
In addition to hearing instruments, the Company's centers also offer a limited
selection of other assistive listening devices and hearing instrument
accessories.
MARKETING
The Company's marketing program is designed to help its hearing care
centers 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
centers for their future hearing care needs. Educating patients about hearing
health, prescribing only necessary hearing enhancing products, ensuring that
each patient leaves a center 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 center 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. In July 2000, the Company launched its first-ever national consumer
advertising campaign. The Company estimates that the campaign, which is expected
to continue throughout the current fiscal year, will reach approximately 120
million people each quarter. Advertisements will appear in publications such as
READER'S DIGEST (MATURE SELECT), READER'S DIGEST LARGE EDITION FOR EASIER
READING, NEW CHOICES, PARADE MAGAZINE, RX REMEDY, SATURDAY EVENING POST,
ROTARIAN, KIWANIS, and THE LION.
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.
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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 on a regional basis with other networks of
hearing care centers such as Hearx Ltd., Helix Hearing Care of America, Newport
Audiology Centers, and American Hearing Centers, as well as with Beltone and
Miracle-Ear, two large manufacturers of hearing instruments that distribute
directly to consumers through national networks of franchised centers. Beltone
and Miracle-Ear place a heavy emphasis on advertising and enjoy significant
consumer brand name recognition. 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.
The Sonus Network franchise program competes for members with buying
groups such as The Audiology Co-Op and American Hearing Aid Associates that have
been formed to provide small hearing instrument retailers with shared economies
of scale. The Sonus Network also competes for members to a lesser extent with
mature franchise systems such as Beltone and Miracle-Ear.
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 centers through its
wholly owned subsidiaries, Sonus-USA, Sonus-Texas, 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 and offer audiology
services. For example, in California, where the Company operates a number of
centers, 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 also operates a number of centers, 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 centers 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 center 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.
8
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A portion of the revenues of the hearing care centers 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 of 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 (75 days for certain models)
after the date of purchase. In general, the Company can return hearing
instruments returned by customers within the return period allowed by the
Company to the manufacturer for a full refund.
EMPLOYEES
At October 1, 2000, the Company had 290 full-time and 96 part-time
employees, of which 104 are audiologists or hearing instrument dispensers
practicing full time and 42 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.
SERVICE AND ENFORCEMENT OF LEGAL PROCESS
The Company is incorporated under the laws of Yukon Territory, Canada.
One of the Company's directors is a resident of Canada and all or a portion of
the assets of such director 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 a director who is not a resident
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. There is doubt as to the enforceability in
Canada against the Company or against any of its directors 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 centers operates in leased space that ranges in size from
800 to 3,000 square feet. Approximately 65 percent of the locations are leased
for one to eight-year terms pursuant to generally non-cancelable leases (with
renewal options in some cases) with the remaining locations leased on a month-to
month basis. The aggregate committed rental expense as of July 31, 2000, for the
subsequent five-year period is approximately $5.8 million.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
9
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON SHARES
The Company's common shares ("Common Shares") are traded on the
American Stock Exchange. The following table sets forth the reported high and
low sales prices in United States dollars for the Common Shares for the periods
indicated:
FISCAL YEAR PERIOD HIGH LOW
----------- ------ ---- ---
1999........................ First Quarter $9.875 $4.500
Second Quarter $5.375 $3.188
Third Quarter $5.750 $4.125
Fourth Quarter $4.938 $4.000
2000........................ First Quarter $4.500 $3.125
Second Quarter $5.000 $2.750
Third Quarter $5.500 $3.438
Fourth Quarter $3.625 $2.750
HOLDERS AND DIVIDENDS
As of October 1, 2000, there were 57 holders of record of Common
Shares.
For as long as Warburg, Pincus Ventures, L.P., beneficially owns at
least 666,666 Series A Convertible Preferred Shares or Series B Convertible
Preferred Shares or the Common Shares into which such preferred 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 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 of trading or dealing in securities 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 the
Company's understanding of the current published administrative and assessing
policies and practices of the Canada Customs and Revenue Agency. 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
holders who are "specified financial institutions" for purposes of the Tax Act,
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 if an interest in such
holder would be a "tax shelter investment" as defined in the Tax Act.
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.
10
<PAGE>
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.
Non-residents whose shares constitute "taxable Canadian property" will
be subject to taxation in respect of a disposition or deemed disposition of
Common Shares 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 Canada-United States Income Tax Convention, 1980 (the
"Convention"), shareholders of the Company that are residents in the United
States 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.
SALES OF UNREGISTERED SECURITIES DURING FISCAL 2000
There were no securities of the Company issued without registration
under the Securities Act of 1933 during the fiscal year ended July 31, 2000,
except as previously reported in the Company's quarterly reports on Form 10-QSB
filed during the fiscal year.
11
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
OVERVIEW
During the fiscal year ended July 31, 2000, the Company achieved
improved financial results compared to the prior fiscal year. For the fiscal
year ended July 31, 2000, the Company generated total revenues of $44.0 million,
an increase of 30% over fiscal 1999. For the fiscal year ended July 31, 2000,
the Company incurred a net loss of $3.1 million, a decrease of $1.8 million from
the fiscal 1999 loss of $4.9 million. As of July 31, 2000, the Company's
accumulated deficit was $14.7 million and its total shareholders' equity was
$25.5 million.
ACQUISITIONS
During the fiscal year ended July 31, 2000, the Company acquired 16
hearing care centers in 10 transactions. The Company also closed or consolidated
10 centers during the fiscal year in order to more effectively allocate its
resources. The aggregate purchase price for the acquisitions consisted of cash
payments of $438,000, promissory notes issued by the Company of $521,000
generally payable over three years, and $85,000 in assumed liabilities. As a
result of the acquisitions, the Company recorded approximately $6,000 in
inventory, $157,000 in property and equipment, $10,000 in other assets, and
$795,000 in goodwill, which included costs related to acquisitions, and $85,000
for covenants not to compete.
The 16 hearing care businesses acquired by the Company during the
fiscal year ended July 31, 2000, have combined historical revenues for their
immediately preceding fiscal years of approximately $3.9 million. The Company
expects these centers to contribute to the Company's future revenues consistent
with their historical revenues, as well as to have a positive effect on cash
flows and liquidity.
As of July 31, 2000, the Company had recorded $20,970,000 in goodwill
and $2,311,000 in covenants not to compete. The unamortized balance totaled
$19,678,000 at July 31, 2000, which represented approximately 52% of the
Company's total assets.
RESULTS OF OPERATIONS
YEAR ENDED JULY 31, 2000, COMPARED TO YEAR ENDED JULY 31, 1999
REVENUES. Net revenues for the fiscal year ended July 31, 2000, were
$43,959,000, representing a 30% increase over net revenues of $33,759,000 for
the prior fiscal year. The increase was due to the 16 centers acquired during
fiscal 2000, as well as an increase of 5% in same-store revenue compared to
1999. Product sales revenues were $37,252,000 for the 2000 fiscal year, up 28%
from the $29,044,000 for fiscal 1999. Audiological service revenues increased 6%
from $3,392,000 in fiscal 1999 to $3,589,000 for the 2000 fiscal year. Other
revenues increased 136% to $3,118,000 in fiscal 2000 from $1,323,000 in fiscal
1999 due to the rapid growth of the Company's franchise license program, The
Sonus Network, and increased revenues from the Company's Hear PO Corp.
subsidiary.
GROSS PROFIT ON PRODUCT SALES. Product gross profit for the fiscal year
ended July 31, 2000, was $24,365,000 compared to $18,278,000 for the prior
fiscal year. Gross profit percentage on product sales increased to 65% for
fiscal 2000 from 63% for fiscal 1999. The increase in product gross profit
percentage was due to more favorable contracts with suppliers, increased
utilization of the Company's private-label hearing instruments, and better price
management.
CLINICAL EXPENSES. As a percentage of net revenues, clinical expenses
decreased to 45% for the fiscal year ended July 31, 2000, compared to 53% for
the fiscal year ended July 31, 1999. The percentage decrease was due to the
Company's ability to cut costs, streamline its operations, and eliminate
inefficient and duplicative processes. Clinical expenses for the fiscal year
ended July 31, 2000, were $19,885,000, representing an increase of 12% over
clinical expenses of $17,795,000 for the prior fiscal year. This increase was
primarily due to clinical expenses associated with the 16 additional centers
that were acquired by the Company during the fiscal year ended July 31, 2000.
Clinical expenses include all personnel, marketing, occupancy and other
operating expenses at the center level.
PROVISION FOR AGED RECEIVABLES. During the fourth quarter of fiscal
2000, the Company incurred a charge of $2,300,000 to increase its reserves
related to aged accounts receivable. The Company established the reserve based
on the aging of the accounts receivable, especially those receivables in excess
of one year, because management believes that full collection of such
receivables is doubtful.
GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net revenues,
general and administrative expenses decreased to 20% for the fiscal year ended
July 31, 2000, versus 22% for the same period in the prior fiscal year. The
decrease in general and administrative expenses as a percentage of revenues was
due to growth in the Company's revenue base as a result of its strategic
acquisition program and enhanced marketing efforts, as well as continued efforts
to cut administrative costs. General and administrative expenses in dollar terms
increased 16% from $7,583,000 for the fiscal year ended July 31, 1999, to
$8,778,000 for the fiscal year ended July 31, 2000. The increase was due to
increased personnel costs and other corporate expenses related to building the
appropriate infrastructure to support the growth of the Company.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense for the fiscal year ended July 31, 2000, was
12
<PAGE>
$3,109,000, an increase of 27% over the depreciation and amortization expense of
$2,450,000 for the prior fiscal year. The increase resulted from the
depreciation of property and equipment and amortization of goodwill and
covenants not to compete associated with the 16 additional centers acquired by
the Company during the fiscal year ended July 31, 2000.
INTEREST INCOME AND EXPENSE. Interest income for the fiscal year ended
July 31, 2000, was $260,000 compared to $261,000 for the prior fiscal year.
Interest expense for the fiscal year ended July 31, 2000, was $342,000 compared
to $300,000 for the fiscal year ended July 31, 1999, an increase of 14%, due to
higher balances of long-term debt incurred in connection with acquisitions and
capital expenditures.
NET LOSS. For the fiscal year ended July 31, 2000, the Company's net
loss decreased to $3,101,000 compared to a net loss of $4,884,000 for the fiscal
year ended July 31, 1999. The Company had income from operations before
depreciation and amortization for fiscal 2000 of $109,000 compared to an
operating loss from operations before depreciation and amortization of
$2,385,000 for fiscal 1999, an improvement of $2,494,000.
YEAR ENDED JULY 31, 1999, COMPARED TO YEAR ENDED JULY 31, 1998
REVENUES. Net revenues for the fiscal year ended July 31, 1999, were
$33,759,000, representing a 51% increase over revenues of $22,368,000 for the
prior fiscal year. The increase was primarily due to the 31 centers acquired
during fiscal 1999. Net revenue was also favorably impacted by an increase of 5%
in comparable center revenue in fiscal 1999. Comparable centers are those
centers that have been open at least 24 months. Product sales revenues were
$29,044,000 for the 1999 fiscal year, up 55% from the $18,792,000 for fiscal
1998. Audiological service revenues increased from $3,311,000, or 15% of total
revenues, in fiscal 1998, to $3,392,000, or 10% of total revenues, for the 1999
fiscal year.
GROSS PROFIT ON PRODUCT SALES. Product gross profit for the fiscal year
ended July 31, 1999, was $18,278,000 compared to $11,080,000 for the prior
fiscal year. Gross profit percentage on product sales increased to 63% for
fiscal 1999 from 59% for fiscal 1998. The increase in gross profit percentage on
product sales was primarily attributable to increased buying power with hearing
instrument manufacturers, less dependence on sales discounts, better price
management and a new tiered pricing strategy based on levels of technology.
CLINICAL EXPENSES. As a percentage of net revenues, clinical expenses
decreased to 53% for the fiscal year ended July 31, 1999, compared to 55% for
the fiscal year ended July 31, 1998. The percentage decrease was due to the
Company's ability to cut costs, streamline its operations, and eliminate
inefficient and duplicative processes. Clinical expenses for the fiscal year
ended July 31, 1999, were $17,795,000, representing an increase of 45% over
clinical expenses of $12,297,000 for the prior fiscal year. This increase was
primarily due to clinical expenses associated with the 31 additional centers
that were acquired by the Company during the fiscal year ended July 31, 1999.
Clinical expenses include all personnel, marketing, occupancy and other
operating expenses at the center level.
GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net revenues,
general and administrative expenses decreased to 22% for the fiscal year ended
July 31, 1999, versus 26% for the same period in the prior fiscal year. The
decrease in general and administrative expenses as a percentage of revenues was
due to growth in the Company's revenue base as a result of its strategic
acquisition program and enhanced marketing efforts, as well as an administrative
restructuring and cost-cutting program implemented by the Company in fiscal
1999. General and administrative expenses in dollar terms increased 29% from
$5,896,000 for the fiscal year ended July 31, 1998, to $7,583,000 for the fiscal
year ended July 31, 1999, due to planned increases in corporate staff and other
corporate expenses related to the operation of a larger organization.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense for the fiscal year ended July 31, 1999, was $2,450,000, an increase of
80% over the depreciation and amortization expense of $1,361,000 for the prior
fiscal year. The increase resulted from the depreciation of property and
equipment and amortization of goodwill and covenants not to compete associated
with the 31 additional centers acquired by the Company during the fiscal year
ended July 31, 1999, as well as from depreciation and amortization associated
with businesses acquired in the second half of fiscal 1998.
INTEREST INCOME AND EXPENSE. Interest income for the fiscal year ended
July 31, 1999, decreased to $261,000 from $452,000 for the prior fiscal year.
The decrease was due to lower balances of cash and short-term investments held
by the Company. Interest expense for the fiscal year ended July 31, 1999, was
$300,000 compared to $149,000 for the fiscal year ended July 31, 1998, due to
higher balances of long-term debt incurred in connection with acquisitions.
NET LOSS. For the fiscal year ended July 31, 1999, the Company had a
net loss of $4,884,000 compared to a net loss of $4,594,000 for the fiscal year
ended July 31, 1998. The Company's loss from operations before depreciation and
amortization for fiscal 1999 was $2,385,000 compared to an operating loss before
depreciation and amortization of $3,537,000 for fiscal 1998.
13
<PAGE>
LIQUIDITY AND CASH RESERVES
For the fiscal year ended July 31, 2000, net cash used in operating
activities was $2,051,000 compared to $2,281,000 for fiscal 1999. Net cash used
in operating activities for fiscal 2000 resulted primarily from the Company's
earnings before depreciation and amortization of $8,000 and increases in
accounts receivable, other receivables, and inventory of $4,971,000, $1,141,000,
and $447,000, respectively, offset by an increase in accounts payable and
accrued liabilities of $1,839,000 and the Company's provision for bad debt
expense and provision for aged receivables of $391,000 and $2,300,000,
respectively. Net cash used in operating activities for fiscal 1999 was
primarily attributable to the Company's loss before depreciation and
amortization of $2,434,000, an increase in accounts receivable of $554,000, and
a decrease in accounts payable and accrued liabilities of $558,000, offset by
decreases in other receivables and inventory of $172,000 and $560,000,
respectively, the provision for bad debt expense of $389,000, and compensation
cost recognized for options granted to non-employees of $203,000.
Net cash used in investing activities was $3,706,000 for fiscal 2000,
consisting primarily of the purchase of property and equipment of $3,305,000 and
net cash paid for business acquisitions of $438,000. In fiscal 1999, investing
activities provided net cash of $878,000 as a result of the sale of short -term
investments of $6,408,000, which was offset by the purchase of property and
equipment of $3,368,000, additional costs related to acquisitions of $188,000,
and net cash paid on business acquisitions of $2,062,000.
Financing activities provided net cash of $6,038,000 in fiscal 2000,
primarily as a result of the issuance of preferred stock in October 1999 for net
proceeds of $9,860,000, offset by repayments of long-term debt and capital lease
obligations of $3,236,000 and repayments of bank loans and short-term notes
payable of $500,000. Financing activities used net cash of $821,000 in fiscal
1999, as the result of the repayment of long-term debt and capital lease
obligations of $1,626,000, offset by borrowings under bank loans and short-term
notes payable of $454,000, advances from shareholders of $190,000, and the
issuance of common stock that provided proceeds of $248,000.
In July 2000, the Company, through its subsidiaries Sonus-USA and
Sonus-Texas, entered into a revolving line of credit agreement with a commercial
bank. The line of credit, which is primarily secured by accounts receivable,
matures on June 30, 2001, and bears interest at the bank's prime rate plus 1/2%.
The amount available for borrowing under the line of credit was $2,000,000 at
July 31, 2000, and there was no amount outstanding at that date.
The Company believes that its cash and short-term investments,
revolving line of credit, and cash generated from operations will be sufficient
to meet its anticipated cash needs for working capital and capital expenditures
for at least the next twelve months. However, the Company's ability to generate
net cash from operations will depend heavily on its ability to collect existing
accounts receivable in a timely manner. The Company may seek additional funding
to support the Company's strategy of acquiring additional hearing care centers.
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 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.
ACCOUNTING PRONOUNCEMENTS
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. In addition, Statement
of Financial Accounting Standard No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" ("SFAS No. 138") was issued in June
2000. SFAS No. 138 amends the accounting and reporting standards of SFAS No. 133
for certain derivative instruments and certain hedging activities. Because the
Company does not currently hold any derivative instruments and does not
currently engage in hedging activities, the adoption of SFAS No. 133 and SFAS
No. 138 will not have a material impact on the Company's consolidated financial
position or consolidated results of operations. SFAS No. 133 and SFAS No. 138
are effective for the Company beginning August 1, 2000.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). The Company is required to adopt the provisions of SAB 101 no later than
December 31, 2000. Based on the revenue recognition policy of the Company, the
adoption of SAB 101 will not have a material impact on the Company's financial
position or results of operations.
14
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ITEM 7. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS
SONUS CORP.:
We have audited the accompanying consolidated balance sheets of Sonus
Corp. and subsidiaries as of July 31, 2000 and 1999, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the years in the three-year period ended July 31, 2000. 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 auditing standards generally
accepted in the United States of America. 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, 2000 and 1999, and the consolidated
results of their operations and their cash flows for each of the years in the
three-year period ended July 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Portland, Oregon
November 13, 2000
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<TABLE>
SONUS CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
July 31,
----------------------------
2000 1999
------------- -----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 788 $ 498
Accounts receivable, net of allowance for doubtful accounts
of $1,391 and $907, respectively, and reserve for aged
receivables of $2,300 and $0, respectively 6,359 3,666
Other receivables 1,497 346
Inventory 952 499
Prepaid expenses 396 340
------------- ------------
Total current assets 9,992 5,349
Property and equipment, net 8,090 6,208
Other assets 24 60
Goodwill and covenants not to compete, net 19,678 19,768
------------- ------------
$ 37,784 $ 31,385
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable-related party $ --- $ 500
Accounts payable 5,460 3,727
Accrued payroll 1,643 1,223
Other accrued liabilities 1,441 1,317
Convertible notes payable --- 931
Capital lease obligations, current portion 289 129
Long-term debt, current portion 2,176 2,150
------------- ------------
Total current liabilities 11,009 9,977
Capital lease obligations, less current portion 181 96
Long-term debt, less current portion 1,078 2,497
------------- ------------
Total liabilities 12,268 12,570
------------- ------------
Commitments and contingencies
Shareholders' equity:
Series A convertible preferred stock, no par
value per share, 2,666,666 shares authorized,
issued, and outstanding (liquidation preference of $20,340) 15,701 15,701
Series B convertible preferred stock, no par
value per share, 2,500,000 shares authorized,
issued, and outstanding in 2000 (liquidation preference
of $10,667) 9,860 ---
Common stock, no par value per share, unlimited
number of shares authorized, 6,098,706 issued
and outstanding (6,109,026 in 1999) 14,916 14,976
Notes receivable from shareholders (93) (93)
Accumulated deficit (14,696) (11,595)
Accumulated other comprehensive loss (172) (174)
------------- ------------
Total shareholders' equity 25,516 18,815
------------- ------------
$ 37,784 $ 31,385
============= ============
See accompanying notes to consolidated financial statements.
</TABLE>
16
<PAGE>
<TABLE>
SONUS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended July 31,
----------------------------------------------
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
Product $ 37,252 $ 29,044 $ 18,792
Service 3,589 3,392 3,311
Other 3,118 1,323 265
------------ ------------ ------------
Net revenues 43,959 33,759 22,368
Costs and expenses:
Cost of products sold 12,887 10,766 7,712
Clinical expenses 19,885 17,795 12,297
Provision for aged receivables 2,300 --- ---
General and administrative expenses 8,778 7,583 5,896
Depreciation and amortization 3,109 2,450 1,361
------------ ------------ ------------
Total costs and expenses 46,959 38,594 27,266
------------ ------------ ------------
Loss from operations (3,000) (4,835) (4,898)
Other income (expense):
Interest income 260 261 452
Interest expense (342) (300) (149)
Other, net (19) (10) 1
------------ ------------ ------------
Net Loss $ (3,101) $ (4,884) $ (4,594)
============ ============ ============
Net loss per share of common stock:
Basic and diluted $ (0.51) $ (0.80) $ (0.89)
Weighted average shares outstanding:
Basic and diluted 6,083 6,090 5,160
See accompanying notes to consolidated financial statements.
</TABLE>
17
<PAGE>
SONUS CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
<TABLE>
Preferred stock-Series A Preferred stock - Series B Common stock
------------------------ -------------------------- ------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JULY 31, 1997 --- $ --- --- --- 5,427,657 $ 11,098
Net loss --- --- --- --- --- ---
Foreign currency translation adjustment --- --- --- --- --- ---
Comprehensive loss --- --- --- --- --- ---
Stock issued upon conversion
of convertible note --- --- --- --- 25,925 128
Stock issued in connection with acquisition
contingent upon satisfaction of certain
conditions --- --- --- --- 22,936 ---
Repurchase of common stock --- --- --- --- (3,000) (25)
Proceeds from exercise of stock options --- --- --- --- 10,000 9
Stock issued in connection with Series A
convertible preferred stock, net of
costs of $2,299 2,666,666 15,701 --- --- --- ---
Proceeds from exercise of warrants --- --- --- --- 373,998 1,957
Proceeds from exercise of stock options --- --- --- --- 2,400 18
Advance on shareholder note --- --- --- --- --- ---
Stock issued upon conversion
of convertible notes --- --- --- --- 220,000 1,430
Payment of cash in lieu of fractional shares --- --- --- --- (8) ---
--------- -------- --------- ------- --------- --------
BALANCE AT JULY 31, 1998 2,666,666 15,701 --- --- 6,079,908 14,615
Net loss --- --- --- --- --- ---
Foreign currency translation adjustment --- --- --- --- --- ---
Comprehensive loss --- --- --- --- --- ---
Proceeds from exercise of warrants --- --- --- --- 39,799 248
Repurchase of common stock --- --- --- --- (10,680) (90)
Repayment on shareholder notes --- --- --- --- --- ---
Payment of cash in lieu of fractional shares --- --- --- --- (1) ---
Stock options granted to non-employees --- --- --- --- --- 203
--------- -------- --------- ------- --------- --------
BALANCE AT JULY 31, 1999 2,666,666 15,701 --- --- 6,109,026 14,976
Net loss --- --- --- --- --- ---
Foreign currency translation adjustment --- --- --- --- --- ---
Comprehensive loss
Stock issued in connection with Series B
convertible preferred stock, net of costs of $140 --- --- 2,500,000 9,860 --- ---
Repurchase of common stock --- --- --- --- (10,320) (86)
Stock options granted to non-employees --- --- --- --- --- 26
--------- -------- --------- ------- --------- --------
BALANCE AT JULY 31, 2000 2,666,666 $ 15,701 2,500,000 $ 9,860 6,098,706 $ 14,916
========= ======== ========= ======= ========= ========
Accumulated
Shareholder other Total
notes Accumulated comprehensive Comprehensive shareholders'
receivable deficit income (loss) income (loss) equity
---------- ------- ------------- ------------- ------
<S> <C> <C> <C> <C> <C>
BALANCE AT JULY 31, 1997 (124) $ (2,117) $ (22) $ 8,835
Net loss --- (4,594) --- $ (4,594) (4,594)
Foreign currency translation adjustment --- --- (207) (207) (207)
---------
Comprehensive loss --- --- $ (4,801) ---
=========
Stock issued upon conversion
of convertible note --- --- --- 128
Stock issued in connection with acquisition
contingent upon satisfaction of certain
conditions --- --- --- ---
Repurchase of common stock --- --- --- (25)
Proceeds from exercise of stock options --- --- --- 9
Stock issued in connection with Series A
convertible preferred stock, net of
costs of $2,299 --- --- --- 15,701
Proceeds from exercise of warrants --- --- --- 1,957
Proceeds from exercise of stock options --- --- --- 18
Advance on shareholder note (159) --- --- (159)
Stock issued upon conversion
of convertible notes --- --- --- 1,430
Payment of cash in lieu of fractional shares --- --- --- ---
--------- -------- --------- ---------
BALANCE AT JULY 31, 1998 (283) (6,711) (229) 23,093
Net loss --- (4,884) --- $ (4,884) (4,884)
Foreign currency translation adjustment --- --- 55 55 55
---------
Comprehensive loss --- --- --- $ (4,829) ---
=========
Proceeds from exercise of warrants --- --- --- 248
Repurchase of common stock --- --- --- (90)
Repayment on shareholder notes 190 --- --- 190
Payment of cash in lieu of fractional shares --- --- --- ---
Stock options granted to non-employees --- --- --- 203
--------- -------- --------- ---------
BALANCE AT JULY 31, 1999 (93) (11,595) (174) 18,815
Net loss --- (3,101) --- $ (3,101) (3,101)
Foreign currency translation adjustment --- --- 2 2 2
---------
Comprehensive loss $ (3,099)
=========
Stock issued in connection with Series B
convertible preferred stock, net of costs of $140 --- --- --- 9,860
Repurchase of common stock --- --- --- (86)
Stock options granted to non-employees --- --- --- 26
--------- -------- --------- ---------
BALANCE AT JULY 31, 2000 $ (93) $(14,696) $ (172) $ 25,516
========= ======== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
<TABLE>
SONUS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended July 31,
----------------------------------------------
2000 1999 1998
------------ ------------ ------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $ (3,101) $ (4,884) $ (4,594)
Adjustments to reconcile net loss to net cash
used in operating activities:
Bad debt expense 391 389 412
Provision for aged receivables 2,300 --- ---
Depreciation and amortization 3,109 2,450 1,361
Compensation cost for options granted
to non-employees 26 203 ---
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable (4,971) (554) (51)
Other receivables (1,141) 172 (181)
Inventory (447) 560 (405)
Prepaid expenses (56) (59) 24
Accounts payable and accrued liabilities 1,839 (558) 1,231
------------ ------------ ------------
Net cash used in operating activities (2,051) (2,281) (2,203)
------------ ------------ ------------
Cash flows from investing activities:
Maturity (purchase) of short-term investments --- 6,408 (6,408)
Purchase of property and equipment (3,305) (3,368) (1,414)
Additional costs related to acquisitions --- (188) (198)
Deferred acquisition costs and other, net 37 88 (1)
Net cash used in business acquisitions (438) (2,062) (3,765)
------------ ------------ ------------
Net cash provided by
(used in) investing activities (3,706) 878 (11,786)
------------ ------------ ------------
Cash flows from financing activities:
Net repayments of long-term debt
and capital lease obligations (3,236) (1,626) (1,625)
Deferred financing costs, net --- 3 (20)
Net advances (repayments) of bank loans and short-term
notes payable (500) 454 (39)
Advances from (payments to) shareholders --- 190 (159)
Issuance of common stock for cash, net of costs --- 248 1,984
Issuance of preferred stock for cash, net of costs 9,860 --- 15,701
Acquisition of treasury stock (86) (90) (25)
------------ ------------ ------------
Net cash provided by (used in) financing activities 6,038 (821) 15,817
------------ ------------ ------------
Net change in cash and cash equivalents 281 (2,224) 1,828
Effect on cash and cash equivalents of changes in
foreign translation rate 9 2 (207)
Cash and cash equivalents, beginning of year 498 2,720 1,099
------------ ------------ ------------
Cash and cash equivalents, end of year $ 788 $ 498 $ 2,720
============ ============ ============
Supplemental disclosure of
non-cash investing and financing activities:
Interest paid during the year $ 353 $ 218 $ 149
Non-cash financing activities:
Issuance and assumption of debt in acquisitions 573 2,611 1,781
Acquisition of clinical equipment and computer hardware with
capital lease obligations 566 --- ---
Issuance of common stock upon conversion of convertible note --- 650 ---
Issuance of debt for covenants not to compete with purchase --- --- 1,557
See accompanying notes to consolidated financial statements.
</TABLE>
19
<PAGE>
SONUS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2000 AND 1999
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF COMPANY
Sonus Corp., a Yukon Territory, Canada corporation (the "Company"),
through its primary operating subsidiaries, Sonus-Canada Ltd., a British
Columbia, Canada corporation, Sonus-USA, Inc., a Washington corporation, and
Sonus-Texas, Inc., an Oregon corporation, owns and operates 106 hearing care
centers in the United States and Western Canada. The centers are located in the
states of Arizona, California, Illinois, Michigan, Missouri, New Mexico, Oregon,
Texas, and Washington, and in the Canadian provinces of British Columbia and
Alberta. Each of the Company's hearing care centers provides its hearing
impaired patients with a full range of audiological products and services. The
Company intends to expand its network of hearing care centers by acquiring
centers in its existing, as well as new, geographic markets. The Company also
operates a franchise licensing program called The Sonus Network, with over 430
current locations. 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. The Company, through its subsidiary Hear PO
Corp., a New Mexico corporation, also obtains contracts to provide hearing care
benefits to managed care group and corporate health care organizations through
its approximately 1,400 affiliated audiologists and sells Hear PO brand private
label hearing instruments.
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
("SFAS") 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.
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 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. A valuation allowance is
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
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 SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". 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, 2000 and 1999, the Company had no short-term investments
and
20
<PAGE>
therefore no unrealized holding gains or losses. Gross realized gains and losses
on sales of available-for-sale securities for fiscal 2000, 1999, and 1998 were
nominal. Realized gains and losses are computed by determining cost on a
specific identification basis.
Gross proceeds from sales and maturities of available-for-sale
investments during fiscal 2000, 1999, and 1998 were $11,001,000, $6,408,000, and
$18,511,000, respectively.
ACCOUNTS RECEIVABLE
The Company establishes the allowance for doubtful accounts based on
historical charge-offs of accounts receivable. During fiscal 2000, the Company
also established a reserve for aged receivables based on the aging of the
accounts receivable and other factors, which in the opinion of management,
deserve current recognition.
INVENTORY
Inventory primarily consists of hearing instruments, hearing instrument
batteries, and assistive listening devices and is 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
Computer equipment and software Five years
Property and equipment purchased under capitalized leases and leasehold
improvements are amortized over the shorter of the lease term or their estimated
useful lives and such depreciation is included with depreciation expense.
ADVERTISING EXPENSE
The Company defers its advertising costs until the advertisement is
actually run, at which time the full expense is recognized. Deferred advertising
costs were $60,000 and $84,000 at July 31, 2000 and 1999, respectively.
Advertising expense was $4,004,000, $3,632,000, and $2,786,000 for the years
ended July 31, 2000, 1999, and 1998, 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 as of July 31:
(in thousands) 2000 1999
---- ----
Goodwill $20,970 $19,774
Covenants not to compete 2,311 2,226
Less: Accumulated amortization (3,603) (2,232)
-------- -------
$19,678 $19,768
======== ========
Amortization charged to operations was $1,386,000, $1,195,000, and
$635,000 for the years ended July 31, 2000, 1999 and 1998, respectively.
DEFERRED ACQUISITION AND FINANCING COSTS
Costs related to the acquisition of centers 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.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company assesses the recoverability of long-lived assets, including
goodwill, by determining whether the carrying amount of the long-lived asset
over its remaining life can be recovered through undiscounted projected future
cash flows. The Company has not recognized any impairment losses during the
years ended July 31, 2000, 1999, and 1998.
21
<PAGE>
NET LOSS PER SHARE
On August 1, 1997, the Company adopted SFAS No. 128, "Earnings Per
Share", which provides that "basic net income (loss) per share" and "diluted net
income (loss) per share" for all periods presented be computed using the
weighted average number of common shares outstanding during the respective
period, with diluted net income per share including the effect of potentially
dilutive common shares. The following potential common shares have been excluded
from the computation of diluted net loss per share for the years presented
because the effect would have been anti-dilutive:
<TABLE>
Years Ended July 31,
--------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
(in thousands)
Shares issuable under stock options and warrants 4,263 3,629 2,001
Shares issuable upon conversion of convertible
notes payable 47 153 382
Shares of convertible preferred stock on an as
converted basis 4,743 2,667 1,600
</TABLE>
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net income (loss) and foreign
currency translation adjustment and is presented in the consolidated statement
of shareholders' equity. SFAS No. 130 requires only additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations.
STOCK BASED COMPENSATION
The Company accounts for its stock plans in accordance with SFAS No.
123, "Accounting for Stock-Based Compensation", which establishes a fair value
method of accounting for stock plans. As allowed by SFAS No. 123, the Company
has elected to continue to apply Accounting Principles Board Opinion ("APB") No.
25, "Accounting for Stock Issued to Employees", which prescribes an intrinsic
value based method of accounting for stock plans covering employees and to
provide the pro-forma disclosures of the effects of SFAS No. 123 on net income
(loss) and net income (loss) per share.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation" ("FIN 44"), which provides interpretive guidance on several
implementation issues related to Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." The Company adopted FIN 44 effective
July 1, 2000. The adoption of FIN 44 did not have a material impact on the
consolidated financial statements for the year ended July 31, 2000.
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash and cash equivalents
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of financial instruments such as cash and cash
equivalents, accounts receivable, other receivables, trade payables, notes
payable, and convertible notes payable approximate their fair value because of
the short-term nature of these instruments. The carrying amount of the Company's
long-term debt approximates fair value because the interest rates approximate
the rates that management believes are currently available to the Company. The
carrying amount of capital lease obligations approximates fair value.
22
<PAGE>
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
NOTE 2. ACQUISITIONS
During the fiscal year ended July 31, 2000, the Company acquired 16
hearing care centers in 10 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 $438,000,
promissory notes issued by the Company of $521,000 generally payable over three
years, and $85,000 in assumed liabilities. As a result of the acquisitions, the
Company recorded approximately $6,000 in inventory, $157,000 in property and
equipment, $10,000 in other assets, and $795,000 in goodwill, which included
costs related to acquisitions, and $85,000 for covenants not to compete.
During the fiscal year ended July 31, 1999, the Company acquired 31
hearing care centers in 17 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 $1,704,000,
promissory notes issued by the Company of $1,749,000 generally payable over
three years, and $900,000 in assumed liabilities. As a result of the
acquisitions, the Company recorded approximately $95,000 in accounts receivable,
$90,000 in inventory, $457,000 in property and equipment, $20,000 in other
assets, and $3,700,000 in goodwill, which included costs related to
acquisitions. In addition to the purchase price for the acquisitions, the
Company also recorded $299,000 for covenants not to compete, of which $79,000
was paid in cash at the time of closing, with the balance payable over three
years.
The following unaudited pro forma financial information reflects the
historical operations of the Company and the hearing care centers acquired by
the Company during the fiscal year ended July 31, 2000 (the "Acquisitions").
Such financial information has been prepared for comparative purposes only and
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, 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.
YEAR ENDED JULY 31,
-------------------
(Unaudited)
(in thousands,
except per share amounts) 2000 1999
---- ----
Net revenues $45,813 $37,809
Net loss (3,044) (4,686)
Net loss per share (basic and diluted) (0.50) (0.77)
23
<PAGE>
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of July 31:
(in thousands) 2000 1999
---- ----
Professional equipment $2,695 $2,154
Office equipment 1,155 926
Leasehold improvements 1,599 1,030
Computer equipment and software 6,941 4,689
------- -----
12,390 8,799
Less accumulated depreciation (4,300) (2,591)
------- -------
$8,090 $6,208
====== ======
NOTE 4. CONVERTIBLE NOTES PAYABLE
At July 31, 1999, the Company had outstanding promissory notes in the
amount of $931,000 convertible at any time into 143,000 Common Shares at a rate
of $6.50 per share. The notes were paid in full during November and December
1999, along with interest of $37,848.
NOTE 5. 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, 2000 (in thousands):
2001.................................................................$322
2002............................................................... 200
-----
Total minimum lease payments........................................ 522
Less: amount representing interest................................. (52)
-----
Present value of minimum lease payments........................... 470
Less current portion.................................................(289)
-----
$181
=====
Total assets under capitalized leases at July 31, 2000 and 1999, were $462,000
and $112,000, net of accumulated depreciation of $573,000 and $375,000,
respectively.
24
<PAGE>
NOTE 6. LONG-TERM DEBT
Long-term debt consists of the following as of July 31 (in thousands):
<TABLE>
<S> <C> <C> <C>
2000 1999
---- ----
Installment notes incurred in connection with acquisitions
payable in monthly installments due from 2001 to 2004 with a weighted
average interest rate of 6.9%, partially secured by purchased assets...........$ 292 $ 460
Installment notes incurred in connection with acquisitions payable
in quarterly installments due from 2001 to 2002 with a weighted
average interest rate of 6.5%, partially secured by purchased assets........... 249 517
Installment notes incurred in connection with acquisitions payable in annual
installments due from 2000 to 2005 with a weighted
average interest rate of 6.2%, partially secured by purchased assets............ 1,733 2,167
Non-interest bearing installment obligations for covenants not to compete
due from 2000 to 2003 (net of discount of $41), partially
secured by assets purchased in related acquisitions............................ 350 637
Equipment loans from suppliers with interest rates from 7.8% to 18% per annum
due 2000 to 2003, secured by equipment......................................... 299 366
Working capital loan from a supplier with floating interest rate of prime
plus3/4% due 2001, secured by certain accounts receivable....................... 331 500
------- -------
3,254 4,647
Less current portion......................................................... (2,176) (2,150)
------ ---------
$ 1,078 $ 2,497
======= ========
</TABLE>
Annual maturities of long-term debt are as follows (in thousands): 2001 -
$2,176; 2002 - $699; 2003 - $386; 2004 - $17; 2005 - $16.
NOTE 7. LINE OF CREDIT
In July 2000, Sonus-USA, Inc. and Sonus-Texas, Inc. entered into a
$2,000,000 revolving line of credit agreement with a commercial bank. The line
of credit matures on June 30, 2001, and bears interest at the bank's prime rate
plus 1/2%, or 10% at July 31, 2000. The amount available for borrowing under the
line of credit was $2,000,000 at July 31, 2000, and there was no amount
outstanding at that date. The line of credit is secured by all accounts
receivable, inventory, chattel paper and general intangibles of Sonus-USA, Inc.
and Sonus-Texas, Inc. At July 31, 2000, the Company was in compliance with all
financial covenants under the line of credit.
NOTE 8. SHAREHOLDERS' EQUITY
SERIES A CONVERTIBLE PREFERRED SHARES
The Company has 2,666,666 Series A Convertible Preferred Shares (the
"Series A Shares") outstanding. The Company originally issued 13,333,333 Series
A Shares in a private placement in December 1997. A one-for-five reverse split
(consolidation) of the Series A Shares was effected in January 2000. All Series
A Share amounts have been restated to reflect the one-for-five reverse split.
The following summarizes certain terms of the Series A Shares:
VOTING RIGHTS. Each Series A Share is entitled to one vote (or such
other number of votes equal to the number of Common Shares into which such
Series A 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 Series A 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 $6.75
per share (the "Base Amount"). As of July 31, 2000, cumulative undeclared
dividends amounted to $2,340,000. All accrued and unpaid dividends will be
forfeited upon the conversion of the Series A 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:
25
<PAGE>
(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");
(b) The Common Shares are traded on a U.S. Principal Market at a daily
closing price greater than $8.00 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
Series A 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 $0.22 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 Series A Shares will not be
counted).
If the Triggering Conditions have not been met by:
(1) January 1, 2003, the dividend rate will thereafter be 15% per annum
of the Base Amount;
(2) January 1, 2004, the dividend rate will thereafter be 18% per annum
of the Base Amount; or
(3) 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 Series A Shares
upon liquidation, the holders of Series A 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 Series A Shares upon liquidation, a
liquidating distribution in an amount equal to the greater of (i) $6.75 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 Series A 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 Series A Shares. After payment of the full
amount of the liquidating distribution to which they are entitled, the holders
of Series A Shares will have no right to any of the remaining assets of the
Company.
OPTIONAL REDEMPTION. The Series A Shares may not be redeemed before
December 24, 2002. Thereafter, the Series A 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) $6.75 per share plus any accrued and unpaid
dividends or (ii) the fair market value of a Series A 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 Series
A Shares. The Series A Shares are not subject to mandatory redemption or any
sinking fund provisions.
CONVERSION RIGHTS. The Series A 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 one Series A
Share 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 Series A Shares, any
accrued and unpaid dividends with respect to such shares will be forfeited. The
Company has the right to force conversion of the Series A Shares, in whole or in
part, upon satisfaction of certain conditions.
SERIES B CONVERTIBLE PREFERRED SHARES
On October 1, 1999, the Company issued 2,500,000 Series B Convertible
Preferred Shares (the "Series B Shares") in a private placement for $10,000,000
in cash. The following summarizes certain terms of the Series B Shares:
VOTING RIGHTS. Each Series B Share is entitled to one vote (or such
other number of votes equal to the number of Common Shares into which such
Series B 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. Cash dividends will accrue on the Series B Shares at an
annual rate of 8% of the conversion price then in effect until November 1, 2004,
increasing in steps thereafter to 18% beginning November 1, 2006, provided that
the Company has met specified quarterly earnings targets. If the Company has not
met the earnings targets by July 31, 2002, dividends will not accrue or be
payable on the Series B Shares. As of July 31, 2000, cumulative undeclared
dividends amounted to $667,000. Upon conversion of the Series B Shares,
26
<PAGE>
any accumulated dividends will be forfeited.
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 Series B Shares
upon liquidation, the holders of Series B 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 Series B Shares upon liquidation, a
liquidating distribution in an amount equal to the conversion rate then in
effect multiplied by (i) the conversion price then in effect plus any accrued
and unpaid dividends or (ii) the amount that would have been distributable to
such holders if they had converted their Series B Shares into Common Shares
immediately prior to such dissolution, liquidation, or winding up, plus any
accrued and unpaid dividends, whichever is greater. 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 Series B Shares. After payment of the full
amount of the liquidating distribution to which they are entitled, the holders
of Series B Shares will have no right to any of the remaining assets of the
Company. The Company will be prohibited from paying cash dividends to holders of
Common Shares unless the accumulated dividends on the Series B Shares have been
paid in full.
OPTIONAL REDEMPTION. The Series B Shares may not be redeemed before
October 1, 2004. Thereafter, the Series B 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 conversion rate then in effect multiplied by (i) the conversion
price then in effect plus any accrued and unpaid dividends or (ii) the fair
market value of a Series B 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 Series B Shares, whichever is
greater. The Series B Shares are not subject to mandatory redemption or any
sinking fund provisions.
CONVERSION RIGHTS. Until October 31, 2000, the Series B Shares are
convertible at the option of the holder on a one-for-one basis into 2,500,000
Common Shares. Because the Company's receivables as of July 31, 1999, that were
collected by July 31, 2000, totaled less than $4,736,000 and the Company has not
yet attained specified quarterly earnings targets, the conversion rate was
adjusted such that the Series B Shares are convertible into 3,722,375 Common
Shares as of the fiscal quarter ended October 31, 2000. The conversion rate is
also subject to adjustment for stock dividends, stock splits, recapitalizations,
and other similar events. In addition, until the Company attains specified
quarterly earnings targets, the conversion rate will increase each fiscal
quarter. The amount of such quarterly adjustments will be based on a factor of
2% of the original purchase price plus the sum of all prior adjustments until
November 1, 2004, increasing in steps thereafter to 4.5% beginning November 1,
2006. Once the Company has met the specified earnings targets for four
consecutive fiscal quarters, no further adjustments in the conversion rate will
be made. The Series B Shares are subject to mandatory conversion at the option
of the Company if certain share price and earnings targets are met.
SHARE PURCHASE WARRANTS
The Company has outstanding share purchase warrants issued in
connection with the Series A Shares to purchase 2,000,000 Common Shares at an
exercise price of $6.75 per share until October 1, 2004. The Company may force
the exercise of the warrants upon satisfaction of all the Triggering Conditions,
except that the Company's net income before income taxes, dividends on the
Series A Shares and the Series B 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 $0.35 instead of $0.22 per fully
diluted Common Share per fiscal quarter.
In August 1998, the Company issued 39,799 Common Shares at $6.25 per
share in connection with the exercise of share purchase warrants issued in
September and December 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 2,500,000 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, 2000 or 1999.
27
<PAGE>
<TABLE>
The activity during the years ended July 31 was as follows:
2000 1999 1998
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
- - -
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- ----- ------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Outstanding - beginning of year 2,028,000 $6.74 1,560,000 $7.54 488,400 $6.41
Granted 853,000 5.20 655,000 5.56 1,138,000 8.12
Exercised -- -- -- -- (12,400) 2.10
Canceled (387,000) 7.09 (187,000) 8.70 (54,000) 9.79
--------- --------- -------
Outstanding - end of year 2,494,000 6.16 2,028,000 6.74 1,560,000 7.54
========= ========= =========
Exercisable at end of year 1,160,953 6.41 808,441 6.54 363,200 5.98
Weighted-average fair value of
options granted during the year 3.42 4.26 8.38
</TABLE>
During the year ended July 31, 2000, the Company cancelled 55,000 stock
options with a weighted-average exercise price of $6.00 per share and reissued
55,000 stock options with a weighted-average exercise price of $5.08 per share.
The reissued stock options have a remaining contractual life of 9.9 years and
are accounted for using variable accounting until exercised, forfeited, or
expire unexercised.
The following table summarizes information about stock options
outstanding at July 31, 2000:
<TABLE>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- -------------------------------------
WEIGHTED- WEIGHTED
NUMBER OUTSTANDING AVERAGE - NUMBER WEIGHTED -
REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF AS OF CONTRACTUAL EXERCISE AS OF EXERCISE
EXERCISE PRICES JULY 31, 2000 LIFE PRICE JULY 31, 2000 PRICE
-------------------- --------------- ---------------- ------------ ------------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
$1.00 --$2.00 60,000 0.39 $1.28 60,000 $ 1.28
2.01-- 3.50 25,000 0.54 3.36 25,000 3.36
3.51-- 5.00 475,000 9.44 4.16 113,451 4.17
5.01-- 6.50 993,000 7.14 5.95 395,502 6.06
6.51-- 8.00 682,400 6.26 6.97 405,700 7.01
8.01-- 9.50 96,000 3.30 8.66 80,000 8.76
9.51 --12.00 162,600 7.51 10.70 81,300 10.70
---------------- ------------------- ---------------- ------------ --------------- ---------------
$1.00--$12.00 2,494,000 6.98 $6.16 1,160,953 $ 6.41
========== ==========
</TABLE>
No compensation cost has been recognized for the Company's stock option
grants to employees under APB No. 25. Total compensation cost recognized in the
statements of operations for options granted to non-employees under SFAS No. 123
during the years ended July 31, 2000, 1999 and 1998, was $26,000, $203,000 and
$0, respectively. Pro forma information regarding net income (loss) and net
income (loss) per share is required under SFAS No. 123 and has been determined
as if the Company had accounted for all 2000, 1999 and 1998 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 2000, 1999, and 1998: risk-free
interest rates of 6.04%, 5.92% and 5.5%, respectively; an expected option life
of 9.59 years, 9.60 years and 7.69 years, respectively; expected volatility of
106%, 90% and 114%, respectively; and dividend yield of zero.
28
<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 No. 123, net loss and
net loss per share would have been as follows:
<TABLE>
2000 1999 1998
---- ---- ----
(in thousands, except per share data)
Net loss applicable to common shareholders:
<S> <C> <C> <C>
As reported $(3,101) $(4,884) $(4,594)
Pro forma (1) $(5,897) $(6,176) $(5,988)
Net loss per share (basic and diluted):
As reported $(0.51) $(0.80) $(0.89)
Pro forma (1) $(0.97) $(1.01) $(1.16)
</TABLE>
(1) SFAS No. 123 applies to awards granted in fiscal years that begin after
December 15, 1994. Consequently, the effects of applying SFAS No. 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 fiscal 1998, 1999, and 2000.
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. and its
subsidiaries file corporate income tax returns in the United States. There is no
provision for income taxes for the years ended July 31, 2000, 1999, and 1998, as
the Company incurred net operating losses.
A reconciliation of the Company's expected tax benefit using the United
States federal statutory income tax rate to the actual effective rate is as
follows:
2000 1999 1998
---- ---- ----
Tax benefit at statutory rate (34)% (34)% (34)%
Adjustment for higher Canadian tax rate 1 -- (1)
Expenses not deductible for tax purposes 7 5 3
State taxes, net of federal (6) (5) (5)
Change in valuation allowance impacting
statement of operations 32 34 37
-- -- --
Tax rate per financial statements ---% ---% ---%
=== === ===
The components of temporary differences that give rise to significant
portions of deferred income taxes are as follows at July 31 (in thousands):
<TABLE>
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 5,371 $ 4,754 $ 2,698
Allowance for doubtful accounts 1,462 364 277
Capitalized financing costs 473 694 980
Other 135 32 15
------ ------ -------
7,441 5,844 3,970
Deferred tax liabilities:
Property and equipment due to
differences in depreciation (609) (83) ---
Goodwill and start-up costs (368) (305) (240)
------- ------- -------
6,464 5,456 3,730
Less valuation allowance $(6,464) $ (5,456) $(3,730)
------- ------- -------
---- ---- ----
======= ======= =======
</TABLE>
29
<PAGE>
At July 31, 2000, the Company had approximate net operating loss
carryforwards for tax purposes which, if not utilized, expire in the years ended
as follows (in thousands):
CANADA UNITED STATES TOTAL
2001 $16 $ --- $16
2002 25 --- 25
2003 429 --- 429
2004 238 --- 238
2005 655 --- 655
2006 482 --- 482
2007 548 --- 548
2009 --- 24 24
2010 --- 29 29
2011 --- 656 656
2012 --- 781 781
2013 --- 3,932 3,932
2019 --- 4,515 4,515
2020 --- 910 910
------ ------- -------
$2,393 $10,847 $13,240
====== ======= =======
A provision of the Internal Revenue Code requires that the utilization
of net operating losses be limited when there is a change of more than 50
percent in ownership of the Company. Such a change occurred in December 1997.
This ownership change may limit the utilization of any United States federal net
operating losses incurred prior to the change in ownership date.
NOTE 10. RELATED PARTY TRANSACTIONS
Gregory J. Frazer, Ph.D., an officer and director of the Company, and
Mr. Frazer's wife were shareholders in certain Hearing Care Associates
corporations that the Company acquired during the fiscal years ended July 31,
1998 and 1997. During the fiscal year ended July 31, 1999, the Company issued a
three-year promissory note to Mr. Frazer in the principal amount of $102,000,
payable in equal quarterly installments, in connection with purchase price
adjustments for hearing care centers previously acquired from Mr. Frazer. The
Company also entered into expanded non-compete agreements with Mr. Frazer and
his wife that pay them a total of $10,758 per month until September 2001. 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.
Mr. Frazer and his wife have the right, until September 30, 2001, to
require the Company to redeem an aggregate of 1,680 of their Common Shares as of
the last day of each calendar quarter at a price of $8.35 per share. The
redemption rights are noncumulative and expire if not exercised as of the end of
any calendar quarter as to such quarter. Pursuant to such redemption rights, the
Corporation redeemed during the fiscal years ended July 31, 2000 and 1999, a
total of 5,040 and 6,720 Common Shares, respectively, from Mr. Frazer and his
wife for consideration of $42,084 and $56,112, respectively.
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, which bore interest at 10% and 7.75%,
respectively, were repaid on July 6, 1999, along with interest of $16,077. 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 $29,187 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 was repaid on March 30, 1999, along with interest at 7.75% per
annum in the amount of $4,287. On March 19, 1998, the Company loaned Mr. Dawson
$32,272, in order to pay taxes incurred as a result of option exercises in April
1996. The current balance of the loan, which matures on December 31, 2000, and
bears interest at 7.75% per annum, is $35,760.
On December 8, 1998, the Corporation loaned Scott E. Klein, President
and Chief Operating Officer of the Company, $100,000 in connection with the
purchase of his primary residence in Portland, Oregon. The loan, which was due
on the earlier of the sale of Mr. Klein's residence in Minnesota or October 31,
1999, was repaid on June 7, 1999, along with interest at 8% in the amount of
$4,000.
On July 21, 1999, Cindy Dawson-Austin, mother of Mr. Dawson, loaned the
Company $500,000 for working capital. The loan, along with interest at 12% per
annum in the amount of $23,342, was repaid on December 10, 1999.
30
<PAGE>
In April 1999, Mr. Dawson purchased from an unrelated party a
convertible note in the principal amount of $492,693 that had been issued by the
Company in October 1996. The note was repaid on December 10, 1999. See Note 4
"Convertible Notes Payable."
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, 2000 (in thousands):
Year ending July 31:
--------------------
2001 $2,039
2002 1,565
2003 1,134
2004 790
2005 292
Thereafter 221
--------
Total minimum lease payments $6,041
========
Rental expense under operating leases was $2,528,000, $2,236,000, and
$1,426,000 for the years ended July 31, 2000, 1999, and 1998, respectively.
CONTINGENT PAYMENTS
The terms of certain of the Company's acquisition agreements provide
for additional consideration to be paid if the acquired entity's revenues or
results of operations exceed certain target levels. Such additional
consideration is paid in cash and is recorded when earned as additional purchase
price. The maximum amount of contingent consideration that the Company may be
required to pay is $294,000 for fiscal 2001 and $507,000 thereafter.
CLAIMS
The Company is a party to various lawsuits and claims incidental to its
business. In the opinion of management, the ultimate disposition of these
matters will not have a material adverse effect on the Company's financial
position, results of operations, or liquidity.
NOTE 13. SEGMENT INFORMATION
The Company adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" during fiscal 1999. In accordance with SFAS
No. 131, the Company has identified one operating segment: the sale and
servicing of hearing instruments and the provision of audiology services
primarily to individual consumers. No customer constituted more than 5% of total
revenues. Revenues by country were as follows for the years ended July 31:
(in thousands) 2000 1999 1998
---- ---- ----
United States $40,353 $30,511 $19,498
Canada 3,606 3,248 2,870
------ ------- -----
Total $43,959 $33,759 $22,368
======= ======= =======
31
<PAGE>
NOTE 14. SUBSEQUENT EVENTS
In August and October of 2000, the Company acquired 4 hearing care
centers in 4 transactions for a total purchase price of $122,000. The Company
has paid $11,000 of the total purchase price in cash, with $25,000 due in
January 2001 and the remainder over a 3-year period. Each transaction was
accounted for as a purchase.
NOTE 15. CANADIAN VERSUS U.S. GAAP
As of July 31, 2000, 1999, and 1998 there were no material differences
between Canadian generally accepted accounting principles ("GAAP") and U.S.
GAAP.
32
<PAGE>
SUPPLEMENTARY DATA: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of
operations for the years ended July 31, 2000, 1999, and 1998 (in thousands,
except per share data):
<TABLE>
Quarter ended
--------------------------------------------------------
October 31, January 31, April 30, July 31,
1999 2000 2000 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $ 10,142 $ 10,494 $ 12,083 $ 11,240
Income (loss) from operations (531) (454) 86 (2,101)
Net income (loss) (585) (445) 111 (2,182)
EBITDA (1) 167 273 842 (1,173)
Net income (loss) per share (basic) $ (0.10) $ (0.07) $ 0.02 $ (0.36)
Net income (loss) per share (diluted) $ (0.10) $ (0.07) $ 0.01 $ (0.36)
Quarter ended
--------------------------------------------------------
October 31, January 31, April 30, July 31,
1998 1999 1999 1999
---- ---- ---- ----
Net revenues $ 7,701 $ 8,486 $ 9,093 $ 8,479
Income (loss) from operations (1,523) (701) 75 (2,686)
Net income (loss) (1,474) (699) 65 (2,776)
EBITDA (1) (1,048) (187) 637 (1,787)
Net income (loss) per share (basic
and diluted) $ (0.24) $ (0.11) $ 0.01 $ (0.46)
Quarter ended
--------------------------------------------------------
October 31, January 31, April 30, July 31,
1997 1998 1998 1998
---- ---- ---- ----
Net revenues $ 5,307 $ 4,109 $ 5,719 $ 7,233
Loss from operations (79) (1,135) (778) (2,906)
Net loss (96) (1,085) (581) (2,832)
EBITDA(1) 198 (812) (429) (2,494)
Net loss per share (basic and diluted) $ (0.02) $ (0.24) $ (0.10) $ (0.49)
</TABLE>
---------------
(1) "EBITDA" is defined as income (loss) from operations plus depreciation and
amortization and 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
33
<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 16, 2000 (the "Proxy
Statement"), under the headings "Section 16(a) Beneficial Ownership Reporting
Compliance" and "2. 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 "Compensation Committee Interlocks and Insider
Participation."
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits are listed in the Exhibit Index on page 36 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, 2000.
34
<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: November 13, 2000 SONUS CORP.
By
/s/ Brandon M. Dawson
--------------------------------------
Brandon M. Dawson
Chairman 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 November 13, 2000.
SIGNATURE TITLE
--------- -----
/s/ Brandon M. Dawson Chairman and Chief Executive Officer and Director
---------------------
Brandon M. Dawson
/s/ Scott Klein President and Chief Operating Officer and Director
----------------------
Scott Klein
/s/ Paul C. Campbell Senior Vice President and Chief Financial Officer
-------------------- (Principal Financial Officer)
Paul C. Campbell
/s/ Douglas A. Pease Controller
--------------- (Principal Accounting Officer)
Douglas A. Pease
A MAJORITY OF OTHER DIRECTORS:
*JOEL ACKERMAN Director
*HAYWOOD D. COCHRANE, JR. Director
* LESLIE H. CROSS Director
*HUGH T. HORNIBROOK Director
*DAVID J. WENSTRUP Director
/s/ Scott Klein
--------------------------------
*By Scott Klein, as attorney-in-fact
35
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION OF EXHIBIT
------ ----------------------
3.1 Articles of Incorporation of the Company. Incorporated by
reference to Exhibit 3.1 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended July 31, 1999 (the
"1999 Form 10-KSB").
3.2 Bylaws of the Company. Incorporated by reference to Exhibit
3.2 to the Company's quarterly report on Form 10-QSB for the
quarter ended January 31, 1999.
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 filed November 25, 1997.
10.2 Securities Purchase Agreement between the Company and Warburg
dated October 1, 1999. Incorporated by reference to Exhibit 4
to the Company's current report on Form 8-K filed October 12,
1999.
10.3 Amended and Restated Warrant Agreement between the Company
and Warburg dated October 1, 1999, and related Amended and
Restated Warrant Certificate dated October 1, 1999.
Incorporated by reference to Exhibit 10.3 to the 1999 Form
10-KSB.
10.4 Form of Convertible Subordinated Note. Incorporated by
reference to Exhibit 10.4 to the 1999 Form 10-KSB.
10.5 1993 Stock Option Plan. Incorporated by reference to
Exhibit 10.26 to the Company's Registration Statement on
Form SB-2 filed March 12, 1997 (File No. 333-23137) (the
"SB-2).*
10.6 Second Amended and Restated Stock Award Plan (as amended
February 11, 2000).*
10.7 Employment Agreement dated October 1, 1996, between
Sonus-USA, and Gregory J. Frazer. Incorporated by reference
to Exhibit 10.28 to the SB-2.*
10.8 Employment Agreement dated December 24, 1997, between the
Company and Brandon M. Dawson. Incorporated by reference to
Exhibit 10.30 to Post-Effective Amendment No. 1, filed
March 5, 1998 to the SB-2.*
10.9 Employment Agreement dated October 30, 1998, between the
Company and Scott Klein. Incorporated by reference to
Exhibit 10.1 to the Company's quarterly report on Form
10-QSB for the quarter ended October 31, 1998.*
10.10 Employment Agreement dated February 11, 2000, between the
Company and Paul C. Campbell. Incorporated by reference to
Exhibit 10 to the Company's quarterly report on Form 10-QSB
for the quarter ended January 31, 2000.*
10.11 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.*
10.12 Promissory Note of Brandon M. Dawson dated March 19, 1998,
as amended, and related Pledge Agreement between the
Company and Mr. Dawson, dated May 1, 1998. Incorporated by
reference to Exhibit 10.11 to the 1999 Form 10-KSB.*
10.13 Noncompetition Agreement dated January 25, 1999, between
Sonus-USA, Inc. and Gregory J. Frazer. Incorporated by
reference to Exhibit 10.15 to the 1999 Form 10-KSB.
10.14 Amendment Agreement effective as of August 1, 1998, by and
between Sonus-USA, Inc. and Gregory J. Frazer. Incorporated
by reference to Exhibit 10.16 to the 1999 Form 10-KSB.
21 The Company's subsidiaries are SONUS-USA, Inc., a
Washington corporation, Sonus- Canada Ltd., a British
Columbia (Canada) corporation, Sonus-Texas, Inc., an Oregon
corporation, and Hear PO Corp., a New Mexico corporation.
23 Consent of KPMG LLP.
24 Power of attorney of certain officers and directors.
27 Financial Data Schedule.
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* Management contract or compensatory plan or arrangement.
36
