<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 22, 1998
REGISTRATION NO. 333-56545
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------------
SCIENTIFIC LEARNING CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 8200 94-3234458
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>
1995 UNIVERSITY AVENUE, SUITE 400
BERKELEY, CA 94704
(510) 665-9700
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
SHERYLE J. BOLTON
CHIEF EXECUTIVE OFFICER
SCIENTIFIC LEARNING CORPORATION
1995 UNIVERSITY AVENUE SUITE 400
BERKELEY, CA 94704
(510) 665-9700
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
JEFFREY S. ZIMMAN NORA L. GIBSON
JULIA L. DAVIDSON RANDALL M. LAKE
JODIE M. BOURDET BARBARA SKAGGS GALLAGHER
ISOBEL A. JONES BROBECK, PHLEGER & HARRISON LLP
COOLEY GODWARD LLP SPEAR STREET TOWER
ONE MARITIME PLAZA, 20TH FLOOR ONE MARKET
SAN FRANCISCO, CA 94111 SAN FRANCISCO, CA 94105
(415) 693-2000 (415) 442-0900
------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
------------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
number for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
SUBJECT TO COMPLETION, DATED JULY 22, 1998
2,400,000 SHARES
[LOGO]
COMMON STOCK
ALL OF THE SHARES OF COMMON STOCK OFFERED HEREBY ARE BEING OFFERED BY
SCIENTIFIC LEARNING CORPORATION (THE "COMPANY"). PRIOR TO THIS OFFERING (THIS
"OFFERING"), THERE HAS BEEN NO PUBLIC MARKET FOR THE COMMON STOCK OF THE
COMPANY. IT IS CURRENTLY ESTIMATED THAT THE INITIAL PUBLIC OFFERING PRICE WILL
BE BETWEEN $12.00 AND $14.00 PER SHARE. SEE "UNDERWRITING" FOR A DISCUSSION OF
THE FACTORS TO BE CONSIDERED IN DETERMINING THE INITIAL PUBLIC OFFERING PRICE.
THE COMPANY HAS APPLIED TO HAVE THE COMMON STOCK APPROVED FOR QUOTATION ON THE
NASDAQ NATIONAL MARKET UNDER THE SYMBOL "SCIL."
SEE "RISK FACTORS" COMMENCING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
--------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
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- ----------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT (1) COMPANY (2)
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------
PER SHARE..................................... $ $ $
TOTAL (3)..................................... $ $ $
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</TABLE>
(1) SEE "UNDERWRITING" FOR INFORMATION CONCERNING INDEMNIFICATION OF THE
UNDERWRITERS AND OTHER MATTERS.
(2) BEFORE DEDUCTING EXPENSES PAYABLE BY THE COMPANY, ESTIMATED AT $750,000.
(3) THE COMPANY AND THE SELLING STOCKHOLDERS HAVE GRANTED TO THE UNDERWRITERS A
30-DAY OPTION TO PURCHASE UP TO 166,342 AND 193,658 ADDITIONAL SHARES OF
COMMON STOCK, RESPECTIVELY, SOLELY TO COVER OVER-ALLOTMENTS, IF ANY. IF THE
UNDERWRITERS EXERCISE THIS OPTION IN FULL, THE TOTAL PRICE TO PUBLIC,
UNDERWRITING DISCOUNT, PROCEEDS TO COMPANY AND PROCEEDS TO SELLING
STOCKHOLDERS WILL BE $ , $ , $ AND $ ,
RESPECTIVELY. SEE "UNDERWRITING."
THE SHARES OF COMMON STOCK ARE OFFERED BY THE SEVERAL UNDERWRITERS NAMED
HEREIN, SUBJECT TO RECEIPT AND ACCEPTANCE BY THEM AND SUBJECT TO THEIR RIGHT TO
REJECT ANY ORDER IN WHOLE OR IN PART. IT IS EXPECTED THAT DELIVERY OF THE
CERTIFICATES REPRESENTING SUCH SHARES WILL BE MADE AGAINST PAYMENT THEREFOR AT
THE OFFICE OF NATIONSBANC MONTGOMERY SECURITIES LLC ON OR ABOUT , 1998.
--------------------------
NationsBanc Montgomery Securities LLC
BancAmerica Robertson Stephens
Pacific Growth Equities, Inc.
, 1998
<PAGE>
INSIDE FRONT COVER OF PROSPECTUS: [Contains a collage of three photographs
of children using Fast ForWord, one of which also shows a speech and language
professional assisting the child. Text in the upper left corner of the page
states "Language Takes Us Everywhere-TM-" and the Fast ForWord logo appears in
the bottom right corner.]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED
HEREBY, INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. THESE TRANSACTIONS MAY BE EFFECTED ON
THE NASDAQ NATIONAL MARKET OR OTHERWISE AND, IF COMMENCED, MAY BE DISCONTINUED
AT ANY TIME. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING
ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THE INFORMATION
CONTAINED IN THIS PROSPECTUS: (i) GIVES EFFECT TO THE CONVERSION OF ALL OF THE
COMPANY'S PREFERRED STOCK INTO COMMON STOCK ON A ONE-FOR-ONE BASIS PRIOR TO
COMPLETION OF THIS OFFERING AND (ii) ASSUMES THAT THE UNDERWRITERS'
OVER-ALLOTMENT OPTION IS NOT EXERCISED. THIS PROSPECTUS CONTAINS FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS PROSPECTUS. FACTORS THAT MAY
CAUSE OR CONTRIBUTE TO SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN "RISK FACTORS," AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS
PROSPECTUS.
THE COMPANY
The Company develops, markets and sells proven, neuroscience-based education
and training programs designed to increase human learning and performance. The
Company's initial product, Fast ForWord, is an intensive, computer-based
training program that focuses on improving critical pre-reading skills,
including receptive and expressive communication skills, in children with
language-based learning problems. The program, which to date has been used by
approximately 5,500 children, modifies and emphasizes characteristics of speech
and sound so that they can be more readily differentiated and processed. Through
thousands of repetitions, the program enables children to master the essential
building blocks, or "phonemes," of the English language and facilitates the
learning of other critical language skills, such as morphology (the system of
word formation), syntax and grammar, and executive function skills, such as
short-term memory and event sequencing capabilities.
The Fast ForWord program typically lasts from four to eight weeks and
consists of 100 minutes per day of training for five days per week under the
supervision of a teacher, speech and language professional, parent or other
learning facilitator trained in the use of the program. Fast ForWord measures
the child's responses during each exercise and continually adjusts and adapts
the program to challenge each individual child appropriately with customized
training. In addition, because the results from each child's Fast ForWord
exercises are compiled daily in a central database via the Internet, Fast
ForWord is able to automatically generate up-to-date performance charts and
templates, enabling the learning facilitator to monitor the child's progress on
a daily basis. Delivered through a variety of distribution channels, including
public schools, speech and language professionals in private practice and
Company-operated learning centers ("Learning Centers"), Fast ForWord is designed
to support teachers, speech and language professionals, parents and other
learning facilitators in providing a program that can be integrated with school
curricula and other language programs to assist children in overcoming
language-based learning challenges and provide a foundation for language skills
and academic learning.
Humans are born with the potential to learn any language, and one of a
child's early tasks is to learn to extract meaning from speech by identifying
its basic auditory building blocks, or phonemes. In the first 12 to 16 months of
a child's development, the brain learns to recognize the phonemes that are
relevant to the child's native language. Studies have shown that approximately
20% of children have significant reading difficulties, most of which can be
attributed to difficulty in acquiring, retaining and manipulating phonemes.
According to industry sources, 20% of all children in the United States have
significant language-based learning difficulties. Extrapolating from U.S.
Department of Commerce, Bureau of the Census data, this figure represents
approximately 8,000,000 children between the ages of four and 13. The Company
believes that approximately 800,000 children in the United States enter this
category each year and that their language-based learning problems result in
part from the inability to make reliable distinctions among certain elements of
speech.
Based upon decades of independent neuroscience research on the brain's
ability to adapt to certain stimuli, Fast ForWord uses computer-controlled,
repetitive and adaptive training exercises to modify the manner in which the
brain processes language. In formal and widely noted research studies, as
published in
3
<PAGE>
the peer-reviewed journal SCIENCE in January 1996, the Company's founding
scientists from the University of California at San Francisco ("UCSF") and
Rutgers, The State University of New Jersey ("Rutgers") demonstrated that
children with language-based learning problems could significantly improve their
language skills through such exercises. The Company has sponsored two field
trials involving approximately 1,000 children with language-based learning
problems. Participants on average achieved improvement of one to two years in
language processing and related skills after completion of the Fast ForWord
program in four to eight weeks. The Company believes that similar improvements,
if achievable at all through traditional remediation programs, have typically
required several years. In addition, Fast ForWord has successfully produced
broad results. More than 80% of the children who completed the Company-sponsored
field trials were identified by standardized tests as having language-based
learning problems. Of such children, 90% have made statistically significant
gains on one or more standardized tests of critical language skills.
The Company's goal is to establish itself as the leading provider of proven,
neuroscience-based education and training products and services focused
specifically on language-based learning problems and on other neurologically
based challenges faced by children and adults. The Company plans to
substantially increase its penetration into the over 100,000 schools in the
United States with students in kindergarten through high school by expanding its
direct marketing programs, pursuing district level school contracts and
increasing the number of schools acting as reference sites for Fast ForWord. The
Company also intends to increase its marketing directly to speech and language
professionals in private practice and parents. Furthermore, the Company intends
to develop new products based on practical applications of neuroscience
research, including additional language-based products. The Company is currently
field testing a beta version of Fast ForWord Two for children who have completed
Fast ForWord and are ready for a program that focuses on more advanced
pre-reading skills. The Company is also developing other language-based
products, including an English-as-a-Second-Language ("ESL") program for foreign
students and for adults, an adult version of Fast ForWord and an assessment or
screening test for language-based learning problems. In addition, the Company is
evaluating foreign language versions of Fast ForWord and a program to assist
stroke victims in reacquiring language skills. By adhering to proven research,
rigorously testing its products and publishing the results and communicating the
efficacy of its products and services, the Company intends to become a trusted
name in education and training.
The Company was incorporated in 1995 in the State of California under the
name "Scientific Learning Principles Corporation" and was reincorporated in 1997
in the State of Delaware under its present name. The Company commenced
operations in February 1996 and is an early stage company with a history of
operating losses. The Company's principal executive office is located at 1995
University Avenue, Suite 400, Berkeley, California 94704 and its telephone
number is (510) 665-9700.
RISK FACTORS
The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors."
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company............................. 2,400,000 shares
Common Stock to be outstanding after the Offering............... 11,671,893 shares (1)
Use of proceeds................................................. Sales and marketing, research and
product development, repayment of
indebtedness and other general
corporate purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol.......................... SCIL
</TABLE>
- --------------------------
(1) Based on the number of shares outstanding as of June 30, 1998. Excludes: (i)
1,611,498 shares of Common Stock issuable upon exercise of options and
warrants outstanding as of June 30, 1998 with a weighted average exercise
price of $0.65 per share; (ii) 2,800,000 shares of additional Common Stock
reserved for issuance under the Company's 1998 Equity Incentive Plan; (iii)
100,000 shares of Common Stock reserved for issuance under the Company's
1998 Non-Employee Directors' Stock Option Plan; and (iv) 500,000 shares of
Common Stock reserved for issuance under the Company's 1998 Employee Stock
Purchase Plan. See "Management--Employee Benefit Plans," "Certain
Transactions" and "Description of Capital Stock."
5
<PAGE>
SUMMARY FINANCIAL DATA
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31, SIX MONTHS ENDED JUNE 30,
-------------------- -------------------------
1996 1997 1997 1998
--------- --------- --------- --------------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................................... $ -- $ 2,962 $ 689 $ 1,800
Gross profit..................................................... -- 2,013 366 1,333
Operating loss................................................... (2,611) (5,135) (2,241) (4,240)
Net loss......................................................... (2,497) (5,058) (2,190) (4,272)
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------------------
AS ADJUSTED
ACTUAL (1)
--------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit).............................................................. $ (2,019) $ 26,247
Total assets........................................................................... 3,844 32,110
Long-term debt, including current portion.............................................. 1,090 --
Redeemable convertible preferred stock................................................. 8,002 --
Stockholders' equity (deficit) (2)..................................................... (8,232) 28,036
</TABLE>
- --------------------------
(1) As adjusted to reflect the conversion of outstanding Preferred Stock into
5,098,252 shares of Common Stock upon completion of this Offering, the sale
of 2,400,000 shares of Common Stock offered hereby at an assumed initial
public offering price of $13.00 per share after deducting underwriting
discounts and estimated offering expenses and the application of the
estimated net proceeds therefrom. See "Use of Proceeds" and
"Capitalization."
(2) The Company has paid no cash dividends since its inception.
6
<PAGE>
RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO THE OTHER
INFORMATION SET FORTH IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE
CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE
PURCHASING ANY OF THE SHARES OF COMMON STOCK OF THE COMPANY. THIS PROSPECTUS
CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION, STATEMENTS OF THE COMPANY'S PLANS,
OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE CAUTIONARY STATEMENTS MADE IN THIS
PROSPECTUS SHOULD BE READ AS BEING APPLICABLE TO ALL FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS PROSPECTUS. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE DISCUSSED IN THIS PROSPECTUS. FACTORS THAT MAY CAUSE OR
CONTRIBUTE TO SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS.
UNCERTAINTY OF MARKET ACCEPTANCE. The Company's future success is, in part,
dependent on acceptance of Fast ForWord by public schools, administrators,
teachers, speech and language professionals, parents and other learning
facilitators. Market acceptance of Fast ForWord may depend on a number of
factors, including, among others: (i) continued demonstration of efficacy and
acceptance of the Company's efficacy results; (ii) willingness of learning
facilitators to adopt new teaching and training methods; (iii) cost of the
Company's programs and of alternative remediation programs; (iv) availability of
government funding; (v) competitive developments; (vi) ability to incorporate
the Fast ForWord program into traditional school programs; (vii) evolving
technology and standards; and (viii) access to and ability to use the Internet
and required computer equipment. The inability of the Company to achieve and
maintain market acceptance, and increase the number of programs sold would
adversely affect the Company's business, financial condition and results of
operations. See "Business--Sales and Marketing."
CHALLENGES TO MARKET PENETRATION. The Company began selling Fast ForWord to
public schools in May 1997 and has not yet derived a significant amount of
revenues from sales to public schools. The Company believes that its ability to
penetrate the public school market will depend, among other things, on its
ability to attract and retain experienced sales personnel, gain access to
educators and other key public school decision-makers and convince them to
implement Fast ForWord, which represents a fundamental shift in the manner of
addressing language-based learning problems. In addition, the Company believes
that schools and teachers may find it difficult to incorporate the intensive
Fast ForWord training program, which is designed to be used for 100 minutes per
day, five days per week, into traditional school programs. The Company believes
that its success in the public schools market will, in part, depend on the
Company developing ways for teachers to more easily incorporate Fast ForWord
into traditional school programs, as to which there can be no assurance.
Fast ForWord represents a substantial change in the way speech and language
professionals operate their private practices. For example, most speech and
language professionals in private practice have not traditionally used computers
or other technology in their practices. The Company believes that to achieve
success in the private practice speech and language professional market, the
Company must, among other things, show speech and language professionals in
private practice that technology, and Fast ForWord in particular, can improve
their practices and that the related expenditure on training is a worthwhile
investment. In addition, the Company must convince speech and language
professionals that its programs are a tool which can be used to supplement their
practice, rather than a competitive threat. Furthermore, the Company believes
that in order to increase the number of programs sold through speech and
language professionals, the Company will need to demonstrate to speech and
language professionals the effectiveness of supervising multiple clients at a
time. There can be no assurance that the Company will be successful in further
penetrating the private practice speech and language professional market.
To date, the Company has had limited experience in selling Fast ForWord
directly to parents. Distribution channels involved in sales to parents may
include Learning Centers, as well as the "at-home" education market. The Company
opened its first eight Fast ForWord Learning Centers in 1998 and has had minimal
revenues to date from such centers. The success of the Learning Centers depends,
in part, on the Company's ability to: (i) identify suitable locations for the
Learning Centers and successfully negotiate
7
<PAGE>
lease or purchase agreements that are beneficial to the Company; (ii) generate
sufficient student attendance at each Learning Center; and (iii) hire and train
high-quality employees to staff each Learning Center. Additionally, the Company
believes that its ability to penetrate the parental market will depend, in part,
on its ability to develop a "remote" or "at-home" course that can be delivered
by video, CD-ROM and/or the Internet for the training of parents in the
supervision and administration of Fast ForWord. There can be no assurance that
the Company will successfully develop distance-based training programs for
parents and other learning facilitators. In addition, the Company believes that
success in selling Fast ForWord to parents will depend upon word-of-mouth
referrals among parents based on their own experiences, which the Company
expects will take considerable time to develop, and there can be no assurance
that such referrals will develop in a rapid or substantial manner, if at all.
See "Business--Sales and Marketing."
RELIANCE ON A SINGLE PRODUCT. Fast ForWord, including the training of
various professionals in the administration and supervision of the program, has
accounted for substantially all of the Company's revenues since inception, and
the Company anticipates that its revenues will continue to be substantially
derived from Fast ForWord and related programs for the foreseeable future.
Historically, the substantial majority of program revenues have been
attributable to sales to speech and language professionals in private practice,
and the Company has only recently begun to sell programs and services to public
schools. Failure to increase sales of the Company's Fast ForWord training
program and to successfully introduce additional programs would have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business--Sales and Marketing."
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; SEASONALITY. The Company's
quarterly operating results have varied significantly in the past and are
expected to fluctuate significantly in the future as a result of a variety of
factors, many of which are beyond the Company's control. Factors that may affect
the Company's quarterly operating results include among others: (i) demand for
technology-based education and training products; (ii) size and timing of
product orders and implementation; (iii) revenue mix between products and
services; (iv) timely development, introduction and market acceptance of the
Company's existing and future products, if any; (v) pricing of the Company's
programs and services; (vi) number and timing of Learning Center openings and
closings; (vii) terms under which Learning Centers are operated; (viii)
competitive conditions; (ix) ability to attract and retain experienced
personnel; (x) availability of government funding for public schools; (xi)
public school calendars and budget cycles; (xii) number and timing of Fast
ForWord training seminars for learning facilitators; and (xiii) general economic
and market conditions. The Company's limited operating history and the emerging
nature of its market make prediction of future revenues and expenses difficult.
The Company's expense levels are based in part on its expectations as to future
revenues and to a large extent are fixed in the short term. There can be no
assurance that the Company will be able to predict its future revenues
accurately and the Company may be unable to adjust spending in a timely manner
to compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall of revenues in relation to the Company's expectations could cause
significant fluctuations in quarterly operating results, which would have an
adverse effect on the Company's business, financial condition and results of
operations.
Demand for the Company's programs and services is subject to certain
seasonal influences which can vary depending on the distribution channel being
employed. The Company does not have sufficient operating experience in its
various distribution channels to predict the overall effect of various seasonal
factors and their effect on future quarterly operating results. The Company
believes that, because of the intensive nature of Fast ForWord, demand for its
programs from speech and language professionals in private practice may be lower
during the school year than in the summer. The Company's strategy to place Fast
ForWord Learning Centers in private schools and take advantage of unused
capacity during summers may further amplify this effect. Certain of the
Company's eight current Fast ForWord Learning Centers are expected to operate
only during the summer and, to date, the Company has no contracts extending
through the school year for the five Learning Centers currently established in
private schools. To the extent the
8
<PAGE>
Company penetrates the public school market, the Company may experience
seasonality due to public school calendars and budget cycles.
Due to all of the foregoing factors, the Company's quarterly revenues and
operating results are difficult to forecast, and the Company believes that
period-to-period comparisons of its operating results will not necessarily be
meaningful and should not be relied upon as an indication of future performance.
It is likely that the Company's operating results will fall below the
expectations of the Company, securities analysts or investors in some future
quarter. In such event, the trading price of the Common Stock would likely be
materially and adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
HISTORY OF OPERATING LOSSES; LIMITED OPERATING HISTORY. The Company
commenced operations in February 1996 and began generating revenues in first
quarter 1997. Because the Company has generated limited revenues to date, it has
incurred significant operating losses and negative cash flow since inception.
The Company has an accumulated deficit of approximately $11.8 million from
inception through June 30, 1998 and expects to incur additional losses for at
least the next two years, due primarily to substantial increases in sales and
marketing and research and development expenses. There can be no assurance that
the Company will ever generate sufficient revenues to achieve or sustain
profitability or generate positive cash flow. There can be no assurance that the
Company's cash resources following this Offering will be sufficient to fund the
Company's negative cash flow and expected capital expenditures for this period.
The Company, therefore, may need to obtain additional equity or debt financing
in the future. There can be no assurance that the Company will be able to obtain
the additional financing to satisfy its cash requirements on acceptable terms or
at all.
The Company has only a limited operating history upon which to base an
evaluation of its current business and prospects. The Company's prospects must
be considered in light of the risks and uncertainties frequently encountered by
companies in the early stage of development, particularly companies in new and
rapidly evolving markets such as neuroscience-based learning products. Such
risks include, but are not limited to: the demand for technology-based learning
products; the management of growth; demand for the Company's programs and
services; the ability of the Company to penetrate its target markets; and
competition. To address these risks, the Company must, among other things:
successfully gain market acceptance for Fast ForWord, particularly in the public
school market; successfully introduce and gain market acceptance for related new
products and services; respond to competitive developments; attract, integrate,
retain and motivate qualified personnel, particularly sales and marketing
professionals; and address new or evolving technologies and standards. There can
be no assurance that the Company will be successful in addressing such risks and
the failure to do so would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
FUTURE DEPENDENCE ON GOVERNMENT FUNDING; UNCERTAINTY ASSOCIATED WITH
"PULLOUT" PROGRAMS. To date, the Company has generated limited revenues from
sales to public schools. However, the Company's future revenues are dependent,
in part, on its ability to increase revenues from public schools, which in turn
are largely dependent upon federal, state and local government funding. Federal
funding for educational technology has been made available through certain
legislation, including Title I of the Elementary and Secondary Education Act of
1965, as amended ("Title I"), and the education rate discount authorized by the
Telecommunications Act of 1996 ("E-Rate"), and many states have enacted similar
legislation. Substantial curtailments, delays or reductions in government
budgets or funding for educational software or technology would have a material
adverse effect on the Company's business, financial condition and results of
operations. Although Fast ForWord can be implemented on a school-wide basis, to
date the program has been used by students in a separate classroom using a
"pullout" approach. Many educators and policy makers are critical of programs
which use a "pullout" approach, which may inhibit acceptance of the Fast ForWord
program.
9
<PAGE>
MANAGEMENT OF GROWTH AND EXPANSION. The Company has recently experienced a
period of significant expansion. The Company's historical growth has placed, and
any further growth would place, a significant strain on the Company's
managerial, operational, financial and other resources. The Company has grown
from five employees at March 31, 1996 to 113 employees at June 30, 1998. During
this period, the Company significantly expanded its operations, introduced Fast
ForWord and opened its first Fast ForWord Learning Centers. The Company has
limited experience in opening and operating Learning Centers, and there can be
no assurance it will be successful in opening and operating additional Learning
Centers. The Company's future success will depend, in part, upon the ability of
its senior management to manage growth effectively, which will require the
Company to implement additional management information systems, to develop
further its operating, administrative, financial and accounting systems and
controls and to maintain close coordination among its accounting, finance,
marketing, sales, customer support and professional services organizations. The
failure of the Company to successfully manage its growth could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON CONTINUED PRODUCT DEVELOPMENT. The Company's future success
will depend to a significant extent on its ability to enhance its existing
programs and develop new programs, including Fast ForWord Two, a more advanced
pre-reading skills sequel to Fast ForWord, and additional products based on the
Company's proprietary technology. There can be no assurance that: (i) the
Company will be successful in developing and marketing new language-based
products, including enhancements to Fast ForWord if any, or new products that
address new market segments or respond to technological developments, evolving
industry standards or changing customer requirements; (ii) that the Company will
not experience difficulties that could delay or prevent the successful
development, introduction and sale of such new products; or (iii) such new
products will adequately meet the requirements of the marketplace and achieve
any significant degree of market acceptance. If release of any new products is
delayed or if these products fail to achieve market acceptance when released,
the Company's business, financial condition and results of operations could be
materially adversely affected. In addition, the introduction or announcement of
new product offerings, including enhancements if any, by the Company or the
Company's competitors or major hardware, systems or software vendors may cause
customers to defer or forgo purchases of the Company's products, which could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, the Company attempts to maintain high
standards for the demonstrated clinical efficacy of its products. The Company's
adherence to these standards could delay or inhibit the introduction of new
products. Moreover, there can be no assurance that the Company's products will
not be rendered obsolete or that the Company will have sufficient resources to
make the necessary investments or be able to develop and market the products
required to maintain its competitive position. See "Business--Research and
Development."
DEPENDENCE ON PROPRIETARY TECHNOLOGY. The Company's ability to compete
effectively will depend in part on its ability to develop and maintain the
proprietary aspects of its technology and operate without infringing on the
proprietary rights of others. The Company relies on a combination of patents,
trademarks, copyrights, trade secret laws, confidentiality procedures and
contractual provisions to protect its proprietary rights in its products and
technology. The Company has filed patent applications in the United States and
internationally relating to its technology, including 30 with the United States
Patent and Trademark Office ("USPTO"). Additionally, the Company is the
exclusive licensee of the technology owned by UCSF and Rutgers with respect to
the basic speech and sound modification algorithms used in Fast ForWord pursuant
to a licensing agreement (the "University License") with the Regents of the
University of California (the "Regents"). The licensed technology is the subject
of a pending patent application. There can be no assurance that any of the
Company's or its licensor's pending patent applications will result in the
issuance of any patents, or that, if issued, any such patents will offer
protection against competitors with similar technology. There can be no
assurance that any patents issued to the Company or its licensors will not be
challenged, invalidated or circumvented in the future or that the rights created
thereunder will provide a competitive advantage. The Regents may terminate the
University License if the Company fails to perform or violates its terms, and
fails to cure such violation within 60 days of the Regents' written notice
thereof. Such termination could occur if the Company fails to make royalty
10
<PAGE>
and milestone payments or to perform other obligations under the agreement,
including providing periodic progress reports, preparing, filing and prosecuting
U.S. and foreign patent applications, providing indemnification, insuring its
activities in connection with work under the agreement, maintaining the
confidentiality of information received from the Regents relating to the
agreement, and similar terms customary under licensing agreements with academic
institutions. Additionally, the University License terminates upon the
expiration of the last-to-expire patent licensed under the agreement or if all
patent applications licensed under the agreement are abandoned and no patent
ever issues. The Company may terminate the University License at any time by
giving written notice of its intent to do so, and the termination will take
effect 60 days from the effective date of such notice. The loss or inability to
maintain the University License could delay the Company's introduction of new
products or cause the recall of products from the market, which would have a
material adverse effect on the Company's business, financial condition and
results of operations. In such event, even if the Company could identify and
license technology equivalent to the technology covered by the University
License, development and integration of such alternative technology would be
likely to delay the Company's product line, which would have a material adverse
effect on the Company's business, operating results and financial condition. In
addition, there can be no assurance that competitors, many of whom have
substantially greater resources than the Company and have made substantial
investments in competing technologies, will not seek to apply for and obtain
patents covering technologies that are more effective than the Company's
technologies, that would render the Company's technologies or products obsolete
or uncompetitive or that would prevent, limit or interfere with the Company's
ability to make, use or sell its products either in the United States or in
international markets.
The technology industry has been characterized by extensive litigation
regarding patents and other intellectual property rights. There can be no
assurance that the Company will not in the future become subject to patent
infringement claims and litigation or interference proceedings conducted in the
USPTO to determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings and related legal
and administrative proceedings are both costly and time consuming. Litigation
may be necessary to enforce any patents issued to the Company, to protect trade
secrets or know-how owned by the Company or to determine the enforceability,
scope and validity of the proprietary rights of others. Any litigation or
interference proceedings will result in substantial expense to the Company and
significant diversion of effort by the Company's technical and management
personnel. An adverse determination in litigation or interference proceedings to
which the Company may become a party could subject the Company to significant
liabilities to third parties or require the Company to seek licenses from third
parties which may not be available on commercially reasonable terms or at all.
The Company's current products incorporate technologies which are the
subject of patents issued to, and patent applications filed by, others. The
Company has obtained licenses for certain of these technologies and may be
required to obtain licenses for others. There can be no assurance that the
Company will be able to obtain licenses for technology patented by others on
commercially reasonable terms, or at all, that it will be able to develop
alternative approaches if unable to obtain licenses or that the Company's
current and future licenses will be adequate for the operation of the Company's
business. The failure to obtain such licenses or identify and implement
alternative approaches could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its trade secrets, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Intellectual Property."
RISK OF PRODUCT DEFECTS; PRODUCT CLAIMS. Software programs frequently
contain errors or failures, especially when first introduced or when new
versions are released. The Company could, in the future, lose revenues as a
result of software errors or defects. There can be no assurance that, despite
testing by the
11
<PAGE>
Company and by current and potential customers, errors will not be found in new
products or releases, whether before or after commencement of commercial
shipments, resulting in loss of revenue or delay in market introduction or
acceptance, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which could have a
material adverse effect upon the Company's business, financial condition and
results of operations. The Company has recently adopted a refund policy under
which the Company currently provides a refund in the event that a child's
performance on Fast ForWord indicates (based on criteria provided by the Company
in the policy) that the program is too difficult or too easy for the child. In
the school setting, the school is entitled to enroll a new child in the program,
rather than receive a refund. While the Company does not expect this policy to
have a material effect on its operations, the Company has limited experience
with this policy, and there can be no assurance that it could not have a
material adverse effect in the future on the Company's business, financial
condition and results of operations. The Company markets products to the public
and faces an inherent business risk of financial exposure to product liability
claims. In addition, to the extent the Company provides professional or similar
services, the Company may also face a risk of exposure to professional liability
claims. The Company currently carries product and professional liability
insurance that, in general, covers product and professional liability claims up
to the policy limits. There can be no assurance that such insurance will
continue to be available to the Company at a reasonable cost, if at all, or that
such insurance will be adequate to satisfy any liability or litigation expenses.
Any claim or claims against the Company, regardless of their merit or eventual
outcome, could have a material adverse effect on the Company's business,
financial condition and results of operations.
LENGTHY SALES CYCLE. The use of the Company's programs and services
generally requires the Company to provide a significant level of education to
prospective speech and language professionals, schools, parents and other
learning facilitators regarding the use and benefits of the Company's programs
and services. In addition, the Company's programs involve a significant
commitment of time and resources, and, with respect to the public schools
market, are subject to school budget cycles. For these and other reasons, the
period between initial contact and the implementation of the Company's programs
and services may be lengthy and is subject to a number of significant delays
over which the Company has little or no control. The Company's sales cycle could
be lengthened as it targets school- and district-wide sales. Delay in the sale
or implementation of a limited number of sales transactions could have a
material adverse effect on the Company's business, financial condition and
results operations and cause the Company's operating results to vary
significantly from quarter to quarter. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business--Sales and
Marketing."
OPPOSING SCIENTIFIC THEORIES. The Company's first product, Fast ForWord, is
based on particular theories of neuroscience and language acquisition. The
Company's founders are prominent in their academic fields and are actively
involved in academic debate about their own and opposing scientific theories of
neuroscience and language acquisition. As a result, the theories on which Fast
ForWord is based have been, and are likely to be, subject to public debate and
challenges. Future publications, if any, regarding the Company's field trial
results may engender additional public debate and challenge. Although the
Company believes that the Fast ForWord program is based primarily upon
non-controversial scientific theories, some of the principles and methodologies
underlying and associated with the Company's products are opposed by certain
academicians and educators. Some of the philosophical opponents of these certain
principles and methodologies, particularly to the extent they author
publications, could influence the market for the Company's products and
services. Consequently, academic publications and debate challenging the
theories of neuroscience and language acquisition propounded by the founders and
others could significantly affect the market for the Company's programs and
services and could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Programs and
Services."
ADOPTION OF INTERNET SOLUTIONS. One of the key features of Fast ForWord is
its daily uploading and downloading of information to and from the Company's
proprietary database via the Internet. The Internet has experienced, and may
continue to experience, significant growth in the number of its users
12
<PAGE>
and amount of traffic. There can be no assurance that the Internet
infrastructure will continue to support the demands placed on it by this
continued growth or that the performance or reliability of the Internet will not
be adversely affected by this continued growth. In addition, the Internet could
lose its viability due to delays in the development or adoption of new standards
and protocols to handle increased levels of activity or due to increased
governmental regulation. Changes in or insufficient availability of
communications services to support the Internet could result in slower response
times and could adversely affect their usage. If the use of the Internet,
particularly within schools and among speech and language professionals in
private practice, fails to develop or develops more slowly than expected, or if
the Internet infrastructure does not adequately support continued growth, the
Company's business, financial condition and results of operations would be
materially and adversely affected. See "Business--Computer Technology."
COMPETITION. The educational technology market in which the Company
operates is very competitive. The Company competes primarily against providers
of traditional methods of remediation for language-based learning problems,
which typically require several years of one-on-one training for children with
identified language-based learning problems. Although the traditional approach
to language-based learning problems is fundamentally different from the approach
taken by the Company, such programs are more widely known and accepted and,
therefore, represent significant competition. In addition, the Company competes
to some extent with other companies offering educational software products to
schools and speech and language professionals in private practice and with other
operators of learning centers. Existing competitors may continue to broaden
their product lines, and potential competitors, including large software
developers and educational publishers, may enter or increase their focus on the
school market, resulting in greater competition for the Company. Moreover, the
Company expects that it will face additional competition from new entrants into
the market. Many competitors have substantially greater technical, marketing and
distribution resources than the Company. There can be no assurance that the
Company will continue to be able to market its products successfully or compete
effectively in the educational technology market. See "Business--Competition."
DEPENDENCE ON KEY PERSONNEL; ABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL. The Company's success depends to a significant extent upon the
continued active participation of certain key members of management. The loss of
one or more of these persons could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
believes that its future success will depend upon its ability to continue to
attract, motivate and retain highly-skilled managerial, sales and marketing, and
product development personnel. Competition for such personnel is intense. The
failure to attract or retain the necessary personnel, as to which there can be
no assurance, would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Employees."
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field and cannot distinguish century dates prior to January 1, 2000 from dates
on and after January 1, 2000. These date code fields will need to distinguish
dates prior to January 1, 2000 from dates on and after January 1, 2000 dates
("Year 2000 Compliance") and, as a result, many companies' software and computer
systems may need to be upgraded or replaced in order to reach Year 2000
Compliance. Although the Company believes that its products and internal systems
are in Year 2000 Compliance, the Company utilizes third-party equipment and
software that may not be in Year 2000 Compliance. Failure of such third-party
equipment or software to be in Year 2000 Compliance could require the Company to
incur unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Furthermore, the purchasing patterns of customers or potential
customers may be affected by Year 2000 Compliance issues as educational
institutions expend significant resources to correct their current systems for
Year 2000 Compliance. These expenditures may result in reduced funds available
to purchase products and services, such as those offered by the Company, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
13
<PAGE>
IMPACT OF GOVERNMENT REGULATION. The Company's business is potentially
subject to or affected by a variety of federal, state and local laws and
regulations, including, without limitation laws and regulations relating to: (i)
education; (ii) licensing of speech and language professionals in private
practice and delivery of speech and language testing and remediation services;
(iii) consumer protection and anti-fraud and related protections, including the
regulation of referrals by professionals; and (iv) government funding.
Compliance with these and other laws and regulations impose additional costs on
the conduct of the Company's business, and failure to comply with such laws and
regulations, changes in such laws and regulations, or in their applicability to
the business of the Company may impose additional costs, and could materially
and adversely affect the Company's business, financial condition and results of
operations. While the Company has not expressly agreed to grant any distribution
territory or franchise to any person or entity and believes that it is not
currently subject to the laws regulating distributors or franchisors, in the
future the Company may make such distribution or franchise arrangements, or may
be deemed to have made such arrangements, and could, as a result, be subject to
laws regulating distributors or franchisors. Such regulation could materially
and adversely affect the Company's business, financial condition and results of
operations. In addition, while the Company has been advised on an unofficial
basis by officials of the United States Food and Drug Administration ("FDA")
that Fast ForWord is an educational tool not subject to FDA regulation, there
can be no assurance that the FDA will not make a contrary determination in the
future with respect to Fast ForWord or other products under development by the
Company. Such regulation could, among other effects, impose numerous additional
requirements on the marketing of the Company's products, cause delays in
bringing products to market, prevent the introduction of products or necessitate
their withdrawal, any of which could materially and adversely affect the
Company's business, financial condition and results of operations.
CONTROL BY EXISTING MANAGEMENT AND STOCKHOLDERS. Following the completion
of this Offering, the Company's executive officers and directors and their
respective affiliates will beneficially own approximately 60.6% of the
outstanding Common Stock (58.8% if the Underwriters exercise their
over-allotment option in full). As a result, these stockholders, by acting in
concert, will be able to exercise significant influence over all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. Such concentration of ownership may also
have the effect of delaying, preventing or deterring a change in control of the
Company. In addition, in connection with the issuance of Series B Preferred
Stock and warrants to purchase Series C Preferred Stock, the Company entered
into an agreement that requires the Company, following the completion of this
Offering and as long as Warburg Pincus Ventures, L.P. ("Ventures") owns at least
10% or 20% of the outstanding Common Stock, to nominate and use its best efforts
to elect one or two individuals, respectively, designated by Ventures for
election to the Board of Directors. See "Certain Transactions," "Principal and
Selling Stockholders" and "Description of Capital Stock--Board Representation
Rights."
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE. Prior to this
Offering, there has been no public market for the Company's Common Stock and
there can be no assurance that an active public market for the Common Stock will
develop or be sustained after this Offering. The initial offering price will be
determined by negotiation among the Company and the Underwriters based upon
several factors and may bear no relation to the price at which the Common Stock
will trade after this Offering. For a discussion of the factors taken into
account in determining the initial public offering price, see "Underwriting."
The market price of the Company's Common Stock is likely to be highly volatile
and could be subject to wide fluctuations in response to the timing of future
product releases, if any, by the Company, variations in the Company's annual or
quarterly financial results or those of its competitors, changes by financial
research analysts in their estimates of the future earnings of the Company,
conditions in the economy in general or in the Company's industry in particular,
unfavorable publicity or changes in applicable laws and regulations affecting
the Company or the educational technology industry or other events or factors,
many of which are beyond the Company's control. In addition, the stock market
has experienced significant price and volume fluctuations that have affected the
market prices of educational technology companies and that often have been
unrelated or disproportionate to the operating performance of such companies.
These broad market fluctuations may adversely affect the market price of the
Company's Common Stock.
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<PAGE>
In the past, following periods of volatility in the market price of a company's
stock, securities class action litigation has occurred against that company.
Such litigation could result in substantial costs and would, at a minimum,
divert management's attention and resources, which could have a material adverse
effect of the Company's business, financial position and results of operations.
Any adverse determination in such litigation could also subject the Company to
significant liabilities.
SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of shares in
the public market following this Offering could have a material adverse effect
on the market price of the Common Stock. Immediately following this Offering,
the Company will have 11,671,893 shares of Common Stock outstanding assuming no
exercise of the Underwriters' over-allotment option and no exercise of
outstanding options or warrants after June 30, 1998. Of these shares, all the
shares sold in this Offering will be freely tradable without restrictions or
further registration under the Securities Act of 1933, as amended (the
"Securities Act"). The remaining 9,271,893 shares of Common Stock will be
"restricted securities" as defined by Rule 144 ("Rule 144") adopted under the
Securities Act. These shares may be sold in the public market only if registered
or if they qualify for an exemption from registration under Rule 144 or Rule 701
("Rule 701") adopted under the Securities Act. The Company is unable to predict
the effect that future sales made under Rule 144, Rule 701 or otherwise will
have on the market price of the Common Stock prevailing at that time. In
addition, following closing of this Offering the Company intends to register
shares of Common Stock issuable upon the exercise of stock options granted under
the Company's stock option plans. After the effective date of such registration,
shares issued upon the exercise of stock options generally will be available for
sale in the public market. The Company, its executive officers and directors and
certain stockholders beneficially owning in the aggregate 8,932,932 shares of
Common Stock have agreed, subject to certain limited exceptions, not to offer,
sell, contract to sell, grant any option to purchase or otherwise dispose of any
shares of Common Stock, without the prior written consent of NationsBanc
Montgomery Securities LLC, for a period of 180 days after the first day any of
the Common Stock to be sold in this Offering is released by the Underwriters for
sale to the public. Any shares subject to these lock-up agreements may be
released at any time by NationsBanc Montgomery Securities LLC, with or without
notice. The holders of approximately 3,678,571 shares of Common Stock are
entitled to certain registration rights with respect to such shares. See "Shares
Eligible for Future Sale" and "Underwriting."
IMMEDIATE AND SUBSTANTIAL DILUTION. Purchasers of Common Stock in this
Offering will experience immediate and substantial dilution of $10.60 per share.
To the extent outstanding options or warrants to purchase Common Stock are
exercised or the Company issues additional shares of Common Stock, they may
experience further dilution. See "Dilution."
POSSIBLE ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS. The Company's
Amended and Restated Certificate of Incorporation (the "Restated Certificate")
authorizes the Board of Directors to issue up to 1,000,000 shares of Preferred
Stock and to determine the price, rights, preferences and privileges, including
voting rights, of those shares without any further vote or action by the
stockholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any Preferred Stock
that may be issued in the future. The Restated Certificate and Amended and
Restated Bylaws (the "Restated Bylaws"), among other things, require that
stockholder actions occur at duly called meetings of the stockholders, do not
permit cumulative voting in the election of directors and require advance notice
of stockholder proposals and director nominations. Additionally, the Restated
Certificate provides for a classified Board of Directors and specifies that the
authorized number of directors may be changed only by resolution of the Board of
Directors. Amendment of these provisions requires the vote of stockholders
holding at least two-thirds of the Company's outstanding shares. Certain
provisions contained in the Company's charter documents and certain applicable
provisions of Delaware law could serve to depress the Company's stock price or
discourage a hostile bid in which stockholders could receive a premium for their
shares. In addition, these provisions could have the effect of making it more
difficult for a third party to acquire a majority of the outstanding voting
stock of the Company, or delay, prevent or deter a merger, acquisition or tender
offer in which the Company's stockholders could receive a premium
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<PAGE>
for their shares, a proxy contest for control of the Company or other change in
the Company's management. See "Description of Capital Stock."
UNSPECIFIED USE OF PROCEEDS; MANAGEMENT DISCRETION. The Company intends to
use a portion of the net proceeds to repay the outstanding balances under its
existing bank lines of credit, estimated to be approximately $2.0 million upon
completion of this Offering. In addition, the Company plans to substantially
increase sales and marketing expenses and research and development expenses,
which are expected to be funded in part by gross profits and in part by use of a
portion of the net proceeds of this Offering. The actual amount and timing of
such expenditures will depend on business and market developments. The remaining
net proceeds, representing approximately 15% to 43% of the total net proceeds of
the Offering, have not been allocated for a particular purpose. The Company
intends to use such remaining net proceeds for general corporate purposes,
including working capital. As a result, the Company will have significant
discretion as to the use of the net proceeds of this Offering. As a consequence,
the Company's management will have wide discretion in the allocation of the net
proceeds of this Offering which may result in such proceeds being applied to
uses stockholders may not deem desirable. In addition, there can be no assurance
that such proceeds can or will be invested to yield a significant return, if
any. See "Use of Proceeds."
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<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,400,000 shares of
Common Stock offered by the Company, at an assumed initial public offering price
of $13.00 per share, are estimated to be approximately $28,266,000 ($30,227,000
if the Underwriters' over-allotment option is exercised in full), after
deducting underwriting discounts and estimated offering expenses payable by the
Company.
The Company expects to use the net proceeds of this Offering for working
capital and other general corporate purposes, capital expenditures and repayment
of certain indebtedness. In particular, the Company intends to use a portion of
the net proceeds to repay the outstanding balances under its existing bank lines
of credit, estimated to be approximately $2.0 million upon completion of this
Offering. Approximately 70% of such borrowings will have been used to fund
operating losses and approximately 30% will have been in connection with
equipment financing. In addition, the Company expects to use approximately $1.5
million of such proceeds for capital expenditures during the remainder of 1998.
Further, the Company currently expects to use approximately $10 million to $14
million of the net proceeds of this Offering to fund incremental sales and
marketing initiatives and approximately $6 million to $10 million for increased
research and product development efforts. The actual amount and timing of such
expenditures will depend on business and market developments, including those
discussed under "Risk Factors." Pending such uses, the net proceeds of this
Offering will be invested in short-term, interest-bearing, investment grade
securities. See "Risk Factors--Unspecified Use of Proceeds; Management
Discretion."
The Company has a $3.0 million unsecured line of credit with BankBoston N.A.
which expires in May 1999. Borrowings under the line of credit bear interest, at
the election of the Company, at the bank's base rate, or the adjusted LIBOR plus
1.75%, and are guaranteed by Ventures. The Company also has two lines of credit
with Silicon Valley Bank in the amounts of $400,000 and $450,000 to finance
equipment purchases through June 1998 and August 1998, respectively. Borrowings
under these lines of credit bear interest at the bank's prime rate plus 3% and
are due in monthly installments through June 1999 and August 2000, respectively.
Borrowings are secured by substantially all of the Company's assets, excluding
intellectual property.
If the Underwriters' over-allotment option is exercised, the Company will
not receive any proceeds from the sale of shares of Common Stock by the Selling
Stockholders. See "Principal and Selling Stockholders."
DIVIDEND POLICY
The Company has never paid any cash dividends on its capital stock. The
Company currently anticipates that it will retain earnings to support operations
and to finance the growth and development of the Company's business and does not
anticipate paying cash dividends for the foreseeable future. In addition, under
the Company's existing lines of credit, there are restrictions on the Company's
ability to pay dividends without consent of the lenders.
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1998, on an actual basis and as adjusted to reflect: (i) the sale by the
Company of the 2,400,000 shares of Common Stock offered hereby at an assumed
initial public offering price of $13.00 per share after deducting underwriting
discounts and estimated offering expenses, and the application of the estimated
net proceeds therefrom; and (ii) the conversion of all outstanding Preferred
Stock into Common Stock upon completion of this Offering. This table should be
read in conjunction with the Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1998
------------------------------
ACTUAL AS ADJUSTED
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(IN THOUSANDS)
<S> <C> <C>
Long-term debt, including current portion........................................ $ 1,090 $ --
Redeemable convertible Preferred Stock, $0.001 par value per share; 3,678,571
shares issued and outstanding actual, no shares issued and outstanding as
adjusted........................................................................ $ 8,002 $ --
Stockholders' equity (deficit):
Preferred Stock, $0.001 par value per share; 7,000,000 shares authorized
(including 4,700,000 shares designated as redeemable convertible Preferred
Stock); 1,419,681 shares issued and outstanding actual; 1,000,000 shares
authorized, no shares issued and outstanding as adjusted..................... 2,355 --
Common Stock, $0.001 par value per share; 17,500,000 shares authorized;
4,173,641 shares issued and outstanding actual; 50,000,000 shares authorized,
11,671,893 shares issued and outstanding as adjusted (1)..................... 2,795 41,418
Deferred compensation (2)........................................................ (1,555) (1,555)
Accumulated deficit.............................................................. (11,827) (11,827)
-------------- --------------
Total stockholders' equity (deficit)........................................... (8,232) 28,036
-------------- --------------
Total capitalization......................................................... $ 860 $ 28,036
-------------- --------------
-------------- --------------
</TABLE>
- --------------------------
(1) Based on the number of shares outstanding as of June 30, 1998. Excludes: (i)
1,611,498 shares of Common Stock issuable upon exercise of options and
warrants outstanding as of June 30, 1998 with a weighted average exercise
price of $0.65 per share; (ii) 2,800,000 additional shares of Common Stock
reserved for issuance under the Company's 1998 Equity Incentive Plan; (iii)
100,000 shares of Common Stock reserved for issuance under the Company's
1998 Non-Employee Directors' Stock Option Plan; and (iv) 500,000 shares of
Common Stock reserved for issuance under the Company's 1998 Employee Stock
Purchase Plan. See "Management--Employee Benefit Plans," "Certain
Transactions" and "Description of Capital Stock."
(2) See Note 5 of Notes to the Financial Statements included elsewhere in this
Prospectus.
18
<PAGE>
DILUTION
The pro forma net tangible book value (deficit) of the Company at June 30,
1998 was approximately $(230,000) or $(0.02) per share of Common Stock. Pro
forma net tangible book value (deficit) per share represents the amount of the
Company's total tangible assets less total liabilities, divided by the number of
shares of Common Stock outstanding after giving effect to the automatic
conversion of all outstanding shares of Preferred Stock into an aggregate of
5,098,252 shares of Common Stock. After giving effect to the sale by the Company
of the 2,400,000 shares of Common Stock offered hereby at an assumed initial
public offering price of $13.00 per share after deducting the underwriting
discounts and estimated offering expenses payable by the Company and applying
the estimated net proceeds therefrom, the adjusted net tangible book value of
the Company as of June 30, 1998 would have been approximately $28.0 million, or
$2.40 per share of Common Stock. This represents an immediate increase in net
tangible book value of $2.42 per share of Common Stock to existing stockholders
and an immediate dilution in net tangible book value of $10.60 per share to new
investors purchasing shares at the assumed initial public offering price. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price............................... $ 13.00
---------
Pro forma net tangible book value (deficit) per share........... $ (0.02)
Increase per share attributable to new investors................ 2.42
---------
Net tangible book value per share, as adjusted for the Offering..... 2.40
---------
Dilution per share to new investors................................. $ 10.60
---------
---------
</TABLE>
The following table summarizes as of June 30, 1998, on the pro forma basis
described above, the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price per share paid by
the existing stockholders and by the new investors (at an assumed initial public
offering price of $13.00 per share for shares purchased in this Offering, before
deducting underwriting discounts and estimated offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
----------------------- ------------------------ PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------------ --------- ------------- --------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders (1).......................... 9,271,893 79.4% $ 10,477,000 25.1% $ 1.13
New investors...................................... 2,400,000 20.6 31,200,000 74.9 13.00
------------ --------- ------------- ---------
Total............................................ 11,671,893 100.0% $ 41,677,000 100.0%
------------ --------- ------------- ---------
------------ --------- ------------- ---------
</TABLE>
- --------------------------
(1) If the Underwriters' over-allotment option is exercised in full, the number
of shares held by Existing Stockholders will be reduced to 9,078,235 shares,
or 75.5% of the number of shares to be outstanding after this Offering.
The foregoing table assumes no exercise of outstanding stock options and
warrants and excludes: (i) 1,611,498 shares of Common Stock issuable upon
exercise of options and warrants outstanding as of June 30, 1998 with a weighted
average exercise price of $0.65 per share; (ii) 2,800,000 additional shares of
Common Stock reserved for issuance under the Company's 1998 Equity Incentive
Plan; (iii) 100,000 shares of Common Stock reserved for issuance under the
Company's 1998 Non-Employee Directors' Stock Option Plan; and (iv) 500,000
shares of Common Stock reserved for issuance under the Company's 1998 Employee
Stock Purchase Plan. See "Capitalization," "Management--Employee Benefit Plans,"
"Certain Transactions" and "Description of Capital Stock." To the extent that
options or warrants are exercised, there will be further dilution to new
investors.
19
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table sets forth certain historical financial data for the
Company as of and for the years ended December 31, 1996 and 1997 and as of and
for the six months ended June 30, 1997 and 1998. The Company commenced
operations in February 1996. The historical financial data as of and for the
years ended December 31, 1996 and 1997 were derived from the Financial
Statements of the Company that have been audited by Ernst & Young LLP,
independent auditors, and that are included elsewhere in this Prospectus and are
qualified by reference to such financial statements and the notes thereto. The
historical financial data as of and for the six months ended June 30, 1997 and
1998 were derived from unaudited financial statements included elsewhere in this
Prospectus. In the opinion of management, the historical financial data as of
and for the six months ended June 30, 1997 and 1998 have been prepared on the
same basis as the audited financial statements and include all adjusting entries
(consisting only of normal recurring adjustments) necessary to present fairly
the information set forth herein. The historical financial data presented herein
are not necessarily indicative of the results of operations for any future
period and should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
-------------------- --------------------
1996 1997 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Programs................................................................ $ -- $ 2,249 $ 330 $ 1,572
Services................................................................ -- 713 359 228
--------- --------- --------- ---------
Total revenues........................................................ -- 2,962 689 1,800
Cost of revenues:
Programs................................................................ -- 481 124 293
Services................................................................ -- 468 199 174
--------- --------- --------- ---------
Total cost of revenues................................................ -- 949 323 467
--------- --------- --------- ---------
Gross profit.............................................................. -- 2,013 366 1,333
Operating expenses:
Sales and marketing..................................................... 164 2,646 873 2,454
Research and development................................................ 1,514 1,965 809 1,346
General and administrative.............................................. 933 2,537 925 1,773
--------- --------- --------- ---------
Total operating expenses.............................................. 2,611 7,148 2,607 5,573
--------- --------- --------- ---------
Operating loss............................................................ (2,611) (5,135) (2,241) (4,240)
Interest income (expense), net............................................ 70 162 51 (32)
Other income (expense), net............................................... 44 (85) -- --
--------- --------- --------- ---------
Net loss.................................................................. $ (2,497) $ (5,058) $ (2,190) $ (4,272)
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic and diluted net loss per share...................................... $ (0.68) $ (1.27) $ (0.55) $ (1.03)
--------- --------- --------- ---------
--------- --------- --------- ---------
Shares used in computing basic and diluted net loss per share............. 3,679 3,986 3,985 4,129
--------- --------- --------- ---------
--------- --------- --------- ---------
Pro forma basic and diluted net loss per share (1)........................ $ (0.60) $ (0.46)
--------- ---------
--------- ---------
Shares used in computing pro forma net loss per share (1)................. 8,436 9,227
--------- ---------
--------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997 JUNE 30, 1998
--------- --------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)...................................................... $ 3,562 $ 1,569 $ (2,019)
Total assets................................................................... 4,306 4,456 3,844
Long-term debt, including current portion...................................... 35 330 1,090
Redeemable convertible preferred stock......................................... 4,002 8,002 8,002
Stockholders' equity (deficit) (2)............................................. (85) (5,064) (8,232)
</TABLE>
- --------------------------
(1) The pro forma net loss per share data gives effect to the conversion of all
outstanding shares of Preferred Stock into 5,098,252 shares of Common Stock
upon completion of this Offering. See Note 1 of Notes to Financial
Statements included elsewhere in this Prospectus for a further explanation
of the number of pro forma shares used in per share calculations.
(2) The Company has paid no cash dividends since its inception.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH "SELECTED FINANCIAL
DATA" AND THE COMPANY'S FINANCIAL STATEMENTS AND RELATED NOTES THERETO INCLUDED
ELSEWHERE IN THIS PROSPECTUS. THIS PROSPECTUS CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION,
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS
PROSPECTUS. FACTORS THAT MAY CAUSE OR CONTRIBUTE TO SUCH A DIFFERENCE INCLUDE,
BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS," AS WELL AS THOSE
DISCUSSED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
The Company commenced operations in February 1996, and, until April 1997, it
devoted substantially all of its efforts to developing its Fast ForWord program,
performing a field trial, recruiting and training personnel, establishing
relationships with and training teachers and speech and language professionals,
and raising capital. Since the commercial launch of Fast ForWord in April 1997,
the Company has also devoted efforts to sales and marketing activities. The
Company has an accumulated deficit of $11.8 million from inception through June
30, 1998 and expects to incur additional losses for at least the next two years,
due primarily to substantial increases in sales and marketing and research and
development expenses. The Company expects that losses will fluctuate from
quarter to quarter and that such fluctuations may be substantial.
REVENUES. The Company derives revenues from program sales and service fees.
Program revenues are derived from the sale of Fast ForWord programs, which are
generally sold for $850 per child, except where the Company has negotiated
reference site or volume discounts in connection with large sales. Customers
license the right to use the Fast ForWord software during the program period and
do not acquire or otherwise gain unlimited rights to use the software. The
Company believes that per program revenue generally will decrease in the future
as the Company makes more large sales and grants a greater number of
individually negotiated volume discounts in connection with such sales. Revenues
on sales of Fast ForWord are recognized over the average duration of the
program. Service revenues are derived from the Company's Fast ForWord training
seminars for learning facilitators and from services provided to customers of
the Company's Learning Centers. Revenues from seminars are recognized when the
seminar is held. Revenues from Learning Center services are recognized over the
average duration of the program. The Company only recently began operating
Learning Centers and revenues to date have been minimal. Cancellations and
refunds are allowed in limited circumstances, and such amounts have not been
significant. Provisions are made for cancellations and refunds as revenue is
recorded.
The Company's revenues have been derived exclusively from the sale of Fast
ForWord programs and related seminars and services. While the Company is
developing additional products based upon its proprietary technology and
neuroscience expertise, there can be no assurance that it will be successful in
doing so. In addition, to date the substantial majority of the Company's sales
of Fast ForWord have been through speech and language professionals. In the
future, the Company intends to focus a substantial part of its sales and
marketing efforts on public schools and on direct sales to parents through
Learning Centers. Given the limited historical experience of the Company selling
Fast ForWord to schools and operating Learning Centers, there can be no
assurance that the Company will be successful in these strategies. Furthermore,
due to lengthy school budget cycles, possible delays related to government
funding and the inherent complexity of selling to schools and school districts,
the Company expects that its sales cycle could be significantly longer than that
experienced historically as it increasingly focuses on sales to this market. As
a result, the Company may have limited visibility on its future revenues, and
such revenues may fluctuate substantially.
COST OF REVENUES. Cost of revenues consists of program costs and service
costs. Program costs consist of costs associated with the Fast ForWord program,
including royalties, manufacturing, packaging, documentation, fulfillment,
Internet hosting and technical support costs. Service costs consist primarily of
the costs of providing the Company's training seminars, including personnel,
materials, facilities, travel and Learning Center service costs. Such costs of
revenues are generally recognized as incurred. The Company
21
<PAGE>
generally recognizes significantly higher gross margins on its program sales
than on its service sales. As a result of these factors, the Company expects
that gross margins will fluctuate due to changes in the mix between program
revenues and service revenues.
OPERATING EXPENSES. The Company's operating expenses consist of sales and
marketing expenses, research and development expenses and general and
administrative expenses. Sales and marketing expenses principally consist of
salaries and compensation paid to employees engaged in sales and marketing
activities, advertising and promotional materials, public relations costs,
telemarketing and travel. Research and development expenses principally consist
of salaries and compensation paid to employees and consultants engaged in
research and product development activities, product testing, and software and
equipment costs. The Company expenses all software development costs associated
with a product until technological feasibility is established, after which time
all such costs are capitalized until the product is available for commercial
release and are amortized over the estimated lives of the related products.
Technological feasibility is deemed established upon completion of a working
version. To date, capitalizable software development costs have been
insignificant and have been charged to research and development expense. General
and administrative expenses principally consist of salaries and compensation
paid to employees and consultants other than those engaged in research and
development and sales and marketing activities, facilities and related
depreciation, in-house and outside legal and accounting fees and related costs,
and travel.
The Company recorded deferred compensation of $508,000 during the year ended
December 31, 1997 and $1,586,000 during the six months ended June 30, 1998,
representing the difference between the exercise price and the deemed fair value
of certain of the Company's stock options granted to employees. These amounts
are being amortized by charges to operations over the vesting periods of the
individual stock options. Such amortization amounted to $124,000 for the year
ended December 31, 1997 and $415,000 for the six months ended June 30, 1998. The
remaining aggregate deferred compensation of $1,555,000 will be amortized over
the vesting period of the options (generally five years). Additionally, the
Company expects to record charges to operations of approximately $597,000 in
third quarter of 1998, in connection with warrants to purchase 100,000 shares of
the Company's Common Stock. Such warrants were issued to Ventures in June 1998
in connection with the stockholder's guarantee of the Company's new $3.0 million
line of credit. The Company intends to repay borrowings under the line of credit
from the proceeds of this Offering.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data for the Company expressed as a percentage of revenues (unless otherwise
noted). The Company commenced operations, and was in the development stage, in
1996. As a result, there were no revenues, cost of revenues or gross profits in
1996.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED JUNE 30,
DECEMBER 31, ----------------------------
1997 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Programs............................................................. 75.9% 47.9% 87.3%
Services............................................................. 24.1 52.1 12.7
------ ------ ------
Total revenues..................................................... 100.0 100.0 100.0
Cost of revenues:
Programs (1)......................................................... 21.4 37.6 18.6
Services (2)......................................................... 65.6 55.4 76.3
------ ------ ------
Total cost of revenues............................................. 32.0 46.9 25.9
------ ------ ------
Gross margin........................................................... 68.0% 53.1% 74.1%
------ ------ ------
------ ------ ------
</TABLE>
- --------------------------
(1) Program costs are expressed as a percentage of program revenues.
(2) Service costs are expressed as a percentage of service revenues.
22
<PAGE>
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
REVENUES. Revenues increased to $1.8 million in the six months ended June
30, 1998 from $689,000 in the comparable period in 1997. This increase was
primarily attributable to an increase in program revenues from $330,000 to $1.6
million, resulting from increased sales of Fast ForWord, which was commercially
released in April 1997. This revenue increase was partially offset by a decline
in service revenues from $359,000 to $228,000, resulting from the Company's
planned decrease in the number of seminars offered to learning facilitators as
the Company shifted its seminar strategy to focus on fewer, more extensive
seminars.
COST OF REVENUES. Cost of revenues increased to $467,000 in the six months
ended June 30, 1998 from $323,000 in the comparable period in 1997. This
increase was primarily attributable to higher cost of revenues associated with
increased sales of Fast ForWord. As a percentage of revenues, costs of revenue
declined from 46.9% to 25.9% primarily because program revenues, which typically
have significantly lower costs as a percentage of revenues, represented a higher
proportion of total revenues. As a percentage of program revenues, costs of
program revenue declined from 37.6% to 18.6% due primarily to initial product
launch costs in the 1997 period. Costs of service revenue increased from 55.4%
to 76.3% of service revenues as a result of the added costs per session of more
extensive seminars for learning facilitators and startup costs associated with
Learning Centers.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to
$2.5 million in the six months ended June 30, 1998 from $873,000 in the
comparable period in 1997. This increase was primarily attributable to increased
personnel costs resulting from the expansion of its sales and marketing force
and to a lesser extent to increased direct mail, travel and promotional
materials costs. The Company expects to substantially increase sales and
marketing expenses in the future as it increases its sales and marketing efforts
for Fast ForWord and any future products.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $1.3 million in the six months ended June 30, 1998 from $809,000 in
the comparable period in 1997. This increase was primarily attributable to
personnel costs resulting from the expansion of its research and development
staff. The Company expects to substantially increase research and development
expenses in the future as it continues to refine Fast ForWord and develop
additional products based upon its proprietary technology and neuroscience
expertise.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $1.8 million in the six months ended June 30, 1998 from $925,000 in
the comparable period in 1997. This increase was primarily attributable to
personnel costs and facilities costs related to the Company's move to a new
headquarters facility in September 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues were $3.0 million in 1997 and were primarily
attributable to the introduction of training seminars in January 1997 and the
commercial release of Fast ForWord in April 1997. The Company was in the
development stage during 1996 and did not have revenues.
COST OF REVENUES. Cost of revenues was $949,000 in 1997 and was primarily
attributable to costs associated with providing training seminars and costs of
the Fast ForWord program. The Company was in the development stage during 1996
and did not have revenues or associated costs. As a percentage of program
revenues, program costs were 21.4%. Services costs were 65.6% of services
revenue.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $2.6
million in 1997 consisting primarily of personnel costs, direct mail costs,
public relations costs, telemarketing service costs, advertising and other
promotional materials and services. The Company was in the development stage
during 1996 and did not incur significant sales and marketing expenses.
23
<PAGE>
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $2.0 million in 1997 from $1.5 million in 1996. This increase was
primarily attributable to increased personnel and to a lesser extent to
consulting, software and equipment-related costs. Research and development
expenses in 1996 included $554,000 associated with entering into the University
License.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $2.5 million in 1997 from $933,000 in 1996. This increase was
primarily attributable to personnel costs and facilities costs related to the
Company's move to a new headquarters facility in September 1997.
PROVISION FOR INCOME TAXES. The Company recorded no provision for income
taxes in the years ended December 31, 1996 and 1997 as it incurred losses during
such periods. At December 31, 1997, the Company had net operating loss
carryforwards and research credit carryforwards for federal income tax purposes
of approximately $6,600,000 and $85,000, respectively. The net operating loss
carryforwards will expire in years 2011 through 2012. Utilization of the net
operating losses may be subject to a substantial annual limitation, due to the
ownership change limitations provided by the Internal Revenue Code of 1986. The
annual limitation may result in the expiration of net operating losses before
utilization. At December 31, 1996 and 1997, the Company had approximately $1.0
million and $3.0 million, respectively, of deferred tax assets, comprised
primarily of net operating loss carryforwards. Realization of deferred tax
assets is dependent upon future earnings, if any, the timing and amount of which
are uncertain. Accordingly, the net deferred tax assets have been fully offset
by a valuation allowance.
QUARTERLY RESULTS OF OPERATIONS
The Company's quarterly operating results have varied significantly in the
past and are expected to fluctuate significantly in the future as a result of a
variety of factors, many of which are beyond the Company's control. Factors that
may affect the Company's quarterly operating results include among others: (i)
demand for technology-based education and training products; (ii) size and
timing of product orders and implementation; (iii) revenue mix between products
and services; (iv) timely development, introduction and market acceptance of the
Company's existing and future products, if any; (v) pricing of the Company's
programs and services; (vi) number and timing of Learning Center openings and
closings; (vii) terms under which Learning Centers are operated; (viii)
competitive conditions; (ix) ability to attract and retain experienced
personnel; (x) availability of government funding for public schools; (xi)
public school calendars and budget cycles; (xii) number and timing of Fast
ForWord training seminars for learning facilitators; and (xiii) general economic
and market conditions. The Company's limited operating history and the emerging
nature of its market make prediction of future revenues and expenses difficult.
The Company's expense levels are based in part on its expectations as to future
revenues and to a large extent are fixed in the short term. There can be no
assurance that the Company will be able to predict its future revenues
accurately and the Company may be unable to adjust spending in a timely manner
to compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall of revenues in relation to the Company's expectations could cause
significant fluctuations in quarterly operating results, which would have an
adverse effect on the Company's business, financial condition and results of
operations.
Demand for the Company's programs and services is subject to certain
seasonal influences which can vary depending on the distribution channel being
employed. The Company does not have sufficient operating experience in its
various distribution channels to predict the overall effect of various seasonal
factors and their effect on future quarterly operating results. The Company
believes that, because of the intensive nature of Fast ForWord, demand for its
programs from speech and language professionals in private practice may be lower
during the school year than in the summer. The Company's strategy to place Fast
ForWord Learning Centers in private schools and take advantage of unused
capacity during summers may further amplify this effect. Certain of the
Company's eight current Fast ForWord Learning Centers are expected to operate
only during the summer and, to date, the Company has no contracts extending
through the school year for the five Learning Centers currently established in
private schools. To the extent the Company penetrates the public school market,
the Company may experience seasonality due to public school calendars and budget
cycles.
24
<PAGE>
Due to all of the foregoing factors, the Company's quarterly revenues and
operating results are difficult to forecast, and the Company believes that
period-to-period comparisons of its operating results will not necessarily be
meaningful and should not be relied upon as an indication of future performance.
LIQUIDITY AND CAPITAL RESOURCES
From inception through June 30, 1998, the Company used approximately $7.9
million of cash for operating activities, resulting primarily from operating
losses of $11.8 million and increases in accounts receivable of $318,000,
partially offset by increases in deferred compensation of $2.1 million and
accounts payable of $718,000 and depreciation and amortization charges of $1.2
million. Accounts receivable increased from insignificant balances at December
31, 1996 and 1997 to $318,000 at June 30, 1998 as a result of increased sales to
schools. Deferred revenue increased from an insignificant amount at December 31,
1996 to $342,000 at December 31, 1997 to $1.6 million at June 30, 1998,
primarily as a result of increased sales of Fast ForWord programs for which
revenue is recognized over the average duration of the program. Accounts payable
increased from $115,000 at December 31, 1996 to $419,000 at December 31, 1997 to
$718,000 at June 30, 1998 as a result of increased levels of operations.
During this same period, the Company used $2.2 million for investing
activities, consisting principally of the acquisition of computer equipment,
furniture and fixtures. These cash needs have been primarily financed through
the sale of equity securities and borrowings under the Company's existing bank
lines of credit. The Company currently anticipates paying down all indebtedness
under its existing bank lines of credit from the proceeds of this Offering. As
of June 30, 1998, the Company had cash and cash equivalents of $1.0 million.
In June 1998, the Company obtained a $3.0 million unsecured line of credit
with BankBoston N.A. which expires in May 1999. Borrowings under the line of
credit bear interest, at the election of the Company, at the bank's base rate,
or the adjusted LIBOR plus 1.75% (7.41% at June 30, 1998), and are guaranteed by
Ventures. The Company has two lines of credit with Silicon Valley Bank in the
amounts of $400,000, which was used to fund equipment purchases during 1997, and
$450,000 to finance equipment purchases through August 1998. Borrowings under
these lines of credit bear interest at the bank's prime rate plus 3.0% (11.5% at
June 30, 1998) and are due in monthly installments through June 1999 and August
2000, respectively. Borrowings are secured by substantially all of the Company's
assets, excluding intellectual property. Outstanding borrowings and amounts
available for borrowing under all of these bank lines of credit at June 30, 1998
amounted to $1.1 million and $2.6 million, respectively. The Company intends to
use a portion of the net proceeds of this Offering to repay the outstanding
balances under its existing bank lines of credit, estimated to be approximately
$2.0 million, upon completion of this Offering. The estimated increase in
outstanding borrowings from June 30, 1998 to completion of the Offering is
attributable to the funding of operating losses and additional equipment
purchases.
The Company believes that funds generated from operations together with the
net proceeds from this Offering and available borrowings under its existing
lines of credit will be sufficient to finance its anticipated operating losses,
planned capital expenditure requirements and internal growth through 1999. The
Company does not believe that it will be necessary to raise additional funds to
operate the business in the next six months because the net proceeds of this
Offering, revenues and available credit are expected to be sufficient to meet
anticipated sales and marketing expenses, research and development expenses,
other working capital needs and capital expenditures during such period.
However, there can be no assurance that the Company's cash resources following
this Offering will be sufficient to fund the Company's negative cash flow and
expected capital expenditures through 1999. The Company, therefore, may need to
obtain additional equity or debt financing in the future. There can be no
assurance that the Company will be able to obtain the additional financing to
satisfy its cash requirements on acceptable terms or at all.
25
<PAGE>
BUSINESS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
DISCUSSED IN THIS PROSPECTUS. FACTORS THAT MAY CAUSE OR CONTRIBUTE TO SUCH A
DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS,"
AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
The Company develops, markets and sells proven, neuroscience-based education
and training programs designed to increase human learning and performance. The
Company's initial product, Fast ForWord, is an intensive, computer-based
training program that focuses on improving critical pre-reading skills,
including receptive and expressive communication skills in children with
language-based learning problems. The program modifies and emphasizes
characteristics of speech and sound so that they can be more readily
differentiated and processed. Through thousands of repetitions, the program
enables children to master the essential building blocks, or phonemes, of the
English language and facilitates the learning of other critical language skills,
such as morphology (the system of word formation), syntax and grammar, and
executive function skills, such as short-term memory and event sequencing
capabilities. In addition, because the results from each child's Fast ForWord
exercises are compiled daily in a central database via the Internet, Fast
ForWord is able to automatically generate up-to-date performance charts and
templates, enabling the learning facilitator to monitor the child's progress on
a daily basis. Fast ForWord measures the child's response to each exercise and
continually adjusts and adapts the program to challenge each individual child
appropriately with customized training. Fast ForWord is designed to support
teachers, speech and language professionals, parents and other learning
facilitators in providing a program that can be integrated with school curricula
and other language programs to assist children in overcoming language-based
learning challenges and provide a foundation for language skills and academic
learning.
Based upon decades of independent neuroscience research on the brain's
ability to adapt to certain stimuli, Fast ForWord uses computer-controlled,
repetitive and adaptive training exercises to modify the manner in which the
brain processes language. The Fast ForWord program typically lasts from four to
eight weeks and consists of 100 minutes per day of training for five days per
week under the supervision of a teacher, speech and language professional,
parent or other learning facilitator trained in the use of the program. In
Company-sponsored field trials involving approximately 1,000 children with
language-based learning difficulties, participants on average achieved
improvement of more than 1.5 years in language processing and related skills
after completion of the Fast ForWord program. The Company believes that similar
improvements, if achievable at all through traditional remediation programs,
have typically required several years. In addition, Fast ForWord has
successfully produced broad results. More than 80% of the children who completed
Fast ForWord training as part of the Company-sponsored field trials were
identified by standardized tests as having language-based learning problems. Of
such children, 90% have made statistically significant gains on one or more
standardized tests of critical language skills.
Fast ForWord is delivered through a variety of distribution channels,
including public schools, speech and language professionals in private practice
and Company-operated Learning Centers. The Company also provides seminars to
train and educate teachers, speech and language professionals, parents and other
learning facilitators in the use and applications of Fast ForWord. To date,
approximately 5,500 children have participated in the Fast ForWord program and
approximately 2,600 teachers and speech and language professionals have been
trained in administering the program.
BACKGROUND
Humans are born with the potential to learn any language, and one of a
child's early tasks is to learn to extract meaning from speech by identifying
its basic auditory building blocks or phonemes. In the first 12 to 16 months of
a child's development, the brain learns to recognize the phonemes that are
relevant to the
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child's native language. Studies have shown that approximately 20% of children
have significant reading difficulties, most of which can be attributed to
difficulty in acquiring, retaining and manipulating phonemes. Furthermore, in
reviewing studies of children with serious reading difficulties, the National
Institute of Child Health and Human Development (the "NICHD") at the National
Institutes of Health (the "NIH") found substantial evidence that these reading
difficulties result from a child's "difficulty acquiring, retaining,
manipulating and recoding the phonemes or sounds of the English language."
Children with such difficulties often have other learning challenges such as
autism and attention deficit disorder ("ADD").
According to industry sources, approximately 20% of all children in the
United States between the ages of four and 13 have significant language-based
learning difficulties. Extrapolating from U.S. Department of Commerce, Bureau of
the Census data, this figure represents approximately 8,000,000 children between
the ages of four and 13. The Company believes that approximately 800,000
children in the United States enter this category each year and that their
language-based learning problems result in part from the inability to make
reliable distinctions among certain elements of speech. This inability
frequently leads to poor language comprehension, problems in speaking and
subsequent reading problems, and is often associated with low self-esteem, poor
academic performance and behavioral problems. The NICHD at the NIH suggests
that, without early identification and intervention, language-based learning
difficulties often hinder learning and reading into adulthood unless intensive
and specialized remediation programs are provided.
The Company estimates that there are approximately 100,000 speech and
language professionals practicing in the U.S., including approximately 13,000 in
private practice, 50,000 in public schools and 37,000 working part-time or in
adult rehabilitation centers. Traditional remediation programs for language-
based learning problems typically consist of years of weekly one-on-one or
small-group phonics and other language exercises with a private or school speech
and language professional or teacher. Oral phonics exercises in traditional
programs tend to focus on the relationship between sounds and letters. In
contrast, the Company believes that a child must first be able to differentiate
sounds or phonemes before the child can understand the relationship between
sounds and letters. Frequently, traditional programs include regular oral
repetition of phonemes by the speech and language professional. However, humans
cannot stretch and emphasize the acoustics of speech and sound over thousands of
repetitions with the precision of a computer to systematically modify neural
pathways for improved language processing. Additionally, because substantial
results can typically be measured only after several years in children with
identified language-based learning problems, decisions regarding whether a
particular course of traditional intervention is appropriate for an individual
child are often based on subjective evaluations and anecdotal evidence rather
than measurable results.
The Company was founded by scientists who had spent decades researching
neuroscience and the causes of language-based learning problems at UCSF and
Rutgers. As published in the peer-reviewed journal SCIENCE in January 1996, the
scientific founders of the Company demonstrated that children with an inability
to distinguish between phonemes could rapidly learn to identify these previously
indistinguishable speech sounds and correctly reconstruct speech if trained on a
computer-based program that modifies speech through the stretching and selective
amplification of sounds. Children who received this acoustically modified speech
training achieved significantly greater gains than those who received only
normal speech in a similar computer-based format and demonstrated measurable
improvement in areas such as the ability to process rapid auditory events,
phoneme and speech discrimination and language processing and comprehension. The
founders postulated that the children's newly learned ability to distinguish and
process sounds resulted from a behaviorally induced change in the organization
of neural pathways involved in the way their brains process language. This
scientific research demonstrated a practical application of the phenomenon known
as brain plasticity, which is the brain's ability to modify the way it processes
information in response to certain stimuli. The founders established the Company
to move this
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research as rapidly as possible from laboratories into products and services
designed to improve human learning and performance.
MARKET OPPORTUNITY
In order to reach as many children with language-based learning problems as
possible, the Company intends to focus on schools with students in kindergarten
through high school ("K-12") in the United States. Based on information derived
from industry sources, the Company estimates that more than 51 million students
attended over 100,000 K-12 public and private schools in the United States in
the 1996-1997 school year. Public concern over the effectiveness of K-12 schools
in teaching essential academic skills and the rapidly growing role of technology
in the K-12 marketplace have created an increased demand for technology-based
educational programs. While total spending on education in the United States has
grown at an average of 5% per year, spending on technology in public schools in
the United States has more than doubled since the 1991-1992 school year, growing
to an estimated $4.8 billion in the 1997-98 school year. Technology spending is
projected to reach $5.4 billion for the 1998-99 school year, a 13% increase from
the prior school year. While industry sources had previously projected a 20%
increase in technology spending for the 1998-1999 school year, the projected 13%
increase would be the highest increase in technology spending since the
1994-1995 school year. Such expenditures include computers, internet
connections, other technology infrastructure components and software. The
Company believes that the amount spent on language skills software is likely to
increase as more such software becomes available; however, the Company has not
been able to determine the portion of technology expenditures that have been
represented historically by language skills software. Educators, parents and
opinion leaders in the United States are increasingly focused on improving
essential academic skills of all students and, in particular, their reading
proficiency. This focus has generally contributed to an increased demand for
more effective methods to increase academic performance, including the
performance of children with language-based learning difficulties. Schools have
responded to these demands by investing in computers, software and other
educational technology, testing and other assessment programs to measure
students' progress, and professional development training to enhance educators'
effectiveness in the classroom. Forty-seven states have adopted programs to
support the use of technology in the classroom, and federal funds have been made
available for technology purchases through multiple programs, including Title I
and E-Rate. The Company believes that the increasing commitment of educators and
parents to improve essential academic performance for all children in general
and for children with language-based learning problems in particular, combined
with increased demand for technology based programs, has created a significant
opportunity for providers of computer-based educational products and services
that provide measurable results.
THE SCIENTIFIC LEARNING SOLUTION
The Company's initial product, Fast ForWord, is a proprietary, adaptive
computer-based training program for children with language-based learning
problems. The Fast ForWord program is comprised of seven intensive, animated
computer exercises lasting 20 minutes each, which students are expected to
practice for 100 minutes a day, five days a week, for four to eight weeks. Each
exercise modifies the characteristics of speech and sound so they can be
differentiated and processed by the child. Fast ForWord measures the child's
responses during each exercise and continually adjusts and adapts the program to
challenge each individual child appropriately with customized training. As the
child progresses through the program, the child's brain gradually learns how to
process language at a faster rate until the child is eventually able to hear and
process naturally spoken language. The program also facilitates the learning of
other critical language skills such as morphology, syntax and grammar and
executive function skills such as
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short term memory and event sequencing capabilities. The primary advantages of
the Scientific Learning solution are as follows:
RESEARCH-BASED PROGRAM. Fast ForWord is based on twenty-five years of
research in brain plasticity and the underlying causes of language-based
learning problems. As published in the peer-reviewed journal SCIENCE in January
1996, the scientific founders of the Company demonstrated that children with an
inability to distinguish between phonemes could rapidly learn to identify these
previously indistinguishable speech sounds and correctly reconstruct speech if
trained on a computer-based program that modifies speech through the stretching
and selective amplification of sounds. This patent-pending research is licensed
on an exclusive basis by the Company and serves as the basis of the Fast ForWord
program.
PROVEN, RAPID AND MEASURABLE RESULTS. The Company has conducted two field
trials to demonstrate the efficacy of the Fast ForWord program, which has now
been used by approximately 5,500 children. On average, children with language
problems have demonstrated one to two years of language processing improvement
on standardized tests after four to eight weeks of using Fast ForWord. Prior to
the introduction of Fast ForWord, such a level of improvement in children with
identified language-based learning problems, if possible, typically required
several years of traditional pre-reading remediation training. In addition,
because the results from each child's Fast ForWord exercises are compiled daily
in a central database via the Internet, Fast ForWord is able to automatically
generate up-to-date performance charts and templates, enabling the learning
facilitator to monitor the child's progress on a daily basis.
INTEGRATED APPROACH WITH LEARNING FACILITATORS. The Company works closely
with teachers, speech and language professionals, parents and other learning
facilitators to integrate Fast ForWord into a child's existing educational
program and to train learning facilitators in how to use Fast ForWord most
effectively. Through the Internet, Fast ForWord automatically provides learning
facilitators with performance tables and templates enabling them to establish a
baseline analysis and monitor the child's skill level on a daily basis.
Furthermore, by addressing the underlying deficits in a child's basic language
comprehension skills, the Company believes Fast ForWord enables the child to
better benefit from traditional remediation and prevention programs and allows
learning facilitators to focus on other learning challenges the child may have.
EFFECTIVE ALLOCATION OF RESOURCES. Fast ForWord helps children develop the
tools they need to learn and interact more effectively in most classroom
activities, not just language education, by improving their ability to process
language and follow oral instructions. The Company believes that by addressing
the underlying causes of language-based learning problems early, problems can be
identified and addressed at the pre-reading level. The Company further believes
that effective use of Fast ForWord in a school's curriculum decreases the number
of students who will subsequently need expensive remedial help, saving scarce
education resources which can be used for other education programs. Moreover, by
enabling teachers and speech and language professionals in public schools to
deliver individualized computer training simultaneously to multiple children,
rather than requiring one-on-one instruction, Fast ForWord enables schools to
more effectively utilize resources for remediation programs. In the private
sector, the Company believes that the use of Fast ForWord leverages the time
spent by a speech and language professional with a child, potentially resulting
in cost savings for the parent or freeing-up time or money which may then be
spent on addressing other challenges the child may have.
ENGAGING AND ADAPTIVE ANIMATION AND REWARD SYSTEM. Fast ForWord keeps
children entertained with animated characters and sound effects and has the look
and feel of a computer game. Each of the seven training exercises has a
different theme and different graphics for each level within the exercise.
Children receive on-screen animation segments as rewards for correct responses
throughout each training exercise. In addition, children collect points as they
progress through the exercises that, in some training settings, can be redeemed
for age-appropriate prizes. As the child uses the program, Fast ForWord
continually adjusts to the child's individual skill level and changes difficulty
so that, on average, the child is correct
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80% of the time, which allows the program to remain challenging and engaging
while enabling the child to generate a feeling of success and accomplishment.
GROWTH STRATEGY
The Company's goal is to establish itself as the leading provider of proven,
neuroscience-based education and training products and services focused
specifically on language-based learning problems and on other neurologically
based challenges faced by both children and adults. Key elements of the
Company's strategy include:
EXPAND CHANNELS OF DISTRIBUTION. Although to date the substantial majority
of sales of the Fast ForWord program have been through speech and language
professionals in private practice, the Company has recently begun efforts to
significantly expand its channels of distribution. To substantially increase the
number of children with access to Fast ForWord, the Company intends to further
penetrate the over 100,000 schools in the K-12 market through an expanded direct
marketing program, pursuit of district level school contracts and an increase in
the number of schools acting as reference sites. The Company plans to continue
to increase penetration of the private practice speech and language professional
market through the expansion of its direct marketing programs and through its
training seminars. The Company also intends to market directly to parents by
increasing media awareness of its products and by direct marketing efforts from
an expanded number of Learning Centers. Furthermore, the Company intends to
pursue additional channels of distribution, including the "at-home" learning
market, which can benefit from the Company's Internet-based system of
distribution and monitoring, as well as possible alliances with others in the
after-school education and training markets.
RAPIDLY EXPAND SALES AND MARKETING EFFORTS. The Company intends to rapidly
expand its sales and marketing efforts to increase its penetration of the
school, private practice speech and language professional, Learning Center and
"at-home" learning markets. Specifically, the Company intends to: (i) hire
additional salespeople to focus exclusively on sales to the K-12 school market;
(ii) hire additional salespeople to target speech and language professionals in
private practice; (iii) pursue media coverage and publication in scientific
journals; (iv) expand support of the marketing efforts of speech and language
professionals in private practice; and (v) participate in a greater number of
trade shows and conferences.
DEVELOP ADDITIONAL NEUROSCIENCE-BASED LEARNING PRODUCTS. The Company
intends to develop and introduce new products based on practical applications of
brain plasticity research. The Company is currently field testing a beta version
of Fast ForWord Two for children who have completed Fast ForWord and are ready
for a program that focuses on more advanced pre-reading skills. The Company is
also developing other language-based products, including an ESL program for
foreign students and for adults, an adult version of Fast ForWord and an
assessment or screening test for language-based learning problems. In addition,
the Company is evaluating foreign language versions of Fast ForWord and a
program to assist stroke victims in reacquiring language skills. The Company
also is examining ways to leverage its expertise in brain plasticity research in
potential non-language-based products. The Company believes its expertise in
neuroscience and computer technology and its commitment to field testing
products to demonstrate their measurable results, position it well for the
successful introduction of new products.
BUILD A TRUSTED BRAND. The Company intends to invest in the Scientific
Learning Corporation and Fast ForWord names to increase brand awareness and
loyalty. The Company believes that establishing a trusted brand is critical to
success in the education and training markets. Specifically, the Company intends
to: (i) continue to build recognition of the Fast ForWord brand among learning
facilitators and leverage such recognition to build brand awareness of the
Company and future products such as Fast ForWord Two; (ii) communicate the
Company's commitment to proven research and the commercialization of products
with measurable results; (iii) publish field test results; (iv) promote the
publication of media articles and stories regarding the Company and its
products; (v) encourage community-building through support
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efforts such as the Company's Web site and chat rooms; and (vi) engage in direct
marketing campaigns to educators and other key public school decision-makers as
well as to speech and language professionals and parents. The Company believes
it has already established itself as a pioneer and leader in the
commercialization of neuroscience research applications.
PROGRAMS AND SERVICES
BACKGROUND. Children must be able to recognize and process the phonemes
relevant to their language before they can become skilled in the understanding
and use of language and in reading. For example, in order for children to
understand or speak the word "dog," they must first recognize the three phonemes
"duh," "ah" and "guh." To read the word "dog," children must also associate such
phonemes with the three letters "d," "o" and "g." Scientific founders of the
Company working at Rutgers noted that children with language-based learning
problems often have difficulty distinguishing between closely related phonemes,
such as "bah" and "dah." With these particular phonemes, the "b" and "d" sounds
are succeeded by the identical "ah" sound after approximately 40 milliseconds.
Spoken language is made up of numerous, frequent and rapid sound transitions
such as this. Independently-conducted longitudinal research has found that
children who have difficulty distinguishing among related phonemes have problems
understanding and using language. The NICHD at the NIH has found that there is a
strong correlation between these language-based learning problems and
difficulties in learning to read.
The scientific founders of the Company working at UCSF noted that the human
brain changes in response to stimuli, a trait known as brain plasticity. Their
work demonstrated that specific adaptive training techniques drive the brain to
change over time, adjusting how it processes information and thereby permitting
more rapid learning.
Bringing together their work at Rutgers and UCSF, the scientific founders
discovered that with the help of computers, the rapid acoustic changes within
speech sounds could be slowed, emphasized and then differentiated by children
with language-based learning problems. Through thousands of repetitions of
individualized exercises focused on important aspects of speech and language,
these children could gradually master natural speech sounds and develop other
critical language and executive skills. The scientists postulated that the
children's newly learned ability to distinguish and process sounds resulted from
a fundamental change in the organization of neural pathways involved in the way
their brains process language. This theory differs from research by others which
postulates that a particular area of the brain processes language, that speech
and non-speech sounds are processed differently and that auditory processing
problems are not a primary cause of most language learning difficulties. The
Company believes that the manner in which the brain processes speech and
language is not yet fully understood. When the Company refers to Fast ForWord as
proven, it refers to the fact that the program has proven results and not that
it "proves" any particular theory of the manner in which the brain functions.
See "Risk Factors-- Opposing Scientific Theories."
THE FAST FORWORD PROGRAM. Fast ForWord is an intensive, computer-based
training program, which has the look and feel of a computer game and is
comprised of seven training exercises--three exercises for sounds and four for
words. In the three sound exercises, complex auditory information is presented
in a variety of pre-word formats using different frequencies, time durations and
phonemes. The four word exercises consist of words presented either in isolation
or within sentences with various levels of linguistic complexity. The words and
sentences used in these exercises have been electronically modified to expand
and enhance the rapidly changing phonetic elements within natural speech. As a
child's skill level advances, the exercises become increasingly more difficult,
driving him or her continually to increase his or her rate of speech processing,
which in turn leads to more normal speech perception. At the highest level of
each exercise, the child is presented with natural, unmodified speech.
Throughout each training exercise, the program adjusts to the child's individual
skill level so that the child is making correct responses approximately 80% of
the time. This adjustment is designed to keep the program challenging
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and engaging for the child, while allowing the child to generate a feeling of
success and accomplishment and avoid repetitive failure, which can be
discouraging and detrimental to learning.
Fast ForWord is designed to keep children engaged and entertained with
animated characters and sound effects, and its game-like format provides the
thousands of repetitions necessary to improve a child's language skills. Each of
the seven exercises has a different theme and different graphics for each level
within the exercise. Children receive on-screen animation segments as rewards
for correct responses throughout each 20-minute training exercise. In addition,
children collect points as they progress through the exercises that, in certain
training settings, can be redeemed for age-appropriate prizes ranging from small
toys to video game cartridges. The Fast ForWord program is designed to be used
for 100 minutes per day, five days a week for four to eight weeks. Extensive
pilot and field testing of Fast ForWord has shown that students with
language-based learning problems show language processing gains of one to two
years on average upon completion of this intensive program. Additionally, based
on extensive interviews with parents and teachers, children who have completed
the Fast ForWord program are generally reported to have shown substantial
improvements in both self-esteem and behavior as their communication skills
improve.
Results from each child's Fast ForWord exercises are uploaded daily via the
Internet to the Company's proprietary database for analysis and comparison with
the child's progress to date. The Fast ForWord program automatically creates
performance charts and templates in various discrete learning areas which can be
downloaded through the Internet by learning facilitators, enabling them to
monitor the performance of the one or many children under their supervision over
the course of the training program. These charts and templates can also be used
by the facilitator to provide parents and children with measurable results of
the child's progress.
Fast ForWord is designed to be a separate supplemental course of training
that complements a child's regular learning schedule. The program is suitable
for schools, clinics, learning centers, and private or group training with
speech and language professionals. In each case, a Fast ForWord-trained teacher,
speech and language professional or other learning facilitator introduces Fast
ForWord to the child, initiates the training program, monitors and analyzes each
child's progress and helps to ensure successful completion of the program. After
such introduction, parents can also elect to administer the Fast ForWord program
at home.
Manufacture and packaging of the Company's Fast ForWord program requires the
pressing of a CD-ROM, the printing of the packages and related materials and the
assembly of these components. The Company has not entered into any long-term
contracts for such services and instead places purchase orders from time to time
with various third-party suppliers. The Company believes that the market for
supplying such services is highly competitive, and consequently the Company is
not dependent upon a limited number of suppliers.
SEMINARS. To assist teachers, speech and language professionals, parents
and other learning facilitators, the Company provides educational seminars on
language-based learning problems and training seminars in the administration of
the Fast ForWord program. Such workshops range from free two- to three-hour
educational seminars for parents to one- or two-day intensive training seminars
for teachers and speech and language professionals. The training seminars
generally include: (i) an overview of the research behind the development of
Fast ForWord; (ii) a presentation of the clinical results achieved through Fast
ForWord; (iii) hands-on training using CD-ROM and Internet components of the
Fast ForWord program; (iv) case studies and recommended practices for selecting
appropriate candidates for Fast ForWord training; and (v) tips for incorporating
Fast ForWord into the professional's practice or the teacher's school
curriculum. Through these seminars, approximately 2,600 teachers and speech and
language professionals have been trained in administering Fast ForWord. To date
for 1998, the Company has conducted four two-day training seminars and has
scheduled eight additional two-day training seminars in various locations
throughout the country, and plans to schedule additional seminars. In addition,
the
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Company is planning to develop a remote training course that can be delivered by
video, CD-ROM and/or the Internet.
PROFESSIONAL AND PARENTAL SUPPORT. In addition to its educational and
training seminars, the Company provides a number of other support mechanisms for
parents and other learning facilitators involved in addressing language-based
learning problems. The Company believes that, through these forums, it has begun
to create a virtual community among parents and other learning facilitators. For
example, the Company provides an interactive World Wide Web site for children
using Fast ForWord and their families to access program information and research
on language-based learning problems. Chat rooms for parents and downloadable
graphics and software for children are also available. The Company also mails to
the parents of participating children, as well as to schools and speech and
language professionals, a Fast ForWord newsletter that contains items of
interest on the program and language-based learning problems. The Company has a
professional relations staff dedicated to answering questions from and providing
support to professional providers and parents interested in the Fast ForWord
program, and has a toll-free telephone information line.
TECHNICAL SUPPORT. Because many of the teachers, speech and language
professionals, parents and other learning facilitators who administer the Fast
ForWord program have limited computer knowledge and do not have any technical
support on-site to assist them, the Company provides a variety of technical
support services. The Company employs an experienced staff of technical service
representatives who are capable of answering technical questions regarding Fast
ForWord, regardless of platform, as well as questions regarding hardware and
networks. In addition, in connection with use of the Fast ForWord program in
public schools, the Company provides on-site technical training, computer and
software installation, technical support and assistance with integrating the
Fast ForWord program into existing school curricula.
SALES AND MARKETING
The Company intends to invest in the Scientific Learning Corporation and
Fast ForWord names to increase brand awareness and loyalty. The Company believes
that establishing a trusted brand is critical to success in the education and
training markets. Specifically, the Company intends to: (i) continue to build
recognition of the Fast ForWord brand among learning facilitators and leverage
such recognition to build brand awareness of the Company and future products
such as Fast ForWord Two; (ii) communicate the Company's commitment to proven
research and the commercialization of products with measurable results; (iii)
publish field test results; (iv) promote the publication of media articles and
stories regarding the Company and its products; (v) encourage community-building
through support efforts such as the Company's Web site and chat rooms; and (vi)
engage in direct marketing campaigns to educators and other key public school
decision-makers as well as to speech and language professionals and parents. The
Company believes it has already established itself as a pioneer and leader in
the commercialization of neuroscience research applications.
The Company markets and sells Fast ForWord through three primary channels of
distribution: public schools, speech and language professionals in private
practice and the Company's Learning Centers. The Company also intends to pursue
additional channels of distribution, including the "at-home" learning market
which can benefit from the Company's Internet-based system of distribution and
monitoring, as well as possible alliances with others in the after-school
education and training markets. As it expands its sales and marketing efforts in
these primary and additional channels, the Company plans to expand its sales and
marketing organization, which consisted of 42 employees as of June 30, 1998.
PUBLIC SCHOOLS. To more rapidly introduce Fast ForWord into public schools,
the Company has undertaken a reference site program, in which certain schools
agree to provide reference services for Fast ForWord in exchange for a program
discount. Such services include acting as a reference for other educators
interested in Fast ForWord, hosting tours, speaking at events and with the press
about program
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results, participating in studies and cooperating in the publication of results.
These sites provide educators and administrators with the opportunity to see
Fast ForWord in use, which the Company believes helps shorten the sales cycle in
schools. As of June 30, 1998, the Company had established five school reference
sites. The Company initiated its marketing to public schools in late 1997 with a
pilot program involving 19 schools in nine school districts in five states. Fast
ForWord is sold directly to public schools and districts at $850 per child
except where the Company has negotiated reference site or volume discounts in
connection with large sales. The Company believes that per program revenue
generally will decrease in the future as the Company makes more large sales and
grants a greater number of individually negotiated volume discounts in
connection with such sales. To date the Company has trained more than 600
teachers and speech and language professionals in public schools in the
administration of Fast ForWord. The Company plans to expand its sales and
marketing for schools as well as related training seminars. In addition, the
Company is exploring relationships with independent sales representatives and
with other companies that have existing sales relationships with schools to
augment the efforts of the Company's in-house sales team. While the Company
maintains a database of K-12 public schools, to date the majority of leads have
arisen from key educators and other decision-makers within schools and districts
contacting the Company after learning of Fast ForWord from publications in
journals or the general press, presentations at education conferences,
attendance at Company training seminars or from colleagues or parents.
SPEECH AND LANGUAGE PROFESSIONALS. The Company intends to continue to
expand its marketing of Fast ForWord to speech and language professionals
operating in private practice, private schools and hospitals and clinics. To
administer Fast ForWord, the Company currently requires that a speech and
language professional attend a Company training seminar, which to date have been
held in more than 20 cities across the United States. The Company has trained
more than 1,900 speech and language professionals in private practice in how to
administer Fast ForWord. Such seminars currently involve one or two days of
training and cost $995 per person for a Company-sponsored two-day workshop. Fast
ForWord-trained speech and language professionals in private practice recommend
the use of Fast ForWord to parents in appropriate cases and then administer the
program in connection with providing traditional services. In such instances,
Fast ForWord is typically sold directly to parents for $850 per child,
minimizing the administrative burden on the speech and language professional,
who charges separately for time spent supervising the child. The fees charged by
the speech and language professional generally range from $2,000 to $5,000 per
child. Fast ForWord could be used as supplemental to, or potentially as a
partial replacement of, traditional private pre-reading remediation programs,
which the Company estimates typically cost between $15,000 and $20,000. The
Company has been a pioneer in marketing computer-based training programs to
speech and language professionals and has developed a proprietary database of
information regarding thousands of speech and language professionals. Speech and
language professionals are contacted by the Company through telesales and other
direct marketing efforts, which encourage them to attend Company seminars and
use the Fast ForWord program in their practices. In addition, speech and
language professionals learn of the Fast ForWord program through the Company's
participation in trade conferences, publications in journals and the general
press, and the distribution of the Company's informational videos and practice
kits.
LEARNING CENTERS. The Company markets directly to parents through its
Learning Centers, which are intended to provide a supportive, encouraging
environment for a child to participate in the Fast ForWord program, while
providing support and training for the parent. The Company opened its first Fast
ForWord Learning Center in January 1998 and operated three Fast ForWord Learning
Centers as of May 31, 1998. By July 15, 1998, the Company had opened five
additional, expanding the Company's Learning Centers into a total of five
states. The Company now operates centers in California, Washington, Oregon,
Nevada and Florida. Most of the centers opened during summer 1998 are located at
private schools, enabling the Company to take advantage of available classroom
space. Some of the Company's five centers located in private schools are
expected to operate only in the summer months, while others may operate
year-round by offering after-school training, although to date the Company has
no contracts extending these centers beyond the summer months. The Company's
three other Learning Centers are located in office space
34
<PAGE>
leased by the Company. The Company provides monitoring, supervision and weekly
parental consultations in connection with delivery of the Fast ForWord program
at the Learning Centers. For an additional fee, parents can also elect to have a
state-certified speech and language professional test and evaluate their child's
language skills. Through the Fast ForWord Learning Centers, the Company also
offers Fast ForWord At Home for parents who wish to administer the program at
home under the close supervision of the Center. Fast ForWord At Home is
particularly useful for parents and children who have scheduling conflicts or
who live too far away to attend daily training sessions at a Learning Center.
Fast ForWord training at or through a Learning Center typically costs between
$2,000 and $3,000, including program fees, consultation fees and monitoring
fees, as applicable. The Company promotes parental awareness of the Learning
Centers and the Fast ForWord program through direct mail, parent educational
seminars, referrals from schools, speech and language professionals and others,
local advertising, stories in the local press, distribution of a video for
parents and other direct marketing efforts.
OTHER CHANNELS OF DISTRIBUTION. The Company is exploring and developing
other channels of distribution. Currently, parents calling the Company to
inquire about the availability of Fast ForWord are referred to a local Fast
ForWord-trained speech and language professional in private practice or to a
Learning Center, if locally available. However, parents are often located in
areas in which there is no easy access to a trained speech and language
professional or Learning Center. As a result, the Company is developing a remote
or "at-home" course that can be delivered by video, CD-ROM and/or the Internet
for the training of parents in the supervision and administration of Fast
ForWord. In addition, the Company is exploring possible alliances with other
organizations involved in the after-school education and summer education and
training markets.
The Company's future success is, in part, dependent on acceptance of Fast
ForWord by public schools, administrators, teachers, speech and language
professionals, parents and other learning facilitators and on penetration of the
public school, speech and language professional and parental markets. There can
be no assurance that the Company will be successful in developing and
penetrating these markets. See "Risk Factors--Uncertainty of Market Acceptance,"
"--Challenges to Market Penetration," "--Reliance on a Single Product" and
"--Lengthy Sales Cycle."
RESEARCH AND DEVELOPMENT
Approximately one third of the Company's employees are engaged in research
and development activities, which include both product development and outcomes
research. The Company's research and development organization includes
neuroscientists, psychologists, engineers, programmers, statisticians, graphic
artists and animators. The Company believes that its future success depends in
large part on its ability to develop new products and maintain and enhance its
current product line, and on its ability to enhance its market positioning by
leveraging the Company's expertise in neuroscience and computer technology,
which the Company believes have broad applicability. Accordingly, the Company
plans to expand its research and development activities with respect to present
and future products based on brain plasticity. In order to enhance its Fast
ForWord program, the Company is conducting longitudinal studies, as well as
studies focusing on whether the program can be broken into smaller modules to
more easily integrate Fast ForWord into school curricula. The Company is also
currently testing a beta version of Fast ForWord Two for children who have
completed Fast ForWord and are ready for a program that focuses on more advanced
pre-reading skills. The Company is also developing other language-based
products, including an ESL program for foreign students and for adults, an adult
version of Fast ForWord and an assessment or screening test for language-based
learning problems. In addition, the Company is evaluating foreign language
versions of Fast ForWord and a program to assist stroke victims in reacquiring
language skills. The Company also is examining ways to leverage its expertise in
brain-plasticity research in other potential non-language-based products,
including computer-based remediation programs for repetitive stress injury and
tinnitus (ringing in the ears).
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<PAGE>
Once new or improved products are identified and developed through the
Company's research and development process, the Company's product development
team and outcomes research group test the efficacy of such products in extensive
field trials. To promote its goal of commercializing scientifically based and
proven products, the Company intends to release products only after
demonstrating measurable results.
There can be no assurance that: (i) the Company will be successful in
developing and marketing new products or responding to technological
developments, evolving industry standards or changing customer requirements;
(ii) the Company will not experience difficulties that could delay or prevent
the successful development, introduction and sale of such new products; or (iii)
any new products will adequately meet the requirements of the marketplace and
achieve any significant degree of market acceptance. If release dates of any new
products are delayed or if these products fail to achieve market acceptance when
released, the Company's business, operating results and financial condition
could be materially and adversely affected. See "Risk Factors--Dependence on
Continued Product Development."
EFFICACY STUDIES
The Company was founded by scientists who have spent decades researching
neuroscience and the causes of language-based learning problems at UCSF and
Rutgers. The original research studies combining the work of the Company's
founders were funded by UCSF and Rutgers and certain results were published in
the peer-reviewed scientific journal SCIENCE. The primary study included 22
children with language-based learning problems who played computerized versions
of games such as "Simon Says" for 50 hours over a 20-day period. The
experimental group received commands in slowed, stretched and emphasized speech
while the control group received normal speech. Additionally, the experimental
group's exercises adapted to their individual skill level. The results of these
studies were widely noted because the children in the experimental group showed
significant gains of 1.5 years in critical language skills in just four weeks
through the use of the computer-based language training program that became the
basis for Fast ForWord. Six-month follow-up studies demonstrated that the
language skills of these children continued to improve after the completion of
the four-week training period. Children randomly assigned to the control group
did not demonstrate comparable gains.
The Company has funded two additional large-scale trials. The first study,
conducted in 1996, included approximately 500 children between the ages of four
and 14 trained in private clinics and schools across the country and was
designed to test the effectiveness of the Fast ForWord training program in a
variety of settings. Each of the 60 professionals in the 35 locations was an
independent collaborator who agreed to follow the protocols mandated by the
Company and supply pre- and post-assessment testing data on each child based on
the standardized tests used by such professionals in their regular practice.
Most of these children were already identified as needing specific help in
language skills and were involved in remediation programs through regular
sessions with a speech and language professional in private practice or at a
school. As part of the study, the children were administered standardized tests
prior to and following the use of the Fast ForWord program for 100 minutes a
day, five days a week for four to eight weeks. On average, regardless of age or
grade, children involved in the study demonstrated gains of one to two years.
Some of the independent speech and language professionals involved in the
1996 field trial use certain Tests of Language Development ("TOLD") in their
practices and accordingly these tests were administered by such professionals to
196 participating children, both prior to beginning and upon completion of the
Fast ForWord program. These industry-accepted and normed tests, the TOLD-I:2 and
TOLD-P:2, are individually administered comprehensive language tests that assess
various aspects of language performance including semantics, syntax, morphology,
phonology and listening comprehension. Other standardized tests used by
professionals involved in the 1996 field trials were generally less
comprehensive and administered to a fewer number of children. However, the pre-
and post- assessment data based on these other tests was generally consistent
with the results reported on the TOLD-I:2 and TOLD-P:2. Prior to participation
in the Fast ForWord program, only 19% of the children scored at or above the
population
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<PAGE>
mean, as evidenced below by the standard bell curve superimposed on the test
results. After completion of the Fast ForWord program, 52% of the children
scored at or above the population mean.
[GRAPHIC: Side by side graphs subtitled "Before Fast ForWord" and "After
Fast ForWord," respectively, showing test scores of 196 children on certain
tests of language development before and after such children used Fast ForWord,
superimposed on bell curves representing the normal distribution of scores on
such tests. The graphs, together, are titled "Test Results" and are accompanied
by the following text footnotes: "(1) Represents the results from the TOLD-I:2
and -P:2. The changes in the scores reflected in the above graphs (histograms)
are statistically significant and highly reliable (t(195)=18.21, p is less than
.0001) indicating with 99% confidence that the rightward shift in scores
(representing improved performance on the tests) following completion of Fast
ForWord training results from the Fast ForWord training rather than factors of
chance. (2) In order to combine the test results of children of different ages
for comparison to the table of the normal curve (which represents the expected
distribution of test scores among the general population), such test scores were
converted into what are known as "Z-scores." Using Z-scores, the average test
score obtained by the general population (50th percentile) is represented by
zero. The -1.0 Z-score represents the 16th percentile in test performance and
the 1.0 Z-score represents the 84th percentile in test performance. (3) Prior to
the beginning of Fast ForWord training, the tested group of 196 children
achieved an average Z-score of -1.0, representing the 16th percentile in
performance for this test (i.e. these children achieved a score higher than only
15% of the general population). (4) After completion of the Fast ForWord
program, the tested group of 196 children achieved an average Z-score of -0.2,
representing approximately the 42nd percentile in performance for this test
(i.e. these children achieved a score higher than 41% of the general
population)."]
RESULTS RESULTS
(MEASURED IN Z-SCORES)(2) (MEASURED IN
Z-SCORES)(2)
BEFORE FAST FORWORD(3) AFTER FAST FORWORD(4)
-------------------------------
(1) Represents the results from the TOLD-I:2 and -P:2. The
changes in the scores reflected in the above graphs
(histograms) are
statistically significant and highly reliable (t(195)=18.21, p
< .0001) indicating with 99% confidence that the rightward
shift in scores (representing improved performance on the
tests) following completion of Fast ForWord training results
from the Fast ForWord training rather than factors of
chance.
(2) In order to combine the test results of children of
different ages for comparison to the table of the normal
curve (which represents the expected distribution of test
scores among the general population), such test scores were
converted into what are known as "Z-scores." Using Z-scores,
the average test score obtained by the general population
(50(th) percentile) is represented by zero. The -1.0 Z-score
represents the 16(th) percentile in test performance and the
1.0 Z-score represents the 84(th) percentile in test
performance.
(3) Prior to the beginning of Fast ForWord training, the tested
group of 196 children achieved an average Z-score of -1.0,
representing the 16(th) percentile in performance for this
test (i.e. these children achieved a score higher than only
15% of the general population).
(4) After completion of the Fast ForWord program, the tested
group of 196 children achieved an average Z-score of -0.2,
representing approximately the 42(nd) percentile in
performance for this test (i.e. these children achieved a
score higher than 41% of the general population).
The second large-scale study, in the fall of 1997, included approximately
500 children in 19 public schools in nine public school districts in five states
across the country and was designed to test Fast ForWord efficacy with a new
population of children, namely children who were observed by teachers as likely
to be at risk for later academic failure. The children were selected for
participation in the study by their teachers. Most of these children had not
been identified as needing specific help in language skills, nor had they been
assigned to special education classes or other remediation programs outside the
classroom. As part of this study, some of the children were randomly assigned to
a control group which did not receive Fast ForWord training but instead received
traditional remediation training for the same amount of time. The children
trained for 100 minutes a day, five days a week for four to eight weeks. Again,
a substantial majority of the children using Fast ForWord demonstrated similar
gains to those made in earlier studies, making achievements significantly beyond
those made by the control group. Similar results have also been observed in the
overall group of children who have used the Fast ForWord program commercially.
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<PAGE>
COMPUTER TECHNOLOGY
Fast ForWord can be used on either a Windows PC or on an Apple MacIntosh
platform. Fast ForWord is currently supported on a variety of computer
configurations, including an on-site model where learning facilitators supervise
children that train on computers within their offices, an off-site model where
learning facilitators remotely supervise children that train on computers within
their own homes and a client/server model. With the client/server model, which
can support many children simultaneously, a child does not need to use the same
computer for each training session, but can instead use any computer available
which is linked to the network.
The Fast ForWord back-end system is designed to be modular, reliable and
easily scaleable. Centered around the Internet, the back-end system consists of
training computers, data viewing/monitoring computers and the Company's
databases. The Fast ForWord databases are tightly integrated with all Company
databases to provide seamless service from professional support, technical
support and accounting.
This integration allows learning facilitators to use a Web browser to do
most of the necessary monitoring of the children training under their
supervision. After children at a site complete their training for the day, the
learning facilitator uploads all of their data to the Company databases. During
this transaction, the status of each child is updated. This interaction enables
the Company to gather the data that provides the basis of its Internet-delivered
performance reports. Because such uploaded data are then accessed by the
learning facilitator over the Internet and processed primarily on the learning
facilitator's computer, the learning facilitator can monitor and review a
child's progress from virtually anywhere, providing maximum scheduling
flexibility. If data are not uploaded to the Company within the required number
of days, the license key to the program is turned off until contact is made. The
Company is able to protect against unauthorized use because the program cannot
be activated without a license key delivered through the Internet. See "Risk
Factors--Adoption of Internet Solutions."
INTELLECTUAL PROPERTY
The Company's policy is to aggressively protect its proprietary rights in
its products and technology though a combination of patents, trademarks,
copyrights, trade secret laws, confidentiality procedures and contractual
provisions. The Company has filed patent applications in the United States and
internationally relating to its technology, including 30 with the USPTO.
Additionally, pursuant to the University License, the Company is the exclusive
licensee of the technology owned by UCSF and Rutgers with respect to the basic
speech and sound modification algorithms used in Fast ForWord. The licensed
technology is the subject of a pending patent application. There can be no
assurance that any of the Company's or its licensor's pending patent
applications will result in the issuance of any patents, or that, if issued, any
such patents will offer protection against competitors with similar technology.
There can be no assurance that any patents issued to the Company or its
licensors will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage. In
addition, there can be no assurance that competitors, many of whom have
substantially greater resources than the Company and have made substantial
investments in competing technologies, will not seek to apply for and obtain
patents covering technologies that are more effective than the Company's
technologies, that would render the Company's technologies or products obsolete
or uncompetitive or that would prevent, limit or interfere with the Company's
ability to make, use or sell its products either in the United States or in
international markets.
The Company's current products incorporate technologies which are the
subject of patents issued to, and patent applications filed by, others. The
Company has obtained licenses for certain of these technologies and may be
required to obtain licenses for others, although the Company does not believe
that it is currently using technology that is subject to patents held by third
parties without a license. There can be no assurance that the Company will be
able to obtain licenses for technology patented by others on commercially
reasonable terms, or at all, that it will be able to develop alternative
approaches if unable to
38
<PAGE>
obtain licenses or that the Company's current and future licenses will be
adequate for the operation of the Company's business. The failure to obtain such
licenses or identify and implement alternative approaches could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Pursuant to the terms of the University License, the Company must pay UCSF
certain royalties and milestone payments based upon cumulative net sales of the
Company's products. In connection with entering into the University License, the
Company issued 171,788 shares of Series A Preferred Stock to Rutgers and made
other up-front payments. Unless otherwise terminated by operation of law or acts
of the parties, the University License remains in effect until the later of the
expiration of the last-to-expire patent licensed thereunder or the abandonment
of the last patent application licensed thereunder. The Regents may terminate
the University License if the Company violates its terms, including among others
its obligations to make payments thereunder, and fails to cure such violation
within 60 days of the Regents' written notice thereof. The Company may terminate
the University License at any time by giving written notice of its intent to do
so, and the termination will take effect 60 days from the effective date of such
notice. The loss or inability to maintain the University License could delay the
Company's introduction of new products or cause the recall of products from the
market, which would have a material adverse effect on the Company's business,
financial condition and results of operations. In such event, even if the
Company could identify and license technology equivalent to the technology
covered by the University License, development and integration of such
alternative technology would be likely to delay the Company's product line,
which would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company also relies upon trade secrets, technical know-how and
continuing invention to develop and maintain its competitive position, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its right to its trade secrets, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Risk Factors--Dependence on Proprietary Technology."
COMPETITION
The educational technology market in which the Company operates is very
competitive. The Company believes that the principal competitive factors in the
industry are efficacy, ability to deliver measurable results, cost, efficiency
of delivery, ability to provide training to learning facilitators and ability to
complement and supplement public school curriculum. The Company believes that it
competes favorably on the basis of these factors. The Company competes primarily
against providers of traditional methods of remediation for language-based
learning problems, which typically require several years of one-on-one training
in children with identified language-based learning problems. Although the
traditional approach to language-based learning problems is fundamentally
different from the approach taken by the Company, such programs are more widely
known and accepted and, therefore, represent significant competition. In
addition, the Company competes to some extent with other companies offering
educational software products to schools and speech and language professionals
in private practice and with other operators of learning centers. Existing
competitors may continue to broaden their product lines, and potential
competitors, including large software developers and educational publishers, may
enter or increase their focus on the school market, resulting in greater
competition for the Company. Moreover, the Company expects that it will face
additional competition from new entrants into the market. Many competitors have
substantially greater technical, marketing and distribution resources than the
Company. There can be no assurance that the Company will continue to be able to
market its products successfully or compete effectively in the educational
technology market. See "Risk Factors--Competition."
39
<PAGE>
EMPLOYEES
As of June 30, 1998, the Company had 101 full-time and 12 part-time
employees. The Company believes its relations with employees are good. None of
the Company's employees is represented by a union or subject to collective
bargaining agreements. See "Risk Factors--Dependence on Key Personnel."
PROPERTIES
The Company leases a 34,257 square-foot facility in Berkeley, California
under a five-year lease that expires in September 2002. The Berkeley facility
houses the Company's corporate offices and a Fast ForWord Learning Center. The
Company also leases a 772 square-foot facility in Bellevue, Washington for a
Fast ForWord Learning Center, which lease expires in July 1999. The Company has
short-term arrangements with five private schools and one commercial facility
for additional Fast ForWord Learning Centers. The Company believes its
facilities are adequate for its current operations.
40
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth certain information concerning the Company's
directors, executive officers and certain key employees as of June 10, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- -----------------------------------
<S> <C> <C>
Sheryle J. Bolton.................. 51 President, Chief Executive Officer
and Member of the Board of
Directors
Dr. Michael M. Merzenich........... 57 Chief Scientific Officer and Member
of the Board of Directors
Dr. Paula A. Tallal................ 51 Executive Vice President and
Chairman of the Board of Directors
Frank M. Mattson................... 43 Chief Financial Officer, Vice
President, Finance, and Secretary
Dr. William M. Jenkins............. 47 Vice President, Product Development
Dr. Steven L. Miller............... 34 Vice President, Outcomes Research
Dr. Bret E. Peterson............... 35 Vice President, Internet and
Database Systems
Diane H. Church.................... 51 Vice President, Professional
Relations
Kang S. Lim........................ 42 Vice President, Intellectual
Property
Kathryn M. Allen................... 46 Director, Public School Teacher
Training and Marketing
Dr. Kathleen M. Hocker............. 57 Director, Public School Sales
James A. Mills..................... 42 Director, Business Development
Carleton A. Holstrom (1)(2)........ 62 Member of the Board of Directors
Rodman W. Moorhead, III (1)........ 54 Member of the Board of Directors
Dr. Leonard S. Schleifer (1)....... 45 Member of the Board of Directors
James E. Thomas (2)................ 38 Member of the Board of Directors
</TABLE>
- --------------------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
SHERYLE J. BOLTON has served as Chief Executive Officer and a member of the
Board of Directors of the Company since November 1996. Ms. Bolton has also
served as President since June 1997. From January 1994 to July 1995, Ms. Bolton
served as President and Chief Operating Officer of Physicians' Online, Inc., a
physicians' online service provider. From June 1993 to December 1994 and from
September 1995 to October 1996, Ms. Bolton consulted for a number of
international companies, including many in the health care and technology
sectors, specifically in the areas of strategy, operations and finance. Ms.
Bolton's experience also includes senior management positions at Rockefeller &
Co., Inc., a global investment management firm, and Merrill Lynch Capital
Markets, Investment Banking Division. Earlier in her career, she was a teacher
of English as a second language in Africa and a language arts teacher in public
schools in the State of Georgia. Ms. Bolton is a director or trustee of several
mutual funds of Scudder Kemper Investments, Inc., and a director of LotsOff
Corporation, a public company that operates retail stores and sells consumer
goods in the southwestern United States. Ms. Bolton holds a B.A. in English and
an M.A. in Linguistics from the University of Georgia, and an M.B.A. from
Harvard Business School.
DR. MICHAEL M. MERZENICH is a founder of the Company. He has served as its
Chief Scientific Officer since November 1996 and as a member of the Board of
Directors since the Company's inception. From January 1996 to November 1996, Dr.
Merzenich served as the Chief Executive Officer and President of the Company.
During 1997, Dr. Merzenich worked full-time at the Company during a sabbatical
from his faculty position at UCSF. In 1998, Dr. Merzenich returned to his
faculty position at UCSF, but pursuant to
41
<PAGE>
a consulting agreement with the Company devotes 20 percent of his professional
time on consulting activities for the Company. Since 1971, Dr. Merzenich has
been a member of the faculty, and since 1980 a full professor, in Neuroscience,
Physiology, Biomedical Engineering and Otolaryngology at UCSF. He is currently
the Francis A. Sooy Professor of Otolaryngology at UCSF. Dr. Merzenich has more
than 25 years of experience in managing large, multidisciplinary brain
science/behavior/engineering research projects that have led to commercial
products and numerous publications and awards. Dr. Merzenich holds a B.S. in
General Science from the University of Portland and a Ph.D. in Physiology from
The Johns Hopkins University, with additional training from the University of
Wisconsin.
DR. PAULA A. TALLAL is a founder of the Company. She has served as its
Executive Vice President and Chairman of the Board of Directors since January
1996 and as a director since the Company's inception. During 1997, Dr. Tallal
worked full-time at the Company during a sabbatical from her faculty position at
Rutgers. In 1998, Dr. Tallal returned to her faculty position at Rutgers, but
pursuant to a consulting agreement with the Company devotes an average of one
day per week on consulting activities for the Company. Since 1988, Dr. Tallal
has served as co-director of the Center for Molecular and Behavioral
Neuroscience at Rutgers. Dr. Tallal is an active participant in many scientific
advisory boards and governmental committees for both developmental language
disorders and learning disabilities. Dr. Tallal has over 20 years experience
managing multi-site, multi-disciplinary federally funded contracts and grants
that have resulted in over 150 publications, as well as national and
international honors. Dr. Tallal holds a B.A. in Art History from New York
University and a Ph.D. in Experimental Psychology from Cambridge University with
additional training from The Johns Hopkins University.
FRANK M. MATTSON has served as the Company's Chief Financial Officer and
Vice President, Finance since January 1997. He has served as Secretary of the
Company since June 1997. From August 1994 to January 1997, Mr. Mattson served as
Vice President of Finance and Operations, Executive Vice President, Chief
Financial Officer and as a director of MNI Interactive, Inc., a startup
entertainment marketing company. From June 1992 to August 1994, Mr. Mattson was
Vice President of Distribution and Strategic Planning for Ingram Entertainment,
Inc. ("Ingram"), a unit of the Ingram Distribution Group, one of the world's
largest distribution companies. At Ingram, Mr. Mattson directed the post-merger
integration of Ingram and Commtron Corporation ("Commtron"), the largest
distributor in the home video industry until its acquisition by Ingram in 1992.
From 1986 to 1992, Mr. Mattson served in a variety of management positions at
Commtron, a publicly traded company, most recently as Vice President of
Operations and as a director of the company. Mr. Mattson holds a B.S. in
Business from Miami University (Ohio) and an M.A. in Economics from the
University of Wisconsin in Milwaukee. Mr. Mattson has also served on the faculty
of Drake University.
DR. WILLIAM M. JENKINS is a founder of the Company and has served as the
Company's Vice President, Product Development since June 1997. From March 1996
to June 1997, Mr. Jenkins served as Vice President, Research and Development.
Since 1990, Dr. Jenkins has also served as an Adjunct Associate Professor at
UCSF. Dr. Jenkins currently serves on the editorial board in the Systems
Plasticity section of RESTORATIVE NEUROLOGY AND NEUROSCIENCE. Dr. Jenkins is the
principal developer of the Company's current training activities. Dr. Jenkins
holds a B.S. in Psychology, an M.A. in Psychobiology and a Ph.D. in
Psychobiology from Florida State University, with additional post-doctoral
training from UCSF.
DR. STEVEN L. MILLER is a founder of the Company and has served as the
Company's Vice President, Outcomes Research since June 1997. From May 1996 to
June 1997, Dr. Miller served as Vice President, Professional Relations and
Outcomes. From September 1991 to May 1996, he held research appointments at the
Center for Molecular and Behavioral Neuroscience at Rutgers. Dr. Miller has
extensive experience in organizing clinical research studies and conducting
longitudinal studies of children and adults who have language and reading
impairments. Dr. Miller holds a B.A. in Psychology from Bloomsburg University of
Pennsylvania, an M.A. in Neuroscience from the University of Hartford and a
Ph.D. in Psychology from
42
<PAGE>
the University of North Carolina at Greensboro. He received additional training
in Clinical Neuropsychology at the Bowman Gray School of Medicine at Wake Forest
University.
DR. BRET E. PETERSON has served as the Company's Vice President, Internet
and Database Systems since June 1997. He has worked for the Company since June
1996. From January 1995 to March 1996, Dr. Peterson served as a Research
Scientist at Yale University. From January 1994 to December 1995, he was a
post-doctoral fellow at Los Alamos National Laboratory. From September 1993 to
November 1993, Dr. Peterson provided consulting services to Bio-Rad
Laboratories, Inc. From April 1986 to August 1987 he worked as an engineer at
Apple Computer, Inc. Dr. Peterson holds an A.B. in Computer Science from the
University of California at Berkeley, and an M.S. and Ph.D. in Bioengineering
from a joint program with the University of California at Berkeley and UCSF.
DIANE H. CHURCH has served as the Company's Vice President, Professional
Relations since August 1997. From February 1997 to August 1997, Ms. Church was
Georgia Account Team Manager with Compuware Corporation, an information systems
software and services company. Ms. Church was Mid-Atlantic Regional Director and
Regional Director for Telecommunications Accounts at Candle Corporation from
April 1994 to September 1995 and at Legent Corporation Regional Director for
Mid-Atlantic and then South-Eastern Regional Director from April 1990 to April
1994, both of which are information systems software and services companies.
Prior to that time, Ms. Church held senior management positions with Wang
Laboratories, a computer and office equipment company. Ms. Church also worked as
an educator in public schools in the State of Georgia. Ms. Church holds a B.A.
in English and Education from Georgia Southwestern College and an M.B.A. from
Emory University.
KANG S. LIM has served as the Company's Vice President, Intellectual
Property since September 1997. From January 1997 to August 1997, Mr. Lim was the
Director of Intellectual Property for VXTreme, Inc., an Internet applications
software company that was acquired by Microsoft Corporation. From December 1993
to January 1997, Mr. Lim was patent counsel at Sun Microsystems Inc., a computer
workstations company and from May 1992 to December 1993, practiced patent law at
the law firm of Skjerven, Morrill, MacPherson, Franklin & Friel. Mr. Lim holds a
B.Sc. in Computer Engineering from Manchester University, an M.S. in Computer
Engineering from the University of Southern California and a J.D. from the
University of California, Hastings College of the Law.
KATHRYN M. ALLEN has served as Director, Public School Teacher Training and
Marketing since April 1998. Ms. Allen has more than 14 years of experience in
information sales, marketing, and training for the K-12 public school market.
From January 1995 to January 1997, Ms. Allen was Director of Marketing and
Special Sales for Teacher Created Materials, Inc., a supplemental print
publisher and staff development provider. From December 1982 to December 1994,
Ms. Allen held several sales and marketing positions within the Dun & Bradstreet
Corporation, most recently as Western Regional Sales Manager for the Market Data
Retrieval division. Earlier in her career, Ms. Allen was an elementary school
teacher in Japan and Australia. Ms. Allen holds a B.S. in Elementary Education
from Western Connecticut State College and an M.S. in Mathematics from the
University of Bridgeport.
DR. KATHLEEN M. HOCKER has served as Director, Public School Sales, since
March 1998. Dr. Hocker has more than 13 years of experience in educational sales
and marketing specifically to the K-12 public school market and eight years of
teaching experience at the elementary, special, and higher education levels.
From November 1996 to December 1997, Dr. Hocker was the National Sales Manager,
Interactive Products for Steck-Vaugh Company, a leading publisher of educational
materials. From February 1995 to November 1996, Dr. Hocker was the Director of
Curriculum and Assessment for the Northeastern U.S. for Computer Curriculum
Corporation, a division of Simon & Schuster. From October 1993 to January 1995,
she was Marketing Director for Ligature, a curriculum development company. Her
previous experience includes a position as Regional Senior Consultant for
Houghton Mifflin Company and educational consulting for Addison Wesley
Publishing Company. Dr. Hocker holds a B.A. in Elementary Education and an M.Ed.
in Special Education from Antioch University and an Ed.D. from Nova University.
43
<PAGE>
JAMES A. MILLS has served as Director, Business Development since July 1997.
Since October 1997 he has had responsibility for the development of the
Company's Fast ForWord Learning Centers. Prior to joining the Company, Jim was a
consultant advising California-based clients on financial, organizational, and
merger-related consolidation issues. From 1986 to June 1996, Mr. Mills served as
a Vice President at Citicorp Real Estate. Mr. Mills previously worked in cable
television programming and distribution for Viacom International, Inc., a cable
programming start-up venture and a national cable marketing trade association.
Mr. Mills holds a B.S. in Environmental Sciences from Stanford University and an
M.B.A. from Harvard Business School.
CARLETON A. HOLSTROM is a founder of the Company and has been a member of
the Board of Directors of the Company since February 1996. From February 1996 to
March 1997, Mr. Holstrom also served as the Company's Chief Financial Officer.
Mr. Holstrom retired in 1987 as Senior Vice President--Finance of The Bear
Stearns Companies. He is a director of Custodial Trust Company and is a trustee,
overseer or director of a number of non-profit organizations. Mr. Holstrom has
served as a member of the Board of Trustees and Board of Governors of Rutgers,
including as chairman and vice-chairman of both. He is currently a member of the
Board of Overseers' of the College of Letters and Science at the University of
Wisconsin-Madison. Mr. Holstrom holds a B.S. in Economics from University of
Wisconsin-Madison and an M.A. in Economics from Rutgers.
RODMAN W. MOORHEAD, III has been a member of the Board of Directors of the
Company since June 1998. Mr. Moorhead has been employed since 1973 by E.M.
Warburg, Pincus & Co., LLC, a specialized private equity firm (or its
predecessors), where he currently serves as Senior Managing Director. Mr.
Moorhead was nominated to the Company's Board of Directors in accordance with
rights held by Ventures, pursuant to an equity agreement. Upon the completion of
this Offering and so long as Ventures owns a requisite percentage of outstanding
shares of Common Stock, the Company must nominate Mr. Moorhead, or another
individual designated by Ventures and reasonably acceptable to the Company, and
use its best efforts to have Mr. Moorhead or such other individual elected to
the Board. See "Certain Transactions--Board Representation Right." Mr. Moorhead
is a director of Coventry Health Care, Inc., NeXstar Pharmaceuticals, Inc.,
Transkaryotic Therapies, Inc. and Xomed Surgical Products, Inc. and a number of
privately held companies. He is a trustee of The Taft School and a member of the
Overseers' Committee on University Resources at Harvard College. Mr. Moorhead
holds an A.B. in Economics and an M.B.A. from Harvard University.
DR. LEONARD S. SCHLEIFER has been a member of the Board of Directors of the
Company since May 1996. Dr. Schleifer is a founder of Regeneron Pharmaceuticals,
Inc. ("Regeneron"), a public company focused on the application of molecular and
cell biology to the search for novel human therapeutics, and has been a director
and its President and Chief Executive Officer since Regeneron's inception in
1988. He served as Chairman of the Board of Regeneron from 1990 to 1994. From
1984 to 1988, Dr. Schleifer was an Assistant Professor at the Cornell University
Medical School in the Departments of Neurology and Neurobiology, and in 1992 he
was appointed Clinical Professor of Neurology. Dr. Schleifer received his M.D.
and Ph.D. in Pharmacology from the University of Virginia. Dr. Schleifer is a
licensed physician and is certified in Neurology by the American Board of
Psychiatry and Neurology.
JAMES E. THOMAS has served as a member of the Board of Directors of the
Company since November 1996. Since 1989, he has been employed by E.M. Warburg,
Pincus & Co., LLC, a specialized private equity firm (or its predecessors),
where he currently serves as Managing Director. Prior to 1989, Mr. Thomas was a
Vice President of Goldman Sachs International in London. Mr. Thomas was
nominated to the Company's Board of Directors in accordance with rights held by
Ventures, pursuant to an equity agreement. Upon the completion of this Offering
and so long as Ventures owns a requisite percentage of outstanding shares of
Common Stock, the Company must nominate Mr. Thomas, or another individual
designated by Ventures and reasonably acceptable to the Company, and use its
best efforts to have
44
<PAGE>
Mr. Thomas or such other individual elected to the Board. See "Certain
Transactions--Board Representation Right." Mr. Thomas is also a director of
Anergen, Inc., Celtrix Pharmaceuticals, Inc., Menley & James Laboratories, Inc.,
Xomed Surgical Products, Inc., Transkaryotic Therapies, Inc., Oxford
GlycoSciences plc and a number of privately held companies. Mr. Thomas holds a
B.S. in Finance and Economics from The Wharton School of Business at the
University of Pennsylvania and an M.Sc. from The London School of Economics.
BOARD COMPOSITION
The Company currently has authorized seven directors. In accordance with the
terms of the Company's Restated Certificate of Incorporation, which will become
effective upon the closing of this Offering (the "Restated Certificate"), the
terms of office of the directors will be divided into three classes: Class I,
Class II and Class III, which term will expire at the annual meetings of
stockholders to be held in 1999, 2000 and 2001, respectively (or special
meetings held in lieu thereof). The Class I directors are Messrs. Holstrom and
Thomas and Dr. Tallal, the Class II directors are Ms. Bolton and Dr. Schleifer,
and the Class III directors are Dr. Merzenich and Mr. Moorhead. At each annual
meeting of stockholders after the initial classification or special meeting in
lieu thereof, the successors to directors whose terms will then expire will be
elected to serve from the time of election and qualification until the third
annual meeting following election or special meeting held in lieu thereof. In
addition, the Restated Certificate provides that the authorized number of
directors may be changed only by resolution of the Board of Directors. Any
additional directorships resulting from an increase in the number of directors
will be distributed among the three classes so that, as nearly as possible, each
class will consist of one-third of the directors. This classification of the
Board of Directors may have the effect of delaying or preventing changes in
control or management of the Company. Although directors of the Company may be
removed for cause by the affirmative vote of the holders of a majority of the
Common Stock, the Restated Certificate provides that directors may be removed
without cause only by the affirmative vote of holders of at least 66 2/3% of the
voting power of all the then-outstanding shares of the Company's voting stock.
BOARD COMMITTEES
The Board of Directors has an Audit Committee and a Compensation Committee.
The Audit Committee, currently composed of Messrs. Holstrom and Thomas, reviews
the internal accounting procedures of the Company and consults with and reviews
the services provided by the Company's independent auditors. The Compensation
Committee, currently composed of Dr. Schleifer and Messrs. Holstrom and
Moorhead, reviews and recommends to the Board of Directors the compensation and
benefits of the Company. The Compensation Committee also administers the
issuance of stock options and other awards under the Company's equity incentive
plans.
DIRECTOR COMPENSATION
The Company currently provides cash compensation to directors who are not
employees of or consultants to the Company and do not hold five percent or more
of the Company's voting securities ("Non-Employee Directors") for services as
directors at a rate of $1,000 per regular meeting of the Board of Directors
attended in person and $500 per Board Committee meeting and per meeting of the
Board of Directors attended by telephone. Directors will also be reimbursed for
certain expenses in connection with attendance at Board of Directors and
committee meetings. Directors are currently eligible to participate in the
Company's Stock Option Plan and, beginning with the completion of this Offering,
employee directors will also be eligible to participate in the Company's 1998
Employee Stock Purchase Plan and non-employee directors will be eligible to
participate in the 1998 Non-Employee Directors' Stock Option Plan. See
"--Employee Benefit Plans."
45
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the Compensation Committee of the Board of Directors
has been an officer or employee of the Company, except that Mr. Holstrom served
as the Company's Chief Financial Officer from February 1996 to March 1997. No
executive officer of the Company serves as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving on the Company's Board of Directors or Compensation Committee.
EXECUTIVE COMPENSATION
The following table sets forth the compensation awarded or paid by the
Company during the fiscal year ended December 31, 1997 to the Company's Chief
Executive Officer and the other most highly compensated officer receiving
compensation in excess of $100,000 in 1997 (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE (1)
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
-------------------
ANNUAL COMPENSATION NUMBER OF SHARES OF
---------------------------- COMMON STOCK
ALL OTHER UNDERLYING
NAME AND PRINCIPAL POSITION (2) SALARY ($) COMPENSATION ($) OPTIONS (#)
- -------------------------------------------------------------- ---------- ---------------- -------------------
<S> <C> <C> <C>
Sheryle J. Bolton ............................................ $ 205,000 $ 30,000(3) --
Chief Executive Officer
Frank M. Mattson ............................................. $ 140,000 -- 82,500
Chief Financial Officer
</TABLE>
- --------------------------
(1) In accordance with the rules of the Securities and Exchange Commission (the
"Commission"), the compensation described in this table does not include
medical, group life insurance or other benefits received by the Named
Executive Officers that are available generally to all salaried employees of
the Company and certain perquisites and other personal benefits received by
the Named Executive Officers, which do not exceed the lesser of $50,000 or
10% of any such officer's salary and bonus disclosed in this table.
(2) In determining compensation packages for its officers, the Company currently
takes into consideration the equity of the Company held by such officer.
Accordingly, certain officers may receive smaller compensation packages than
other officers of the Company with comparable responsibilities.
(3) Reflects reimbursement of relocation expenses in 1997.
46
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options made during the
year ended December 31, 1997 to each of the Named Executive Officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------
NUMBER OF POTENTIAL REALIZABLE VALUE
SHARES OF PERCENTAGE OF AT ASSUMED ANNUAL RATES OF
COMMON STOCK TOTAL OPTIONS STOCK APPRECIATION FOR
UNDERLYING GRANTED IN EXERCISE OPTION TERM (4)
OPTIONS FISCAL 1997 PRICE EXPIRATION --------------------------
NAME GRANTED (1) (2) ($/SHARE) (3) DATE 5% ($) 10% ($)
- ------------------------ -------------- -------------- ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Sheryle J. Bolton -- -- -- -- -- --
Frank M. Mattson 70,000 20.1% $0.20 1/27/07 $ 1,469,300 $ 2,342,900
12,500 3.6% $0.40 10/28/07 $ 259,875 $ 415,875
</TABLE>
- ------------------------
(1) Each of the options was granted under the Company's Stock Option Plan and
has a term of 10 years, subject to earlier termination in certain events
related to termination of employment. Generally, initial option grants for
executive officers vest as to 25% of the total shares one year from the date
of hire, and one forty-eighth of the total shares vest on each monthly
anniversary thereafter. Additional option grants generally vest as to one
forty-eighth of the total shares each month.
(2) Based on an aggregate of 348,875 shares subject to options granted to
employees of the Company in 1997, including the Named Executive Officers.
(3) The exercise price per share of each option was equal to the fair market
value of the Common Stock as determined by the Board of Directors on the
date of grant.
(4) The potential realizable value is calculated based on the term of the option
at the time of grant (10 years) and an assumed initial public offering price
of $13.00 per share. Stock price appreciation of 5% and 10% is assumed
pursuant to rules promulgated by the Securities and Exchange Commission and
does not represent the Company's prediction of its stock price performance.
The potential realizable value is calculated based on the deemed value at
the date of grant and assumes that the deemed value appreciates from the
date of grant at the indicated annual rate compounded annually for the
entire term of the option and that the option is exercised at the exercise
price and sold on the last day of its term at the appreciated price.
YEAR-END OPTION VALUES (1)
The following table sets forth for each of the Named Executive Officers the
number and value of securities underlying unexercised options held by the Named
Executive Officers at December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT DECEMBER 31, 1997 (2) AT DECEMBER 31, 1997 (3)
------------------------------ -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------- ----------- ----------------- ------------ -----------------
<S> <C> <C> <C> <C>
Sheryle J. Bolton.................... 500,000 -- $ 1,950,000 $ --
Frank M. Mattson..................... 82,500 -- $ 319,250 --
</TABLE>
- ------------------------
(1) No Named Executive Officer exercised any option in fiscal 1997.
(2) Options may be exercised immediately pursuant to early exercise provisions
contained in option agreements. Any unvested shares issued pursuant to such
early exercise provisions are subject to a repurchase option in favor of the
Company upon termination of employment. Such repurchase option terminates at
a rate reflecting the vesting schedule of the underlying option.
Accordingly, such repurchase option generally terminates at a rate of
1/48th per month. See "--Principal and Selling Stockholders."
(3) Based on the difference between the deemed fair market value of the Common
Stock at December 31, 1997 ($4.10 per share) and the exercise price.
47
<PAGE>
EMPLOYEE BENEFIT PLANS
1998 EQUITY INCENTIVE PLAN. The Company's 1998 Equity Incentive Plan (the
"Incentive Plan") was adopted by the Company's Board of Directors and approved
by the Company's stockholders in June 1998. The Incentive Plan amends and
restates the Company's existing Stock Option Plan adopted in February 1996 and
amended in September 1996 (the "Prior Plan"). As of June 30, 1998, there were
options outstanding to purchase an aggregate of 1,511,498 shares of the
Company's Common Stock under the Prior Plan. The Incentive Plan will become
effective upon completion of this Offering. There are currently 2,800,000 shares
of Common Stock authorized for issuance under the Incentive Plan.
The Incentive Plan provides for the grant of incentive stock options, as
defined under the Internal Revenue Code of 1986, as amended (the "Code"), to
employees (including officers) and nonstatutory stock options, restricted stock
purchase awards, stock bonuses and stock appreciation rights to employees
(including officers), directors and consultants of the Company. The Incentive
Plan is administered by the Compensation Committee, which determines recipients
and types of options to be granted, including the exercise price, number of
shares subject to the option and the exercisability thereof.
The terms of stock options granted under the Incentive Plan generally may
not exceed 10 years. The Compensation Committee determines the exercise price of
options granted under the Incentive Plan, provided that the exercise price for
an incentive stock option cannot be less than 100% of the fair market value of
the Common Stock on the date of grant and, prior to the Company's stock being
publicly traded, the exercise price for a nonstatutory stock option cannot be
less than 85% of the fair market value of the Common Stock on the date of grant.
Options granted under the Incentive Plan vest at the rate specified in the
option agreement. Generally, the optionee may not transfer a stock option other
than by will or the laws of descent or distribution unless the optionee holds a
nonstatutory stock option that provides otherwise. However, an optionee may
designate a beneficiary who may exercise the option following the optionee's
death. An optionee whose service relationship with the Company or any affiliate
ceases for any reason may exercise vested options for the term provided in the
option agreement.
No incentive stock option (and prior to the Company's stock being publicly
traded, no nonstatutory stock option) may be granted to any person who, at the
time of the grant, owns (or is deemed to own) stock possessing more than 10% of
the total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant and the term of the option
does not exceed five years from the date of grant. In addition, the aggregate
fair market value, determined at the time of grant, of the shares of Common
Stock with respect to which incentive stock options are exercisable for the
first time by an optionee during any calendar year (under all such plans of the
Company and its affiliates) may not exceed $100,000.
When the Company becomes subject to Section 162(m) of the Code (which denies
a deduction to publicly held corporations for certain compensation paid to
specified employees in a taxable year to the extent that the compensation
exceeds $1,000,000), no person may be granted options under the Incentive Plan
covering more than 625,000 shares of Common Stock in any calendar year.
Shares subject to stock options that have expired or otherwise terminated
without having been exercised in full again become available for the grant of
awards under the Incentive Plan. Under its general authority to grant options,
the Compensation Committee has the implicit authority to reprice outstanding
options or to offer optionees the opportunity to replace outstanding options
with new options for the same or a different number of shares. Both the original
and new options will count toward the Code Section 162(m) limitation set forth
above.
Restricted stock purchases may be at any price determined by the Board in
its sole discretion, and stock bonuses may be awarded in consideration of past
services without a purchase payment. Rights under a stock bonus or restricted
stock bonus agreement may not be transferred other than by will, the laws of
48
<PAGE>
descent and distribution or a domestic relations order during the time the stock
awarded pursuant to such an agreement remains subject to the agreement.
In the event of certain changes in control, all outstanding options under
the Incentive Plan either will be assumed or substituted for by any surviving
entity. If the surviving entity determines not to assume or substitute for such
awards, the vesting provisions of such stock awards will be accelerated and such
stock awards will be terminated upon the change in control if not previously
exercised. In the event of the acquisition pursuant to Section 13(d) or 14(d) of
the Exchange Act of 1934 of securities representing at least fifty percent (50%)
of the combined voting power of the Company, the vesting of stock awards will be
accelerated immediately upon the occurrence of such event.
1998 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN. In June 1998, the Board
adopted, and the Company's stockholders approved, the 1998 Non-Employee
Directors' Stock Option Plan (the "Directors' Plan") to provide for the
automatic grant of options to purchase shares of Common Stock to Non-Employee
Directors of the Company. The Board administers the Directors' Plan, unless the
Board delegates administration to a committee. The aggregate number of shares of
Common Stock that may be issued pursuant to options granted under the Directors'
Plan is 100,000 shares.
Pursuant to the terms of the Directors' Plan, upon the completion of this
Offering, subject to certain exceptions, each Non-Employee Director will
automatically be granted an option to purchase 20,000 shares of Common Stock
(the "Initial Grant"). Any individual who becomes a Non-Employee Director after
this Offering will automatically be granted the Initial Grant upon being elected
to the Board of Directors. Any person who is a Non-Employee Director on the
first anniversary of this Offering automatically will be granted an option to
purchase 4,000 shares of Common Stock (the "Annual Grant") on the first
anniversary of this Offering and on each anniversary thereafter during his or
her service as a Non-Employee Director. Any individual who becomes a
Non-Employee Director after the first anniversary of this Offering will receive,
in addition to the Initial Grant, an Annual Grant on each anniversary of the
date such Non-Employee Director was first elected as a member of the Board
during his or her service as a Non-Employee Director.
Initial Grants vest quarterly over the four-year period following the date
of grant such that the entire Initial Grant shall become exercisable on the
fourth anniversary of the date of grant. Annual Grants vest quarterly over the
one-year period following the date of grant, such that the entire Annual Grant
will become exercisable on the first anniversary of the date of grant.
The exercise price of the options granted under the Directors' Plan will be
equal to the fair market value of the Common Stock on the date of grant. No
option granted under the Directors' Plan may be exercised after the expiration
of 10 years from the date it was granted. Options granted under the Directors'
Plan generally are non-transferable. However, an optionee may designate a
beneficiary who may exercise the option following the optionee's death. An
optionee whose service relationship with the Company or any affiliate (whether
as a Non-Employee Director of the Company or subsequently as an employee,
director or consultant of either the Company or an affiliate) ceases for any
reason may exercise vested options for the term provided in the option agreement
(12 months generally, 18 months in the event of death).
In the event of certain changes in control, all outstanding options under
the Directors' Plan either will be assumed or substituted for by any surviving
or acquiring entity. If the surviving or acquiring entity determines not to
assume or substitute for such options, the options will be accelerated prior to
the change in control and will be terminated if not exercised prior to the
change in control. In the event of the acquisition pursuant to Section 13(d) or
14(d) of the Exchange Act of 1934 of securities representing at least fifty
percent (50%) of the combined voting power of the Company, the vesting of
options will be accelerated immediately upon the occurrence of such event.
49
<PAGE>
1998 EMPLOYEE STOCK PURCHASE PLAN. In June 1998, the Board adopted, and the
Company's stockholders approved, the 1998 Employee Stock Purchase Plan (the
"Purchase Plan"), authorizing the issuance of 500,000 shares of Common Stock
pursuant to purchase rights granted to employees of the Company or to employees
of any affiliate of the Company. The Purchase Plan is intended to qualify as an
employee stock purchase plan within the meaning of Section 423 of the Code.
The Purchase Plan provides a means by which employees may purchase Common
Stock of the Company through payroll deductions. The Purchase Plan is
implemented by offerings of rights to eligible employees. Under the Plan, the
Company may specify offerings with a duration of not more than 27 months, and
may specify shorter purchase periods within each offering. The first offering
will begin on the effective date of this Offering and be approximately 12 months
in duration with purchases occurring every six months. Unless otherwise
determined by the Board of Directors, Common Stock is purchased for accounts of
employees participating in the Purchase Plan at a price per share equal to the
lower of (i) 85% of the fair market value of a share of Common Stock on the date
of commencement of participation in the offering or (ii) 85% of the fair market
value of a share of Common Stock on the date of purchase. Generally, all regular
employees, including executive officers, who work at least 20 hours per week and
are customarily employed by the Company or by an affiliate of the Company for at
least five months per calendar year may participate in the Purchase Plan and may
authorize payroll deductions of up to 15% of their base compensation for the
purchase of stock under the Purchase Plan.
Eligible employees may be granted rights only if the rights together with
any other rights granted under employee stock purchase plans do not permit such
employee's rights to purchase stock of the Company to accrue at a rate which
exceeds $25,000 of fair market value of such stock for each calendar year in
which such rights are outstanding. No employee shall be eligible for the grant
of any rights under the Purchase Plan if immediately after such rights are
granted, such employee has voting power over 5% or more of the Company's
outstanding capital stock. As of the date hereof, no shares of Common Stock had
been purchased under the Purchase Plan.
401(k) PLAN. In January 1996, the Company adopted a tax-qualified employee
savings and retirement plan (the "401(k) Plan") covering all of the Company's
employees. Pursuant to the 401(k) Plan, employees may elect to reduce their
current compensation by up to the lesser of 20% of eligible compensation or the
statutorily prescribed annual limit ($10,000 in 1998) and have the amount of
such reduction contributed to the 401(k) Plan. The trustee under the 401(k)
Plan, at the direction of each participant, invests the assets of the 401(k)
Plan in any of four investment options. The 401(k) Plan is intended to qualify
under Section 401 of the Internal Revenue Code so that contributions by
employees to the 401(k) Plan, and income earned on plan contributions, are not
taxable to employees until withdrawn, and so that the contributions by employees
will be deductible by the Company when made. The Company may make matching or
additional contributions to the 401(k) Plan, in amounts to be determined
annually by the Board of Directors.
EMPLOYMENT AND CONSULTING AGREEMENTS
In October 1996, the Company entered into an employment agreement with Ms.
Bolton that provided that, in the event Ms. Bolton's employment with the Company
is terminated without cause prior to November 1, 1998, Ms. Bolton would receive
her base salary on regularly scheduled pay days for the 12 months following such
termination, provided that such amount would be reduced by any compensation she
is then receiving from other employment as an executive.
In September 1996, the Company entered into consulting agreements with Dr.
Merzenich and Dr. Tallal. The agreement with Dr. Merzenich generally provides,
among other things, that he will devote up to 20 percent of his professional
time on consulting activities for the Company through December 31, 2001. The
agreement with Dr. Tallal generally provides, among other things, that she will
devote an average of one day per week on consulting activities for the Company
through December 31, 2001.
50
<PAGE>
Historically, the amount paid to Dr. Merzenich under his consulting agreement
has not exceeded $60,000 per year. The amount paid to Dr. Tallal under her
consulting agreement was $70,000 in 1997. See "Certain Transactions."
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
In June 1998, the Board authorized the Company to enter into indemnity
agreements with each of the Company's directors and executive officers. The form
of indemnity agreement provides that the Company will indemnify against any and
all expenses of the director or executive officer who incurred such expenses
because of his or her status as a director or executive officer, to the fullest
extent permitted by the Company's Bylaws.
The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") and Bylaws contain certain provisions relating to the limitation
of liability and indemnification of directors and officers. The Certificate
provides that directors of the Company shall not be personally liable to the
Company or its stockholders for monetary damages for any breach of fiduciary
duty as a director, except for liability: (i) for any breach of the directors'
duty of loyalty to the Company or its stockholders; (ii) for acts or omissions
not in good faith or which involve intentional misconduct or a knowing violation
of law; (iii) in respect of certain unlawful payments of dividends or unlawful
stock repurchases or redemptions as provided in Section 174 of the Delaware
General Corporation Law; or (iv) for any transaction from which the director
derives any improper personal benefit. The Certificate also provides that if the
Delaware General Corporation Law is amended after the approval by the Company's
stockholders of the Certificate to authorize corporate action further
eliminating or limiting the personal liability of directors, then the liability
of the Company's directors shall be eliminated or limited to the fullest extent
permitted by the Delaware General Corporation Law. In addition, as permitted by
Section 145 of the Delaware General Corporation Law, the Bylaws of the Company
provide that the Company shall indemnify its directors and executive officers
and may indemnify its other officers, employees and other agents to the fullest
extent not prohibited by Delaware law. These provisions do not affect a
director's responsibilities under any other laws, such as the federal securities
laws or state or federal environmental laws. The Company has purchased a
directors' and officers' liability insurance policy providing coverage up to
specified amounts for losses incurred by the Company, its directors or officers
in connection with certain claims against them, including certain claims under
state and federal securities laws.
51
<PAGE>
CERTAIN TRANSACTIONS
From April to September 1996, the Company issued an aggregate of 1,444,681
shares of its Series A Preferred Stock. An aggregate of 1,142,956 shares of the
Company's Series A Preferred Stock were sold at a price of $1.70 per share; an
aggregate of 92,592 shares of the Company's Series A Preferred Stock were sold
at a price of $1.62 per share to Drs. Merzenich, Holstrom and Jenkins pursuant
to an Employee Stock Purchase Plan. In October and November 1996, the Company
issued an aggregate of 2,250,000 shares of Series B Preferred Stock at a price
of $1.80 per share. In connection with the sale of Series B Preferred Stock, the
Company also issued warrants to purchase a total of 1,428,571 shares of Series C
Preferred Stock with an exercise price of $2.80 per share (all of which have
since been exercised). Listed below are the directors, executive officers and
five percent stockholders who have made equity investments in the Company to
purchase shares of the Company's Preferred Stock or Common Stock. See "Principal
and Selling Stockholders."
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
COMMON PREFERRED PREFERRED PREFERRED AGGREGATE
INVESTOR STOCK STOCK STOCK STOCK CONSIDERATION
- ------------------------------------------------- ---------- ----------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Dr. Michael M. Merzenich......................... 1,250,000 30,864 -- -- $ 51,000
Dr. Paula A. Tallal.............................. 1,250,000 -- -- -- $ 1,000
Dr. William M. Jenkins........................... 833,337 30,864 -- -- $ 50,667
Dr. Steven L. Miller............................. 185,175 -- -- -- $ 148
Warburg, Pincus Ventures, L.P. (1)............... -- -- 2,222,222 1,428,571 $ 8,000,000
Carleton A. Holstrom (2)......................... 231,474 60,276 -- -- $ 100,186
Dr. Leonard S. Schleifer......................... 50,000 29,412 -- -- $ 58,501
</TABLE>
- --------------------------
(1) Messrs. Moorhead and Thomas, directors of the Company, are affiliated with
Ventures. Does not include warrants to purchase 100,000 shares of the
Company's Common Stock issued to Ventures in June 1998 in connection with
Ventures' guarantee of an unsecured line of credit obtained by the Company.
(2) Includes 29,412 shares of Series A Preferred Stock held by the Solon Edward
Trust #2 ("Solon Trust"), for which Mr. Holstrom serves as trustee.
The holders of the Company's Series B and C Preferred Stock are entitled to
certain registration rights with respect to the Common Stock issued or issuable
upon conversion of thereof. See "Description of Capital Stock--Registration
Rights."
In connection with the issuance of Series B Preferred Stock and the warrants
to purchase Series C Preferred Stock referenced above, the Company entered into
an agreement that requires the Company, following the completion of this
Offering and as long as Ventures owns at least 10% and 20% of the outstanding
Common Stock, to nominate and use its best efforts to elect one or two
individuals, respectively, designated by Ventures for election to the Board of
Directors. See "Risk Factors--Control by Existing Management and Stockholders"
and "Description of Capital Stock--Board Representation Rights."
In June 1998, the Company obtained a $3 million unsecured line of credit
from BankBoston, N.A. (the "Line of Credit") which is guaranteed by Ventures. In
connection with Ventures providing such guarantee, the Company issued to
Ventures warrants to purchase 100,000 shares of the Company's Common Stock at
$6.00 per share. Such warrants expire on May 31, 2003. Additionally, in order to
enable the Company to repay the outstanding balance on the Line of Credit,
Ventures agreed to purchase up to 500,000 shares of the Company's capital stock
at $6.00 per share if requested by the Company. The Company's right to require
Ventures to purchase such securities expires upon the completion of this
Offering.
52
<PAGE>
Pursuant to the University License, the Company is obligated to make certain
license-issue fee payments, royalty payments, milestone payments and other
payments (collectively, the "Payments") to the Regents in exchange for a license
to commercially develop and sell products that make use of a patent filed by
Drs. Tallal, Merzenich, Jenkins and Miller (each an "Inventor" and,
collectively, the "Inventors"), among others, and subsequently assigned to the
Regents. Drs. Tallal and Merzenich are members of the Board of Directors of the
Company, and Drs. Jenkins and Miller are vice presidents of the Company. To
date, the Company has paid $200,000 and issued a net of 171,788 shares of its
Common Stock in satisfaction of all license-issue fees owed under the University
License and has paid all royalty payments due under the University Agreement. To
date, no milestone payments have become due under the University License. The
Company accrued an aggregate of $202,000 for payments under the University
License for the year ended December 31, 1997 and commenced making royalty
payments in May 1997. Pursuant to separate patent policies of the University of
California and Rutgers University (each a "University" and, collectively, the
"Universities"), as well as understandings between Inventors affiliated with
each University, each University distributes to those Inventors affiliated with
such University, on an annual basis, a portion of the Payments received from the
Company. To date, the amounts distributed to each Inventor pursuant to the
Universities' patent policies have not exceeded $60,000 per year. The amount of
any future University distributions to the Inventors are indeterminable at this
time because such figures are tied to the Company's future performance; however,
the Company estimates that less than 0.5% of product sales during the term of
the University License will be payable by the Universities to each Inventor. The
University license was negotiated by the Company on an arms-length basis,
without involvement by the Inventors.
Ms. Bolton's husband, Stephen Shane, is a principal of TouchStar
Communications ("TouchStar"), which has produced certain of the Company's
promotional and training videos. The total compensation paid to TouchStar for
such production services was approximately $131,000 and $28,000 in 1997 and the
six months ended June 30, 1998, respectively. No amounts were paid to TouchStar
in 1996.
The Company believes that the foregoing transactions were in its best
interests. As a matter of policy these transactions were, and all future
transactions between the Company and any of its officers, directors or principal
stockholders will be, approved by a majority of the disinterested members of the
Board of Directors, on terms no less favorable to the Company than could be
obtained from unaffiliated third parties and in connection with bona fide
business purposes of the Company. See "Management-- Employment and Consulting
Agreements."
53
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of June 30, 1998 (except
as otherwise indicated) and as adjusted to reflect the sale of the Common Stock
being offered hereby by (assuming no exercise of the Underwriters' over-
allotment option): (i) each person (or group of affiliated persons) who is known
by the Company to own beneficially more than 5% of the Common Stock; (ii) each
of the Named Executive Officers; (iii) each of the Company's directors and (iv)
all directors and executive officers of the Company as a group. Unless otherwise
noted, the address for the individuals listed below is: c/o Scientific Learning
Corporation, 1995 University Avenue, Suite 400, Berkeley, CA 94704.
<TABLE>
<CAPTION>
PERCENTAGE OWNED (1)
------------------------
BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNERS SHARES (1) OFFERING OFFERING
- ------------------------------------------------------------------------------- ---------- ----------- -----------
<S> <C> <C> <C>
Warburg, Pincus Ventures, L.P. (2)............................................. 3,750,793 40.0% 31.9%
466 Lexington Avenue
New York, NY 10017
Sheryle J. Bolton (3).......................................................... 500,000 5.1 4.1
Dr. Michael M. Merzenich (4)................................................... 1,005,864 10.8 8.6
Dr. Paula A. Tallal (5)........................................................ 1,208,268 13.0 10.4
Frank M. Mattson (6)........................................................... 105,000 1.1 *
Dr. William M. Jenkins (7)..................................................... 864,201 9.3 7.4
Carleton A. Holstrom (8)....................................................... 291,750 3.1 2.5
Rodman W. Moorhead, III (2)(9)................................................. 3,750,793 40.0 31.9
Dr. Leonard S. Schleifer....................................................... 79,412 * *
James E. Thomas (2)(9)......................................................... 3,750,793 40.0 31.9
All directors and executive officers as a group (9 persons) (10)............... 7,805,288 78.0% 62.9%
</TABLE>
- --------------------------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Except as indicated by
footnote, and subject to community property laws where applicable, the
persons named in the table above have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by them.
Percentage of beneficial ownership is based on 9,271,893 shares of Common
Stock outstanding as of June 30, 1998 and 11,671,893 shares of Common Stock
outstanding upon completion of this Offering.
(2) Includes 100,000 shares issuable upon the exercise of an immediately
exercisable warrant issued in June 1998. Messrs. Moorhead and Thomas,
directors of the Company, are affiliated with Ventures. The sole general
partner of Ventures is Warburg, Pincus & Co., a New York general
partnership ("WP"). E.M. Warburg, Pincus & Co., LLC, a New York limited
liability company ("EMW LLC"), manages Ventures. The members of EMW LLC are
substantially the same as the partners of WP. Lionel I. Pincus is the
managing partner of WP and the managing member of EMW LLC and may be deemed
to control both WP and EMW LLC. WP has a 15% interest in the profits of
Ventures as the general partner and also owns approximately 1.5% of the
limited partnership interests in Ventures. See "Certain Transactions."
(3) Includes 500,000 shares subject to immediately exercisable stock options,
218,750 of which will be vested as of August 29, 1998 and the remaining
281,250 shares which would be subject to repurchase if purchased prior to
vesting.
(4) Includes 605,864 shares held in the Merzenich Family Trust and 25,000
shares subject to vested stock options.
(5) Includes 400,000 shares held by the Colleen Osburn 1998 Irrevocable Trust,
for which Dr. Tallal serves as trustee. Dr. Tallal disclaims beneficial
ownership of the shares held by the Colleen Osburn 1998 Irrevocable Trust
within the meaning of Rule 13d-3 under the Securities Act of 1934. Also
includes 50,000 shares to be sold if the Underwriter's over-allotment
option is exercised in full. See "Selling Stockholders and Exercise of
Over-Allotment Option."
(6) Includes 105,000 shares subject to immediately exercisable stock options,
31,678 of which will be vested as of August 29, 1998 and the remaining
73,322 shares which would be subject to repurchase if purchased prior to
vesting.
54
<PAGE>
(7) Includes 40,864 shares to be sold if the Underwriter's over-allotment
option is exercised in full. See "Selling Stockholders and Exercise of
Over-Allotment Option."
(8) Includes 231,474 shares held by the Holstrom Family Limited Partnership and
29,412 shares held in the Solon Trust, for which Mr. Holstrom serves as
trustee. Mr. Holstrom disclaims beneficial ownership of the shares held in
the Solon Trust within the meaning of Rule 13d-3 under the Securities Act
of 1934.
(9) All of the shares indicated as owned by Messrs. Moorhead and Thomas are
owned directly by Ventures and are included because of each individual's
affiliation with Ventures. Messrs. Moorhead and Thomas are both directors
of the Company. Mr. Thomas is a Managing Director of EMW LLC and a general
partner of WP. Mr. Moorhead is a Senior Managing Director of EMW LLC and a
general partner of WP. As such, Mr. Moorhead and Mr. Thomas may be deemed
to have an indirect pecuniary interest (within the meaning of Rule 16a-1
under the Securities Exchange Act of 1934) in an indeterminate portion of
the shares beneficially owned by Ventures and WP. Each of Messrs. Moorhead
and Thomas disclaims beneficial ownership of these shares within the
meaning of Rule 13d-3 under the Securities Exchange Act of 1934. The
address for Messrs. Moorhead and Thomas is: c/o Warburg, Pincus Ventures,
L.P., 466 Lexington Avenue, New York, NY 10017.
(10) Includes the information in notes (1) through (9), as applicable.
SELLING STOCKHOLDERS AND EXERCISE OF OVER-ALLOTMENT OPTION
If the Underwriters' over-allotment option is exercised in full, the Selling
Stockholders will sell an aggregate of 193,658 shares of Common Stock. The
number of shares being sold, and, if sold, the number of shares and percentages
of outstanding shares beneficially owned upon completion of this Offering
(assuming the Underwriters' over-allotment option is exercised in full), by the
following individuals will be as follows:
<TABLE>
<CAPTION>
AFTER OFFERING
-------------------------
NUMBER OF SHARES SHARES PERCENTAGE
NAME OF SELLING STOCKHOLDER TO BE SOLD OWNED OWNED
- ---------------------------------------------------------------------- ----------------- ---------- -------------
<S> <C> <C> <C>
Richard Brockway...................................................... 1,000 4,882 *%
David Charron......................................................... 22,000 329,842 2.7
Gordon Connor......................................................... 2,000 6,750 *
Cooper White & Cooper Pension Plan (1)................................ 1,882 4,000 *
Stephen Devries....................................................... 2,500 3,382 *
Highview Investment Limited Partnership (2)........................... 9,500 49,325 *
Dr. William M. Jenkins (3)............................................ 40,864 823,337 6.8
Charles Miller (4).................................................... 2,500 5,000 *
Colleen Osburn........................................................ 50,000 3,080 *
Dr. Paula A. Tallal (5)............................................... 50,000 1,158,268 9.6
Glenn Tobias.......................................................... 11,412 47,413 *
All Selling Stockholders as a group................................... 193,658 2,435,279 20.2%
</TABLE>
- ------------------------
*Less than one percent.
(1) Such shares are beneficially owned by David Tucker.
(2) Gary Aidekman and Kenneth Aidekman are the principal beneficial owners of
the shares held by Highview Investment Limited Partnership ("Highview"), and are
the President and Vice President, respectively, of Highview Capital Corp., the
sole general partner of Highview. The other beneficial owners of the shares held
by Highview are Shirley Aidekman, Matthew Aidekman, Andrew Aidekman, Sage
Aidekman, Dana Aidekman and Alix Aidekman, members of their immediate families,
and Highview Capital Corporation.
(3) Dr. William M. Jenkins is the Company's Vice President, Product Development.
See footnote 7 to the Principal Stockholders table.
(4) Charles Miller is the father of Dr. Steven L. Miller, the Company's Vice
President, Outcomes Research.
(5) Dr. Paula A. Tallal is the Company's Executive Vice President and Chairman
of the Board of Directors. See footnote 5 to the Principal Stockholders table.
55
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following description of the capital stock of the Company and certain
provisions of the Company's Certificate of Incorporation and Bylaws is a summary
and is qualified in its entirety by the provisions of the Certificate of
Incorporation and Bylaws, which have been filed as exhibits to the Company's
Registration Statement, of which this Prospectus is a part.
Upon the closing of this Offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, $0.001 par value per
share ("Common Stock ), and 1,000,000 shares of Preferred Stock, $0.001 par
value per share ("Preferred Stock").
COMMON STOCK
As of June 30, 1998, there were 9,271,893 shares of Common Stock outstanding
held by 107 holders of record. The holders of Common Stock are entitled to one
vote for each share held of record on all matters submitted to a vote of the
stockholders. The holders of Common Stock are not entitled to cumulative voting
rights with respect to the election of directors, and as a consequence, minority
stockholders will not be able to elect directors on the basis of their votes
alone. Subject to preferences that may be applicable to any shares of Preferred
Stock issued in the future, holders of Common Stock are entitled to receive
ratably such dividends as may be declared by the Board of Directors out of funds
legally available therefor. See "Dividend Policy." In the event of a
liquidation, dissolution or winding up of the Company, holders of the Common
Stock are entitled to share ratably in all assets remaining after payment of
liabilities and the liquidation preference of any then outstanding Preferred
Stock. Holders of Common Stock have no preemptive rights and no right to convert
their Common Stock into any other securities. There are no redemption or sinking
fund provisions applicable to the Common Stock. All outstanding shares of Common
Stock are, and all shares of Common Stock to be outstanding upon completion of
this Offering will be, fully paid and nonassessable.
PREFERRED STOCK
Upon the completion of this Offering, all outstanding shares of Series A,
Series B and Series C Preferred Stock will be converted into 5,098,252 shares of
Common Stock. See Note 5 to Financial Statements for a description of currently
outstanding Preferred Stock. Following the conversion, the shares converted will
be retired from the number of authorized shares of Preferred Stock.
Upon the completion of this Offering, the Board of Directors will have the
authority, without further action by the stockholders, to issue up to 1,000,000
shares of Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof, including dividend rights,
conversion rights, voting rights, terms of redemption, liquidation preferences,
sinking fund terms and the number of shares constituting any series or the
designation of such series, without any further vote or action by stockholders.
The issuance of Preferred Stock could adversely affect the voting power of
holders of Common Stock and the likelihood that such holders will receive
dividend payments and payments upon liquidation and could have the effect of
delaying, deferring or preventing a change in control of the Company. The
Company has no present plan to issue any shares of Preferred Stock.
REGISTRATION RIGHTS
Pursuant to an Amended and Restated Registration Rights Agreement among the
Company and certain of its stockholders, such stockholders (the "Holders") are
entitled to certain rights with respect to the registration of approximately
3,678,571 shares of Common Stock under the Securities Act. If the Company
proposes to register any of its securities under the Securities Act, the Holders
are entitled to notice of such registration and are entitled to include their
shares therein at the Company's expense, subject to certain limitations. In
addition, the Holders may require the Company at its expense to register their
shares on Form S-3 when such form becomes available for use by the Company.
56
<PAGE>
BOARD REPRESENTATION RIGHTS
Pursuant to a Securities Purchase Agreement between the Company and
Ventures, among others, the Company is required, following the completion of
this Offering and for so long as Ventures owns beneficially and of record at
least 20% of the outstanding shares of Common Stock, to nominate and use its
best efforts to have two individuals, designated by Ventures and reasonably
acceptable to the Company, elected to the Board. In addition, the Company is
required, following the completion of this Offering and for so long as Ventures
owns beneficially and of record at least 10% of the outstanding shares of Common
Stock, to nominate and use its best efforts to have one individual, designated
by Ventures and reasonably acceptable to the Company, elected to the Board.
Ventures may not assign the above described right.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law (the "Delaware Law"), an anti-takeover law. In general,
the statute prohibits a publicly held Delaware corporation from engaging in a
"business combination" with an "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
For purposes of Section 203, a "business combination" includes a merger, asset
sale or other transaction resulting in a financial benefit to the interested
stockholder, and an "interested stockholder" is a person who, together with
affiliates and associates, owns (or within three years prior, did own) 15% or
more of the corporation's voting stock.
Effective upon the closing of this Offering, the Company's Restated
Certificate and Restated Bylaws, among other things, require that any action
required or permitted to be taken by stockholders be effected at a duly called
annual or special meeting of the stockholders and may not be effected by a
consent in writing, require that advance notice be given of stockholder
proposals and director nominations and prohibit cumulative voting in the
election of directors. Both the Restated Certificate and the Restated Bylaws
will also require the affirmative vote of the holders of at least 66 2/3% of the
voting power of the outstanding shares ("Super-Majority Vote") to remove a
director without cause or amend the Company's Bylaws. In addition, a
Super-Majority Vote will be required to amend certain provisions of the Restated
Certificate, including provisions regarding managing the Company's business,
indemnification of directors, classification of the Board of Directors, the
manner by which vacancies may be filled on the Board of Directors, the manner by
which stockholders may act and notice requirements when stockholders want to
make nominations for elections of directors or bring other business before a
stockholder meeting. The Restated Certificate authorizes the Board of Directors
to issue up to 1,000,000 shares of Preferred Stock and to determine the rights,
preferences and privileges thereof without any further vote or action by the
stockholders, provides for a classified Board of Directors and specifies that
the authorized number of directors may be changed only by a resolution of the
Board of Directors. Special meetings of the stockholders of the Company may be
called only by the Board of Directors, the Chairman of the Board or the Chief
Executive Officer. The provisions described above could have the effect of
making it more difficult for a third party to acquire a majority of the
outstanding voting stock of the Company, or delay, prevent or deter a merger,
acquisition or tender offer in which the Company's stockholders could receive a
premium for their shares, a proxy contest for control of the Company or other
change in the Company's management. See "Risk Factors--Possible Anti-Takeover
Effect of Certain Charter Provisions."
TRANSFER AGENT AND REGISTRAR
BankBoston, N.A. has been appointed as the transfer agent and registrar for
the Company's Common Stock.
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of this Offering, the Company will have outstanding
11,671,893 shares of Common Stock, based on the number of shares of Common Stock
outstanding as of June 30, 1998 and assuming no exercise of the Underwriters'
over-allotment option. Of these shares, all the shares sold in this Offering
will be freely tradable without restrictions or further registration under the
Securities Act. The remaining 9,271,893 shares of Common Stock held by existing
stockholders are "restricted securities" within the meaning of the Securities
Act ("Restricted Shares"). Restricted Shares may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rules 144, 144(k) or 701 promulgated under the Securities Act. The Company has
granted holders of 3,678,571 Restricted Shares certain rights with respect to
the registration of such shares. See "Description of Capital Stock--
Registration Rights."
Holders of 8,932,932 shares of the Company's Common Stock, including all
executive officers and directors, have entered into lock-up agreements with the
representatives of the Underwriters. See "Underwriting." As a result of such
contractual restrictions and the provisions of Rule 144 and 701, additional
shares will be available for sale in the public market as follows: (i) 338,961
Restricted Shares will be eligible for immediate sale on the date of this
Prospectus; (ii) 834,238 shares of Common Stock issuable upon exercise of
currently outstanding options will be eligible for sale 180 days after the date
of this Prospectus upon expiration of lock-up agreements; (iii) 8,932,932
Restricted Shares will be eligible for sale 180 days after the date of this
Prospectus upon expiration of lock-up agreements; and (iv) 100,000 shares of
Common Stock issuable upon exercise of currently outstanding warrants will be
eligible for sale in the public market upon expiration of the one-year holding
period. Depending on the method of exercise, the one year holding period is
calculable either from the date of the issuance of the warrant in June 1998 or
the date of exercise.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, any holder, including an affiliate of the Company
within the meaning of Rule 405 under the Securities Act (an "Affiliate"), of
Restricted Shares as to which at least one year has elapsed since the date of
the holder's acquisition of such shares from the Company or from an Affiliate,
would be entitled within any three-month period to sell a number of shares that
does not exceed the greater of 1% of the then outstanding shares of Common Stock
(approximately 116,718 shares immediately after the completion of this Offering
assuming no exercise of the Underwriters' over-allotment option) or the average
weekly trading volume of the Common Stock on the Nasdaq National Market during
the four calendar weeks preceding the date on which notice of the sale is filed
with the Commission. Sales under Rule 144 are subject to certain requirements
relating to manner of sale, notice and availability of current public
information about the Company. However, a person (or persons whose shares are
aggregated) who is not deemed to have been an Affiliate of the Company at any
time during the 90 days immediately preceding the sale and who beneficially owns
Restricted Shares is entitled to sell such shares under Rule 144(k) without
regard to the limitations described above, provided that at least two years have
elapsed since the date the shares were acquired from the Company or from an
Affiliate of the Company. The foregoing is a summary of Rule 144 and is not
intended to be a complete description of that rule.
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its employees,
directors, officers, consultants or advisors prior to the completion of this
Offering, pursuant to written compensatory benefit plans or written contracts
relating to the compensation of such persons. In addition, the Commission has
indicated that Rule 701 will apply to stock options granted by the Company
before this Offering, along with the shares acquired upon exercise of such
options. Securities issued in reliance on Rule 701 are deemed to be Restricted
Shares and, beginning 90 days after the date of this Prospectus (unless subject
to the contractual restrictions described above), may be sold by persons other
than Affiliates, subject only to the manner of sale provisions of Rule 144 and
by Affiliates under Rule 144 without compliance with its one-year minimum
holding period requirements.
58
<PAGE>
The Company intends to file a registration statement on Form S-8 under the
Securities Act covering shares of Common Stock reserved for issuance under the
Incentive Plan, the Directors' Plan and the Purchase Plan. See
"Management--Employee Benefit Plans." Such registration statement is expected to
be filed and become effective as soon as practicable after the completion of
this Offering. Accordingly, shares registered under such registration statement
will, subject to Rule 144 volume limitations applicable to Affiliates of the
Company, be available for sale in the open market, unless such shares are
subject to vesting restrictions with the Company or the lock-up agreements
described above. As of June 30, 1998, options to purchase 1,511,498 shares of
Common Stock were issued and outstanding. See "Management-- Executive
Compensation" and "--Employee Benefit Plans."
Prior to this Offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active public market for the
Common Stock will develop or be sustained after this Offering. As described
herein, only a limited number of shares will be available for sale shortly after
this Offering because of certain contractual and legal restrictions on resale.
Sales of substantial amounts of Common Stock of the Company in the public market
after completion of this Offering could materially and adversely affect the
prevailing market price and the ability of the Company to raise equity capital
in the future.
59
<PAGE>
UNDERWRITING
The Underwriters named below (the "Underwriters"), represented by
NationsBanc Montgomery Securities LLC, BancAmerica Robertson Stephens and
Pacific Growth Equities, Inc. (the "Representatives"), have severally agreed,
subject to the terms and conditions set forth in the underwriting agreement (the
"Underwriting Agreement"), by and between the Company and the Underwriters, to
purchase from the Company the number of shares of Common Stock indicated below
opposite their respective names, at the public offering price less the
underwriting discount set forth on the cover page of this Prospectus. The
Underwriting Agreement provides that the obligations of the Underwriters are
subject to certain conditions precedent and that the Underwriters are committed
to purchase all of the shares of Common Stock, if they purchase any.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
NationsBanc Montgomery Securities LLC............................................
BancAmerica Robertson Stephens...................................................
Pacific Growth Equities, Inc.....................................................
----------
Total.......................................................................... 2,400,000
----------
----------
</TABLE>
The Representatives have advised the Company that the Underwriters propose
initially to offer the shares of Common Stock to the public on the terms set
forth on the cover page of this Prospectus. The Underwriters may allow selected
dealers a concession of not more than $ per share; and the Underwriters may
allow, and such dealers may reallow, a concession of not more than $ per
share to certain other dealers. After the initial public offering, the offering
price and other selling terms may be changed by the Representatives. The Common
Stock is offered subject to receipt and acceptance by the Underwriters and to
certain other conditions, including the right to reject orders in whole or in
part.
The Company and the Selling Stockholders have granted to the Underwriters an
over-allotment option, exercisable for 30 days from the date of this Prospectus,
to purchase up to a maximum of 193,658 and 166,342 additional shares of Common
Stock, respectively, to cover over-allotments, if any, at the same price per
share as the initial shares to be purchased by the Underwriters. To the extent
the Underwriters exercise such over-allotment option, each of the Underwriters
will be committed, subject to certain conditions, to purchase such additional
shares in approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with this Offering.
The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the Underwriters against certain liabilities,
including civil liabilities under the Securities Act, or will contribute to
payments the Underwriters may be required to make in respect thereof.
The Company's officers and directors and certain stockholders of the Company
prior to this Offering have agreed that for a period commencing on June 8, 1998
and continuing to a date 180 days after the first date any of the Common Stock
to be sold in this Offering is released by the Underwriters for sale to the
public they will not, subject to certain exceptions, directly or indirectly
sell, offer, contract or grant any option to sell, pledge, transfer, establish
an open put equivalent position or otherwise dispose of any shares of Common
Stock, options or warrants to acquire shares of Common Stock or securities
exchangeable or exercisable for or convertible into shares of Common Stock,
without the prior written consent of
60
<PAGE>
NationsBanc Montgomery Securities LLC. This 180-day lock-up will be of no
further force or effect in the event the Registration Statement is not declared
effective on or before December 31, 1998. The Company has also agreed not to
issue, offer, sell, grant options to purchase, or otherwise dispose of any of
the Company's equity securities for a period of 180 days after the effective
date of this Offering without the prior written consent of NationsBanc
Montgomery Securities LLC except for securities issued by the Company in
connection with acquisitions, and for grants and exercises of stock options,
subject in each case to any remaining portion of the 180-day period applying to
shares issued or transferred. In evaluating any request for a waiver of the
180-day lock-up period, NationsBanc Montgomery Securities LLC will consider, in
accordance with their customary practice, all relevant facts and circumstances
at the time of the request, including, without limitation, the recent trading
market for the Common Stock, the size of the request and, with respect to a
request by the Company to issue additional equity securities, the purpose of
such an issuance. See "Shares Eligible For Future Sale."
In connection with this Offering, certain Underwriters and selling group
members and their respective affiliates engage in transactions that stabilize,
maintain or otherwise affect the market price of the Common Stock. Such
transactions may include stabilization transactions effected in accordance with
Rule 104 of Regulation M under the Securities and Exchange Act of 1934, as
amended, pursuant to which such persons may bid for or purchase Common Stock for
the purpose of stabilizing its market price. The Underwriters also may create a
short position for the account of the Underwriters by selling more Common Stock
in connection with this Offering than they are committed to purchase from the
Company and, in such case, may purchase Common Stock in the open market
following completion of this Offering to cover all or a portion of such short
position. The Underwriters may also cover all or a portion of such short
position, up to 360,000 shares of Common Stock, by exercising the Underwriters'
over-allotment option referred to above. In addition, NationsBanc Montgomery
Securities LLC on behalf of the Underwriters, may impose "penalty bids" under
contractual arrangements with the Underwriters, whereby it may reclaim from an
Underwriter (or dealer participating in this Offering) for the account of the
other underwriters, the selling concession with respect to Common Stock that is
distributed in this Offering but subsequently purchased for the account of the
Underwriters in the open market. Any of the transactions described in this
paragraph may result in the maintenance of the price of the Common Stock at a
level above that which might otherwise prevail in the open market. None of the
transactions described in this paragraph is required, and, if they are
undertaken, they may be discontinued at any time.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales of Common Stock offered by this Prospectus to accounts
over which they exercise discretionary authority in excess of 5% of the number
of shares of Common Stock offered hereby.
Prior to this Offering, there has been no public trading market for the
Common Stock. Consequently, the initial public offering price was determined by
negotiations between the Company and the Representatives. Among the factors
considered in such negotiations were the history of and prospects for the
Company and the industries in which it operates, an assessment of the Company's
management, its past and present earnings and the trend of such earnings, the
prospects for future earnings of the Company, the present state of the Company's
development, the general condition of securities markets at the time of this
Offering and the market price of publicly traded stock of comparable companies
in recent periods.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Cooley Godward LLP, San Francisco, California ("Cooley
Godward"). Certain legal matters will be passed upon for the Underwriters by
Brobeck, Phleger & Harrison LLP, San Francisco, California. An investment
partnership affiliated with Cooley Godward owns 27,778 shares of the Company's
Preferred Stock which will convert into 27,778 shares of the Company's Common
Stock upon the closing of this Offering.
61
<PAGE>
EXPERTS
The financial statements of the Company at December 31, 1996 and 1997 and
for the years then ended appearing in this Prospectus and the Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their report thereon appearing elsewhere herein, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
ADDITIONAL INFORMATION
A Registration Statement on Form S-1, including amendments thereto, relating
to the Common Stock offered hereby has been filed by the Company with the
Securities and Exchange Commission (the "Commission"), Washington, D.C. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules thereto. Statements contained in this
Prospectus as to the contents of any contract or other document referred to are
not necessarily complete and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to such Registration Statement, exhibits
and schedules. A copy of the Registration Statement may be inspected by anyone
without charge at the Commission's principal office at the public reference
facility maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices
located at Seven World Trade Center, 13th Floor, New York, New York 10048 and
500 Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of all or any
part thereof may be obtained from the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, upon the payment of certain fees prescribed by the
Commission. The Commission maintains a web site that contains reports, proxy
statements and other information regarding registrants, including the Company.
The address of the Commission's web site is http://www.sec.gov.
As a result of this Offering, the Company will be subject to the information
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). So long as the Company is subject to periodic reporting requirements of
the Exchange Act, it will continue to furnish the reports and other information
required thereby to the Commission. The Company intends to furnish its
stockholders with annual reports containing financial statements audited by an
independent public accounting firm and quarterly reports containing unaudited
financial information for the first three quarters of each fiscal year.
TRADEMARKS
Fast ForWord-Registered Trademark- and the Fast ForWord logo are registered
trademarks of the Company and certain other marks contained in this Prospectus
are trademarks of the Company. This Prospectus also includes trade names and
trademarks of other companies, whose mention herein is with due recognition of
and without intent to misappropriate their marks.
62
<PAGE>
SCIENTIFIC LEARNING CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit)............................ F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Scientific Learning Corporation
We have audited the accompanying balance sheets of Scientific Learning
Corporation as of December 31, 1996 and 1997, and the related statements of
operations, redeemable convertible preferred stock and stockholders' equity
(deficit), and cash flows for the years then ended. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Scientific Learning Corporation
at December 31, 1996 and 1997, and the results of its operations and its cash
flows for the years then ended, in conformity with generally accepted accounting
principles.
/S/ ERNST & YOUNG LLP
Walnut Creek, California
April 9, 1998
F-2
<PAGE>
SCIENTIFIC LEARNING CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY
---------------------------- JUNE 30, JUNE 30,
1996 1997 1998 1998
------------- ------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 3,822 $ 2,699 $ 1,019
Accounts receivable................................ -- 44 318
Prepaid expenses and other current assets.......... 5 157 321
------------- ------------- -----------
Total current assets................................. 3,827 2,900 1,658
Restricted cash deposit.............................. -- 350 350
Property and equipment, net.......................... 466 1,120 1,151
Other assets......................................... 13 86 685
------------- ------------- -----------
Total assets......................................... $ 4,306 $ 4,456 $ 3,844
------------- ------------- -----------
------------- ------------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................... $ 115 $ 419 $ 718
Accrued liabilities................................ 138 356 444
Deferred revenue................................... 1 342 1,644
Current portion of borrowings under bank line
of credit........................................ -- 193 845
Current portion of capital lease obligations....... 11 21 26
------------- ------------- -----------
Total current liabilities............................ 265 1,331 3,677
Borrowings under bank line of credit................. -- 97 212
Capital lease obligations............................ 24 19 7
Other liabilities.................................... 100 71 178
------------- ------------- -----------
Total liabilities.................................... 389 1,518 4,074
Commitments
Redeemable convertible preferred stock, $0.001 par
value, issuable in series:
Authorized shares--4,700,000
Issued and outstanding shares--2,250,000 in 1996,
3,678,571 in 1997 and 1998, and none pro forma
(liquidation preference--$8,050)................. 4,002 8,002 8,002 $ --
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value,
Authorized shares--7,000,000 (including 4,700,000
shares designated as redeemable convertible
preferred stock)
Issued and outstanding shares--1,444,681 in 1996,
1,419,681 in 1997 and 1998, and none pro forma
(liquidation preference--$2,413)............... 2,400 2,355 2,355 --
Common stock, $0.001 par value,
Authorized shares--17,500,000
Issued and outstanding shares--3,985,385 in 1996,
3,986,694 in 1997, 4,173,641 in 1998, and
9,271,893 pro forma............................ 12 520 2,795 13,152
Deferred compensation.............................. -- (384) (1,555) (1,555)
Accumulated deficit................................ (2,497) (7,555) (11,827) (11,827)
------------- ------------- ----------- -----------
Total stockholders' equity (deficit)................. (85) (5,064) (8,232) $ (230)
------------- ------------- ----------- -----------
-----------
Total liabilities and stockholders' equity
(deficit).......................................... $ 4,306 $ 4,456 $ 3,844
------------- ------------- -----------
------------- ------------- -----------
</TABLE>
See accompanying notes.
F-3
<PAGE>
SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1996 1997
--------- ---------
SIX MONTHS ENDED
JUNE 30,
------------------------
1997 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Programs....................................... $ -- $ 2,249 $ 330 $ 1,572
Services....................................... -- 713 359 228
--------- --------- ----------- -----------
Total revenues............................... -- 2,962 689 1,800
Cost of revenues:
Programs....................................... -- 481 124 293
Services....................................... -- 468 199 174
--------- --------- ----------- -----------
Total cost of revenues....................... -- 949 323 467
--------- --------- ----------- -----------
Gross profit..................................... -- 2,013 366 1,333
Operating expenses:
Sales and marketing............................ 164 2,646 873 2,454
Research and development....................... 1,514 1,965 809 1,346
General and administrative..................... 933 2,537 925 1,773
--------- --------- ----------- -----------
Total operating expenses..................... 2,611 7,148 2,607 5,573
--------- --------- ----------- -----------
Operating loss................................... (2,611) (5,135) (2,241) (4,240)
Interest income (expense), net................... 70 162 51 (32)
Other income (expense), net...................... 44 (85) -- --
--------- --------- ----------- -----------
Net loss......................................... $ (2,497) $ (5,058) $ (2,190) $ (4,272)
--------- --------- ----------- -----------
--------- --------- ----------- -----------
Basic and diluted net loss per share............. $ (0.68) $ (1.27) $ (0.55) $ (1.03)
--------- --------- ----------- -----------
--------- --------- ----------- -----------
Shares used in computing basic and diluted net
loss per share................................. 3,678,931 3,985,833 3,985,385 4,129,224
Pro forma basic and diluted net loss per share... $ (0.60) $ (0.46)
--------- -----------
--------- -----------
Shares used in computing pro forma net loss per
share.......................................... 8,436,444 9,227,476
</TABLE>
See accompanying notes.
F-4
<PAGE>
SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY (DEFICIT)
REDEEMABLE -----------------------------------------------------------------------
CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
-------------------- -------------------- -------------------- DEFERRED ACCUMULATED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT
--------- --------- --------- --------- --------- --------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common
stock................... -- $ -- -- $ -- 3,985,385 $ 12 $ -- $ --
Issuance of Series A
preferred stock, net of
issuance costs.......... -- -- 1,247,893 2,046 -- -- -- --
Issuance of Series A
preferred stock in
connection with license
agreement............... -- -- 196,788 354 -- -- -- --
Issuance of Series B
preferred stock, net of
issuance costs.......... 2,250,000 4,002 -- -- -- -- -- --
Net loss.................. -- -- -- -- -- -- -- (2,497)
--------- --------- --------- --------- --------- --------- ------------- ------------
Balances at December 31,
1996.................... 2,250,000 4,002 1,444,681 2,400 3,985,385 12 -- (2,497)
Issuance of common stock
under stock option
plan.................... -- -- -- -- 1,309 -- -- --
Issuance of Series C
preferred stock upon
exercise of warrant, net
of issuance costs....... 1,428,571 4,000 -- -- -- -- -- --
Reduction of Series A
preferred stock issued
in connection with
license agreement....... -- -- (25,000) (45) -- -- -- --
Deferred compensation
related to grant of
stock options........... -- -- -- -- -- 508 (508) --
Amortization of deferred
compensation............ -- -- -- -- -- -- 124 --
Net loss.................. -- -- -- -- -- -- -- (5,058)
--------- --------- --------- --------- --------- --------- ------------- ------------
Balances at December 31,
1997.................... 3,678,571 8,002 1,419,681 2,355 3,986,694 520 (384) (7,555)
Issuance of common stock
under stock option plan
(unaudited)............. -- -- -- -- 186,947 39 -- --
Issuance of common stock
warrants in connection
with guarantee of line
of credit (unaudited)... -- -- -- -- -- 650 -- --
Deferred compensation
related to grant of
stock options
(unaudited)............. -- -- -- -- -- 1,586 (1,586) --
Amortization of deferred
compensation
(unaudited)............. -- -- -- -- -- -- 415 --
Net loss (unaudited)...... -- -- -- -- -- -- -- (4,272)
--------- --------- --------- --------- --------- --------- ------------- ------------
Balances at June 30, 1998
(unaudited)............. 3,678,571 $ 8,002 1,419,681 $ 2,355 4,173,641 $ 2,795 $ (1,555) $ (11,827)
--------- --------- --------- --------- --------- --------- ------------- ------------
--------- --------- --------- --------- --------- --------- ------------- ------------
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
(DEFICIT)
--------------
<S> <C>
Issuance of common
stock................... $ 12
Issuance of Series A
preferred stock, net of
issuance costs.......... 2,046
Issuance of Series A
preferred stock in
connection with license
agreement............... 354
Issuance of Series B
preferred stock, net of
issuance costs.......... --
Net loss.................. (2,497)
--------------
Balances at December 31,
1996.................... (85)
Issuance of common stock
under stock option
plan.................... --
Issuance of Series C
preferred stock upon
exercise of warrant, net
of issuance costs....... --
Reduction of Series A
preferred stock issued
in connection with
license agreement....... (45)
Deferred compensation
related to grant of
stock options........... --
Amortization of deferred
compensation............ 124
Net loss.................. (5,058)
--------------
Balances at December 31,
1997.................... (5,064)
Issuance of common stock
under stock option plan
(unaudited)............. 39
Issuance of common stock
warrants in connection
with guarantee of line
of credit (unaudited)... 650
Deferred compensation
related to grant of
stock options
(unaudited)............. --
Amortization of deferred
compensation
(unaudited)............. 415
Net loss (unaudited)...... (4,272)
--------------
Balances at June 30, 1998
(unaudited)............. $ (8,232)
--------------
--------------
</TABLE>
See accompanying notes.
F-5
<PAGE>
SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1996 1997
--------- --------- SIX MONTHS ENDED
JUNE 30
------------------------
1997 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................................... $ (2,497) $ (5,058) $ (2,190) $ (4,272)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................... 77 326 120 296
Loss on disposal of property and equipment...................... -- 85 -- --
Preferred stock issued in connection with license agreement..... 354 (45) (45) --
Amortization of deferred compensation........................... -- 124 53 415
Changes in operating assets and liabilities:
Accounts receivable........................................... -- (44) (65) (274)
Prepaid expenses and other assets............................. (18) (225) (57) (166)
Accounts payable.............................................. 115 304 180 299
Accrued liabilities........................................... 138 218 165 88
Deferred revenue.............................................. 1 341 714 1,302
Other liabilities............................................. 100 (29) -- 107
--------- --------- ----------- -----------
Net cash used in operating activities........................... (1,730) (4,003) (1,125) (2,205)
INVESTING ACTIVITIES
Restricted cash deposit......................................... -- (350) -- --
Purchase of property and equipment, net......................... (506) (1,045) (383) (267)
--------- --------- ----------- -----------
Net cash used in investing activities........................... (506) (1,395) (383) (267)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock....................... 6,048 4,000 4,000 --
Proceeds from issuance of common stock.......................... 12 -- -- 39
Borrowings under bank line of credit............................ -- 355 355 863
Repayments of borrowings under bank line of credit.............. -- (65) -- (96)
Repayments of capital lease obligations......................... (2) (15) (6) (14)
--------- --------- ----------- -----------
Net cash provided by financing activities....................... 6,058 4,275 4,349 792
--------- --------- ----------- -----------
Increase (decrease) in cash and cash equivalents................ 3,822 (1,123) 2,841 (1,680)
Cash and cash equivalents at beginning of period................ -- 3,822 3,822 2,699
--------- --------- ----------- -----------
Cash and cash equivalents at end of period...................... $ 3,822 $ 2,699 $ 6,663 $ 1,019
--------- --------- ----------- -----------
--------- --------- ----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid................................................... $ 1 $ 32 $ 8 $ 23
--------- --------- ----------- -----------
--------- --------- ----------- -----------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Capital lease obligations incurred.............................. $ 37 $ 20 $ 10 $ 7
--------- --------- ----------- -----------
--------- --------- ----------- -----------
Issuance of common stock warrants in connection with guarantee
of line of credit............................................. $ -- $ -- $ -- $ 650
--------- --------- ----------- -----------
--------- --------- ----------- -----------
</TABLE>
See accompanying notes.
F-6
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Scientific Learning Corporation (the "Company") was incorporated on November
30, 1995 in the State of California and was reincorporated on May 2, 1997 in the
State of Delaware. The Company commenced operations in February 1996. The
Company develops, markets, and sells neuroscience-based education and training
programs designed to increase human learning and performance. The Company's
revenues have been derived primarily from one product, Fast ForWord, which is an
intensive, computer-based training program that focuses on improving receptive
and expressive communication skills in children with language-based learning
problems. Delivered through a variety of distribution channels, including public
schools, speech and language professionals in private practice and
Company-operated Learning Centers, Fast ForWord is designed to support teachers,
speech and language professionals, parents and other learning facilitators in
providing a program that can be integrated with school curricula and other
language programs to assist children in overcoming language-based learning
challenges. The Company was in the development stage during 1996.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INTERIM FINANCIAL INFORMATION
The interim financial information as of June 30, 1998 and for the six months
ended June 30, 1997 and 1998 is unaudited but includes all adjustments,
consisting only of normal recurring adjustments, that the Company considers
necessary for a fair presentation of its financial position at such date and its
results of operations and cash flows for those periods. Operating results for
the six months ended June 30, 1998 are not necessarily indicative of results
that may be expected for any future periods.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid short-term
investments with original maturities of three months or less.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets which
range from three to five years.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards ("FAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," under
which certain software development costs incurred subsequent to the
establishment of technological feasibility are capitalized and amortized over
the estimated lives of the related products. Technological feasibility is
established upon completion of a working version. Through June 30, 1998, such
capitalizable software development costs have been insignificant and all such
costs have been charged to research and development expense.
F-7
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options using the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25")
and makes the pro forma disclosures required by FAS No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123") (Note 5).
REVENUE RECOGNITION
Program revenues are derived from the sale of Fast ForWord programs.
Customers license the right to use the Fast ForWord software during the program
period and do not acquire or otherwise gain unlimited rights to use the
software.
Revenues on sales of Fast ForWord are recognized over the average duration
of the program. Service revenues are derived from the Company's Fast ForWord
training seminars for learning facilitators and from services provided to
customers of the Company's Learning Centers. Revenues from seminars are
recognized when the seminar is held. Revenues from Learning Center services are
recognized over the average duration of the program. The Company only recently
began its Learning Center operations and revenues through June 30, 1998 have
been minimal. Cancellations and refunds are allowed in limited circumstances,
and such amounts have not been significant. Provisions are made for
cancellations and refunds as revenue is recorded. Costs of revenues are
generally recognized as such costs are incurred.
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was $342,000
for the year ended December 31, 1997 (none for 1996).
INCOME TAXES
The Company uses the liability method to account for income taxes as
required by FAS No. 109, "Accounting for Income Taxes." Under this method,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities. Deferred tax assets
and liabilities are measured suing enacted tax rates and laws that will be in
effect when the differences are expected to reverse.
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued FAS No. 130,
"Reporting Comprehensive Income" ("FAS 130"), which established new standards
for reporting and displaying comprehensive income and its components in a full
set of general purpose financial statements. There is no difference in the
Company's historical net losses as reported and the comprehensive net losses
under the provisions of FAS 130 for all periods presented. Accordingly, the
adoption of FAS 130 had no effect on the Company's reported results of
operations.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
In June 1997, the Financial Accounting Standards Board issued FAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"). FAS 131 will change the way companies report selected segment information
in interim financial reports to shareholders. FAS 131 is effective for
F-8
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD (CONTINUED)
the Company's financial statements for the year ending December 31, 1998. The
Company has not reached a conclusion as to the appropriate segments, if any, it
will be required to report to comply with the provisions of FAS 131.
NET LOSS PER SHARE
Net loss per share is presented under the requirements of FAS No. 128,
"Earnings per Share" ("FAS 128") which replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants, and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. Net loss per share amounts for all periods have been
presented to conform to FAS 128 requirements. Potentially dilutive securities
have been excluded from the computation as their effect is antidilutive.
PRO FORMA NET LOSS PER SHARE
Pro forma net loss per share has been computed as described above and also
gives effect, under Securities and Exchange Commission guidance, to the
conversion of preferred shares not included above that will automatically
convert upon completion of the Company's initial offering, using the
if-converted method (Note 5).
The calculation of historical and pro forma basic and diluted net loss per
share is as follows (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------------
1996 1997
---------- ---------- SIX MONTHS ENDED
JUNE 30,
------------------------
1997 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Historical:
Net loss................................................... $(2,497) $(5,058) $(2,190) $(4,272)
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
Weighted average shares of common stock outstanding used in
computing basic and diluted net per loss share........... 3,678,931 3,985,833 3,985,385 4,129,224
Basic and diluted net loss per share....................... $ (0.68) $ (1.27) $ (0.55) $ (1.03)
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
Pro forma:
Net loss................................................... $(2,497) $(5,058) $(2,190) $(4,272)
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
Shares used in computing basic and diluted net loss per
share (from above)....................................... 3,678,931 3,985,833 3,985,385 4,129,224
Adjustment to reflect the effect of the assumed conversion
of preferred stock from the date of issuance............. 4,450,611 5,098,252
---------- -----------
Weighted average shares used in computing pro forma basic
and diluted net per loss share........................... 8,436,444 9,227,476
Pro forma basic and diluted net loss per share............. $ (0.60) $ (0.46)
---------- -----------
---------- -----------
</TABLE>
F-9
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRO FORMA NET LOSS PER SHARE (CONTINUED)
If the Company had reported net income, the calculation of diluted earnings
per share (historical and pro forma) would have included the shares used in the
computation of pro forma net loss per share as well as an additional
approximately 36,017, 1,359,459, 1,252,430, and 1,490,989 common equivalent
shares related to the outstanding options and warrants not included above
(determined using the treasury stock method at the estimated fair value) for the
years ended December 31, 1996 and 1997 and for the six months ended June 30,
1997 and 1998, respectively.
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
Computer equipment............................................................................. $ 425 $ 1,168
Office furniture and equipment................................................................. 103 300
Leasehold improvements......................................................................... 15 21
--------- ---------
543 1,489
Less accumulated depreciation.................................................................. 77 369
--------- ---------
$ 466 $ 1,120
--------- ---------
--------- ---------
</TABLE>
3. BANK LINE OF CREDIT
The Company has a $400,000 line of credit with a bank which was used to
finance equipment purchases during 1997 and expired in June 1998. Borrowings
under the line of credit bear interest at the bank's prime rate plus 3% (11.5%
at December 31, 1997) and are secured by substantially all of the Company's
assets, excluding intellectual property. At December 31, 1997, the Company had
outstanding borrowings in the amount of $290,000 which are being repaid in equal
monthly installments through June 1999. The agreement restricts the Company's
payment of dividends.
In September 1997, the Company obtained a $350,000 irrevocable standby
letter of credit as security for the lease agreement covering its corporate
office facility. A $350,000 certificate of deposit has been pledged as
collateral for the standby letter of credit. The standby letter of credit is
reduced annually by $70,000 provided that there have been no events of default
under the lease agreement. The amount of the letter of credit can be further
reduced if certain financial covenants, as specified in the lease agreement, are
met.
4. INCOME TAXES
At December 31, 1997, the Company had net operating loss carryforwards and
research credit carryforwards for federal income tax purposes of approximately
$6,600,000 and $85,000, respectively. The net operating loss carryforward will
expire in years 2011 through 2012. Utilization of the net operating losses may
be subject to a substantial annual limitation, due to the ownership change
limitations provided by the Internal Revenue Code of 1986. The annual limitation
may result in the expiration of net operating losses before utilization.
F-10
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................................................... $ 768 $ 2,668
Research credit carryforwards.............................................................. 41 110
Other...................................................................................... 217 254
--------- ---------
Total deferred tax assets.................................................................... 1,026 3,032
Valuation allowance.......................................................................... (1,026) (3,032)
--------- ---------
Net deferred tax assets...................................................................... $ -- $ --
--------- ---------
--------- ---------
</TABLE>
Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net deferred
tax assets have been fully offset by a valuation allowance. The valuation
allowance increased by $1,026,000 and $2,006,000 during the years ended December
31, 1996 and 1997, respectively.
5. STOCKHOLDERS' EQUITY
PREFERRED STOCK
Preferred Stock at December 31, 1996 and 1997 and June 30, 1998 is as
follows by series:
<TABLE>
<CAPTION>
SHARES ISSUED AND OUTSTANDING
---------------------------------
DECEMBER 31,
DESIGNATED --------------------
SERIES SHARES 1996 1997
- ------------------------------------------------------- --------- --------- ---------
JUNE 30,
1998
-----------
(UNAUDITED)
-----------
<S> <C> <C> <C> <C> <C>
A Convertible............................... 1,500,000 1,444,681 1,419,681 1,419,681
B Redeemable convertible.................... 2,900,000 2,250,000 2,250,000 2,250,000
C Redeemable convertible.................... 1,800,000 -- 1,428,571 1,428,571
--------- --------- --------- -----------
6,200,000 3,694,681 5,098,252 5,098,252
--------- --------- --------- -----------
--------- --------- --------- -----------
</TABLE>
Each share of preferred stock is convertible into one share of common stock
subject to antidilution provisions. Automatic conversion will occur upon
completion of an initial public offering of the Company's common stock with
proceeds of a minimum of $7.5 million at a minimum price of $8.80 per common
share. The voting rights of preferred stock are equivalent to the voting rights
of common stock into which it is convertible. Dividends on preferred stock are
non-cumulative but fully participating with any cash dividends declared on
common stock. Dividends on Series A, Series B, and Series C preferred stock are
payable in cash in the amount of $.12, $.126 and $.196 per share per annum as
adjusted for any stock dividends, combinations or splits with respect to such
shares, respectively, when and if declared by the
F-11
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
PREFERRED STOCK (CONTINUED)
Board of Directors. No such dividends have been declared as of December 31,
1997. The Series B and C preferred stock have stated redemption values of $1.80
and $2.80 per share, respectively. Series B and C preferred stock are
mandatorily redeemable at their stated redemption values ten years after
issuance.
COMMON STOCK
At December 31, 1997 the Company had reserved shares of common stock for
future issuance as follows:
<TABLE>
<CAPTION>
<S> <C>
Stock Option Plan:
Options outstanding............................................................................... 1,562,087
Options available for future grants............................................................... 686,379
Convertible preferred stock......................................................................... 5,098,252
------------
7,346,718
------------
------------
</TABLE>
STOCK OPTIONS
Under the Company's Stock Option Plan, 2,250,000 shares of common stock were
reserved for the issuance of incentive stock options (ISO) or non-statutory
stock options (NSO) to eligible participants. The ISOs may be granted at a price
per share not less than the fair market value at the date of grant. The NSOs may
be granted at a price per share not less than 85% of the fair market value at
the date of grant. Options granted to date are immediately exercisable and
unvested shares are subject to repurchase by the Company. Options and unvested
shares granted generally vest over a period of up to five years, with a maximum
term of ten years. In the event optionholders cease to be employed by the
Company, all unvested options are forfeited and all vested options may be
exercised within a 90-day period after termination; the Company also has the
right to repurchase at the original purchase price any unvested (but issued)
shares if the holder is no longer employed by the Company. At June 30, 1998, no
outstanding common shares are subject to such repurchase rights. Common shares
purchased under the plan are subject to certain restrictions, including the
right of first refusal by the Company for sale or transfer of these shares to
outside parties. The Company's right of first refusal terminates upon completion
of an initial public offering of common stock.
F-12
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
A summary of the Company's stock option activity under the plan for the
years ended December 31, 1996 and 1997 and the six months ended June 30, 1998 is
as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
---------------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
---------- ---------------
<S> <C> <C>
Granted......................................................... 1,464,887 $ 0.18
Exercised....................................................... (225) 0.17
Canceled........................................................ (6,675) 0.17
---------- -----
Outstanding at December 31, 1996.................................. 1,457,987 0.18
Granted......................................................... 348,875 0.37
Exercised....................................................... (1,309) 0.17
Canceled........................................................ (243,466) 0.19
---------- -----
Outstanding at December 31, 1997.................................. 1,562,087 0.21
Granted (unaudited)............................................. 161,325 0.97
Exercised (unaudited)........................................... (186,947) 0.21
Canceled (unaudited)............................................ (24,967) 0.41
---------- -----
Outstanding at June 30, 1998 (unaudited).......................... 1,511,498 $ 0.30
---------- -----
---------- -----
Vested and exercisable at December 31, 1997....................... 587,300 $ 0.20
---------- -----
---------- -----
Vested and exercisable at June 30, 1998 (unaudited)............... 576,577 $ 0.20
---------- -----
---------- -----
</TABLE>
The following table summarizes information concerning outstanding and
exercisable stock options at December 31, 1997:
<TABLE>
<CAPTION>
OUTSTANDING VESTED AND EXERCISABLE
---------------------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE
NUMBER OF PRICE CONTRACTUAL NUMBER OF PRICE
EXERCISE PRICE SHARES PER SHARE LIFE (YEARS) SHARES PER SHARE
- -------------------------------- ---------- ----------- --------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$0.17-$0.20..................... 1,299,812 $ 0.18 8.5 532,819 $ 0.18
$0.40-$0.44..................... 262,275 $ 0.41 9.6 54,481 $ 0.44
---------- -----------
1,562,087 587,300
---------- -----------
---------- -----------
</TABLE>
The Company recorded deferred compensation of $508,000 during the year ended
December 31, 1997 and $1,586,000 during the six months ended June 30, 1998
representing the difference between the exercise price and the deemed fair value
of certain of the Company's stock options granted to employees. These amounts
are being amortized by charges to operations over the vesting periods of the
individual stock options. Such amortization amounted to $124,000 for the year
ended December 31, 1997 and $415,000 for the six months ended June 30, 1998.
F-13
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
PRO FORMA DISCLOSURES OF THE EFFECT OF STOCK BASED COMPENSATION
Pro forma information regarding results of operations and net loss per share
is required by FAS 123, which also requires that the information be determined
as if the Company had accounted for its employee stock options under the fair
value method of FAS 123. The fair value for these options was estimated at the
date of grant using the minimum value method with the following weighted average
assumptions: a risk-free interest rate of 6.5% and 6.3% for the years ended
December 31, 1996 and 1997, respectively, no dividend yield or volatility
factors of the expected market price of the Company's common stock, and a
weighted average expected life of the option of five years.
The option valuation models were developed for use in estimating the fair
value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected life of the option. Because the
Company's employee stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined using the fair value at the grant dates for awards under those plans
calculated using the minimum value method of FAS 123, the Company's net loss and
pro forma basic and diluted net loss per share would have been increased to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
Pro forma net loss (in thousands)........................................ $ (2,506) $ (5,092)
--------- ---------
--------- ---------
Pro forma basic and diluted net loss per share........................... $ (0.68) $ (1.28)
--------- ---------
--------- ---------
</TABLE>
The weighted average fair value of options granted, which is the value
assigned to the options under FAS 123, was $0.02 and $0.83 for options granted
during the years ended December 31, 1996 and 1997, respectively.
The pro forma impact of options on the net loss for the years ended December
31, 1996 and 1997 is not representative of the effects on net income (loss) for
future years, as future years will include the effects of additional years of
stock option grants.
6. COMMITMENTS
LEASES
The Company leases equipment and its corporate office facility under
non-cancelable capital and operating leases, with initial terms in excess of one
year. The cost of equipment under capital leases is approximately $37,000 and
$57,000 and the related accumulated amortization is $1,000 and $16,000 at
F-14
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. COMMITMENTS (CONTINUED)
LEASES (CONTINUED)
December 31, 1996 and 1997, respectively. Future minimum payments under these
leases as of December 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
----------- -----------
<S> <C> <C>
1998..................................................................... $ 25 $ 747
1999..................................................................... 20 897
2000..................................................................... -- 939
2001..................................................................... -- 980
2002..................................................................... -- 671
--- -----------
Total minimum lease payments............................................. 45 $ 4,234
-----------
-----------
Less amount representing interest........................................ (5)
---
Present value of minimum lease payments.................................. 40
Less amount due within one year.......................................... 21
---
$ 19
---
---
</TABLE>
Rent expense under all operating leases was $67,000 and $418,000 for the
years ended December 31, 1996 and 1997, respectively.
The Company has the option to extend the operating lease covering its
corporate office facility for an additional five years at the end of the lease
term, provided that certain conditions of the lease agreement are met.
LICENSE AGREEMENT
In 1996, the Company entered into a license agreement with a university for
the use of the intellectual property underlying its training methods. In
exchange for the license, the Company issued 196,788 shares of Series A
preferred stock and paid the university a license-issue fee of $200,000. In
March 1997, the number of shares of Series A preferred stock issued under the
agreement was reduced to 171,788.
Under the agreement, additional royalties and milestone payments are payable
to the university based upon revenues from products using the licensed
technology. Royalty and milestone expenses were $202,000 for the year ended
December 31, 1997 (none in 1996) and are included in cost of revenues.
7. EMPLOYEE RETIREMENT AND BENEFIT PLAN
The Company has a defined contribution retirement plan under Section 401(k)
of the Internal Revenue Code which covers substantially all employees. Eligible
employees may contribute amounts to the plan, via payroll withholding, subject
to certain limitations. The Company does not match contributions by plan
participants.
F-15
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS
8. SUBSEQUENT EVENTS (UNAUDITED)
PROPOSED PUBLIC OFFERING OF COMMON STOCK
On June 6, 1998, the Board of Directors authorized the Company to proceed
with an initial public offering of its common stock. If the offering is
consummated as presently anticipated, all of the outstanding preferred stock
will automatically convert into common stock. The unaudited pro forma
stockholders' equity (deficit) at June 30, 1998 gives effect to the conversion
of all outstanding shares of convertible preferred stock at that date into
5,098,252 shares of common stock upon the completion of the offering.
STOCK SPLIT
On June 6, 1998, the Board of Directors approved, and on June 26, 1998 the
stockholders approved, a one-for-two reverse stock split of issued and
outstanding common and preferred stock. All common and preferred share prices,
and amounts associated with rights, preferences, dividends and privileges in the
accompanying financial statements have been retroactively adjusted to reflect
the stock split. In addition, the Board of Directors authorized an increase in
the number of authorized shares of common stock to 50,000,000 and a decrease in
the number of authorized shares of preferred stock to 1,000,000 shares, subject
to stockholder approval.
1998 EQUITY INCENTIVE PLAN
On June 6, 1998, the Company's Board of Directors adopted, and on June 26,
1998 the stockholders approved, the 1998 Equity Incentive Plan which amends and
restates the Company's existing stock option plan. There are 2,800,000 shares of
common stock authorized for issuance under the plan. The plan will become
effective upon completion of the Company's initial public offering of its common
stock.
1998 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
On June 6, 1998, the Company's Board of Directors adopted, and on June 26,
1998 the stockholders approved, the 1998 Non-Employee Directors' Stock Option
Plan and reserved an aggregate of 100,000 shares of common stock for grants of
stock options under such plan.
1998 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1998 Employee Stock Purchase Plan was adopted by the Board of
Directors on June 6, 1998 and approved by the stockholders on June 26, 1998 to
be effective upon the completion of the Company's initial public offering of its
common stock. The Company has reserved a total of 500,000 shares of common stock
for issuance under the plan. Eligible employees may purchase common stock at 85%
of the lesser of the fair market value of the Company's common stock on the
first day of the applicable one year offering period or the last day of the
applicable six month purchase period.
BANK LINES OF CREDIT
In February 1998, the Company entered into an additional line of credit with
a bank which provides for borrowings of up to $450,000 to finance equipment
purchases through August 1998. Borrowings are due in monthly installments
through August 2000 plus interest at the bank's prime rate plus 3% and are
secured by substantially all of the Company's assets, excluding intellectual
property.
F-16
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)
BANK LINES OF CREDIT (CONTINUED)
In June 1998, the Company obtained a $3 million unsecured line of credit
from another bank. Borrowings under the line of credit bear interest, at the
election of the Company, at the bank's base rate or the adjusted LIBOR plus
1.75% and are due in May 1999. Borrowings are guaranteed by a significant
preferred stockholder of the Company. In connection with such guarantee, the
Company issued to the stockholder warrants to purchase 100,000 shares of the
Company's Common Stock at $6.00 per share. Such warrants expire on May 31, 2003.
The Company estimated the fair value of the warrants to be $650,000, which
amount has been recorded as deferred financing costs (included in other assets)
and is being amortized by charges to interest expense over the term of the line
of credit. Additionally, the stockholder agreed to purchase up to 500,000 shares
of the Company's preferred stock at $6.00 per share if requested by the Company.
The Company's right to require the stockholder to purchase such securities
expires upon the closing of an initial public offering of the Company's Common
Stock.
F-17
<PAGE>
INSIDE BACK COVER OF PROSPECTUS: [Contains a photograph of children using
Fast ForWord with a speech and language professional. Text with the photograph
states: "Scientific Learning Corporation is committed to advancing human
learning and performance through neuroscience-based education and training
programs using advanced integrated technologies with proven results. Fast
ForWord-Registered Trademark-, its initial product, is an intensive,
computer-based training program that focuses on improving critical pre-reading
skills, including receptive and expressive communication skills, in children
with language-based learning problems. The Company has sponsored two field
trials involving approximately 1,000 children with language-based learning
problems. Participants on average achieved improvement of one to two years in
language processing and related skills after completion of the Fast ForWord
program in four to eight weeks." The words "Scientific Learning Corporation"
appear in the bottom right corner.]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER, OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER
TO BUY ANY SECURITIES OTHER THAN THE SHARES OF COMMON STOCK TO WHICH IT RELATES
OR AN OFFER TO, OR A SOLICITATION OF, ANY PERSON IN ANY JURISDICTION WHERE SUCH
AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR
THAT INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE
DATE HEREOF.
-------------------------
TABLE OF CONTENTS
-------------------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY............................. 3
RISK FACTORS................................... 7
USE OF PROCEEDS................................ 17
DIVIDEND POLICY................................ 17
CAPITALIZATION................................. 18
DILUTION....................................... 19
SELECTED FINANCIAL DATA........................ 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................... 21
BUSINESS....................................... 26
MANAGEMENT..................................... 41
CERTAIN TRANSACTIONS........................... 52
PRINCIPAL AND SELLING STOCKHOLDERS............. 54
DESCRIPTION OF CAPITAL STOCK................... 56
SHARES ELIGIBLE FOR FUTURE SALE................ 58
UNDERWRITING................................... 60
LEGAL MATTERS.................................. 61
EXPERTS........................................ 62
ADDITIONAL INFORMATION......................... 62
TRADEMARKS..................................... 62
INDEX TO FINANCIAL STATEMENTS.................. F-1
</TABLE>
UNTIL AFTER , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES OFFERED HEREBY,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
2,400,000 SHARES
[LOGO]
COMMON STOCK
---------------
PROSPECTUS
---------------
NationsBanc Montgomery
Securities LLC
BancAmerica Robertson Stephens
Pacific Growth Equities, Inc.
, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the Registrant in connection with the sale
of the Common Stock being registered. All the amounts shown are estimates except
for the registration fee and the NASD filing fee.
<TABLE>
<S> <C>
Registration fee.................................................. $ 11,399
NASD filing fee................................................... 3,950
Nasdaq application fee............................................ 1,000
Blue sky qualification fee and expenses........................... 5,000
Printing and engraving expenses................................... 130,000
Legal fees and expenses........................................... 350,000
Accounting fees and expenses...................................... 200,000
Transfer agent and registrar fees................................. 10,000
Miscellaneous..................................................... 38,651
---------
Total......................................................... $ 750,000
---------
---------
</TABLE>
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Under Section 145 of the Delaware General Corporation Law, the Company has
broad powers to indemnify its directors and officers against liabilities they
may incur in such capacities, including liabilities under the Securities Act of
1933, as amended (the "Securities Act"). The Company's Bylaws also provide that
the Company will indemnify its directors and executive officers and may
indemnify its other officers, employees and other agents to the fullest extent
not prohibited by Delaware law.
The Company's Certificate of Incorporation provides for the elimination of
liability for monetary damages for breach of the directors' fiduciary duty of
care to the Company and its stockholders. These provisions do not eliminate the
directors' duty of care and, in appropriate circumstances, equitable remedies
such as injunctive or other forms of non-monetary relief will remain available
under Delaware law. In addition, each director will continue to be subject to
liability for breach of the director's duty of loyalty to the Company, for acts
or omissions not in good faith or involving intentional misconduct, for knowing
violations of law, for any transaction from which the director derived an
improper personal benefit and for payment of dividends or approval of stock
repurchases or redemptions that are unlawful under Delaware law. These
provisions do not affect a director's responsibilities under any other laws,
such as the federal securities laws or state or federal environmental laws.
The Company has entered into agreements with its directors and executive
officers that require the Company to indemnify such persons against expenses,
judgments, fines, settlements and other amounts actually and reasonably incurred
(including expenses of a derivative action) in connection with any proceeding,
whether actual or threatened, to which any such person may be made a party by
reason of the fact that such person is or was a director or officer of the
Company or any of its affiliated enterprises, provided such person acted in good
faith and in a manner such person reasonably believed to be in or not opposed to
the best interests of the Company and, with respect to any criminal proceeding,
had no reasonable cause to believe his or her conduct was unlawful. The
indemnification agreements also set forth certain procedures that will apply in
the event of a claim for indemnification thereunder.
The Underwriting Agreement filed as Exhibit 1.1 to this Registration
Statement provides for indemnification by the Underwriters of the Company and
its officers and directors for certain liabilities arising under the Securities
Act or otherwise.
II-1
<PAGE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since its incorporation on November 30, 1995, the Company has sold and
issued the following unregistered securities:
1. From January 1996 to June 1996, the Company issued and sold an aggregate
of 3,985,161 shares of Common Stock at prices ranging from $0.0008 to
$0.17 per share to seven executive officers and directors, 185,175 of
which are currently held by one individual who is no longer associated
with the Company.
2. In April 1996, the Company issued and sold an aggregate of 104,937
shares of Series A Preferred Stock at $1.62 per share to four executive
officers and directors pursuant to its Series A Preferred Stock Employee
Purchase Plan, 12,345 of which are currently held by one individual who
is no longer associated with the Company.
3. From April 1996 to May 1996, the Company issued and sold and aggregate
of 1,142,956 shares of Series A Preferred Stock at $1.70 per share to 68
investors, 24,412 of which were sold to Dr. Schleifer, a member of the
Board of Directors of the Company.
4. On September 27, 1996, the Company issued 196,788 shares of Series A
Preferred Stock to Rutgers University in partial payment of a license
fee. On March 28, 1997, Rutgers University returned 25,000 shares to the
Company.
5. From October 1996 to November 1996, the Company issued and sold and
aggregate of 2,250,000 shares of Series B Preferred Stock at $1.80 per
share to two investors, 2,222,222 of which were sold to Ventures, an
affiliate of the Company.
6. On October 1, 1996 the Company issued a warrant to purchase 1,428,571
shares of Series C Preferred Stock at an exercise price of $2.80 per
share to Ventures, an affiliate of the Company. This warrant was
subsequently exercised on June 16, 1997 and the 1,428,571 shares were
issued to the affiliate.
7. Since inception, the Company has granted stock options under its Stock
Option Plan covering an aggregate of 1,699,979 shares of the Company's
Common Stock (net of expirations and cancellations) at exercise prices
ranging from $0.17 to $1.50 per share.
8. Since inception, options to purchase an aggregate of 188,481 shares of
the Company's Common Stock were exercised for an aggregate purchase price
of $39,408.27 at exercise prices ranging from $0.17 to $0.50 per share.
9. In June 1998, the Company issued to Ventures, an affiliate of the
Company, warrants to purchase 100,000 shares of the Company's Common
Stock. These warrants were issued in connection with Ventures' guarantee
of a $3 million unsecured line of credit obtained by the Company in June
1998.
The sales and issuances of securities in the transactions described in
paragraphs 1 through 6 and 9 above were deemed to be exempt from registration
under the Securities Act by virtue of Section 4(2) or Regulation D promulgated
under the Securities Act. The purchasers in each case represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends are affixed to the stock
certificates issued in such transactions. Similar legends were imposed in
connection with any subsequent sales of any such securities. All recipients
either received adequate information about the Company or had access, through
employment or other relationships, to such information.
The sales and issuances of securities in the transactions described in
paragraphs 1, 2, 7 and 8 above were deemed to be exempt from registration under
the Securities Act by virtue of Rule 701 promulgated
II-2
<PAGE>
thereunder in that they were offered and sold either pursuant to written
compensatory benefit plans or pursuant to a written contract relating to
compensation, as provided by Rule 701.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- -------- -----------------------------------------------------------------------
<C> <S>
1.1+ Form of Underwriting Agreement.
3.1+ Amended and Restated Certificate of Incorporation of the Company.
3.2+ Bylaws of the Company.
3.3+ Form of Restated Certificate of Incorporation of the Company to be
filed upon completion of this Offering.
3.4+ Form of Amended and Restated Bylaws of the Company to be effective upon
the closing of this Offering.
4.1 Reference is made to Exhibits 3.1 through 3.4.
4.2+ Registration Rights Agreement among the Company and the parties
indicated therein, dated as of October 1, 1996, as amended on
November 14, 1996.
4.3+ Specimen stock certificate.
5.1 Opinion of Cooley Godward LLP as to the legality of the securities
being registered.
10.1+ Form of Indemnity Agreement between the Company and each its directors
and executive officers, with related schedules.
10.2+ 1998 Equity Incentive Plan (the "Incentive Plan").
10.3+ Form of Stock Option Agreement under the Incentive Plan.
10.4+ Form of Stock Option Grant Notice under the Incentive Plan.
10.5+ 1998 Non-Employee Directors' Stock Option Plan ("Directors' Plan").
10.6+ Form of Nonstatutory Stock Option Agreement under the Directors' Plan
(Initial Grant).
10.7+ Form of Nonstatutory Stock Option Agreement under the Directors' Plan
(Annual Grant).
10.8+ 1998 Employee Stock Purchase Plan ("ESP Plan").
10.9+ Form of Employee Stock Purchase Plan Offering under the ESP Plan.
10.10+ Letter agreement, dated as of October 31, 1996, between Sheryle J.
Bolton and the Company.
10.11+ Consulting Agreement, dated as of September 20, 1996, between Dr.
Michael M. Merzenich and the Company, as modified on January 19,
1998.
10.12+ Consulting Agreement, dated as of September 19, 1996, between Dr. Paula
A. Tallal and the Company, as modified on January 22, 1998.
10.13* Exclusive License Agreement, dated September 27, 1996, between the
Company and the Regents of the University of California.
10.14+ Loan and Security Agreement, dated as of February 13, 1998, between the
Company and Silicon Valley Bank.
10.15+ Revolving Loan Agreement, dated as of June 4, 1998, between the Company
and BankBoston, N.A.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- -------- -----------------------------------------------------------------------
<C> <S>
10.16+ Lease Agreement, dated as of July 31, 1997, between the Company and
GBC-University Associates, L.P.
10.17+ Securities Purchase Agreement, dated September 24, 1996, between the
Company and Warburg, Pincus Ventures, L.P.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Cooley Godward LLP. Reference is made to Exhibit 5.1.
24.1+ Power of Attorney. Reference is made to page II-5.
27.1 Financial Data Schedule.
</TABLE>
- ------------------------
+ Filed previously
* Certain portions of this exhibit have been omitted based upon the Company's
request for confidential treatment pursuant to Rule 406 for portions of the
referenced exhibit.
(b) FINANCIAL STATEMENT SCHEDULES.
All financial statement schedules are omitted because the information called
for is not required, is not applicable, or is shown either in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS.
The Company hereby undertakes to provide at the closing, to the Underwriters
specified in the Underwriting Agreement, certificates in such denominations and
registered in such names as required by the Underwriters permitting prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers, and controlling persons of the Company
pursuant to the provisions described in Item 14 or otherwise, the Company has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefor, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Company of expenses
incurred or paid by a director, officer, or controlling person of the Company in
the successful defense of any action, suit, or proceeding) is asserted by such
director, officer, or controlling person in connection with the securities being
registered, the Company will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The Company undertakes that: (1) for purposes of determining any liability
under the Securities Act, the information omitted from the form of prospectus as
filed as part of the registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Company pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part
of the registration statement as of the time it was declared effective, and (2)
for the purpose of determining any liability under the Securities Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
BONA FIDE offering thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Company has caused this Amendment No. 2 to Registration Statement No. 333-56545
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Berkeley, County of Alameda, State of California, on the 21st day of
July, 1998.
<TABLE>
<S> <C> <C>
SCIENTIFIC LEARNING CORPORATION
By:
/s/ SHERYLE J. BOLTON
-----------------------------------------
Sheryle J. Bolton
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
DIRECTOR
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 2 to Registration Statement No. 333-56545 has been signed below by
the following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ----------------------------------- -------------------------- -------------------
<C> <S> <C>
President, Chief Executive
/s/ SHERYLE J. BOLTON Officer and Director
- ----------------------------------- (PRINCIPAL EXECUTIVE July 21, 1998
Sheryle J. Bolton OFFICER)
/s/ DR. MICHAEL M. MERZENICH*
- ----------------------------------- Chief Scientific Officer July 21, 1998
Dr. Michael M. Merzenich and Director
/s/ DR. PAULA A. TALLAL* Executive Vice President
- ----------------------------------- and Chairman of the July 21, 1998
Dr. Paula A. Tallal Board
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ----------------------------------- -------------------------- -------------------
Chief Financial Officer,
/s/ FRANK M. MATTSON Vice President, Finance
- ----------------------------------- and Secretary (PRINCIPAL July 21, 1998
Frank M. Mattson FINANCIAL AND ACCOUNTING
OFFICER)
<C> <S> <C>
/s/ CARLETON A. HOLSTROM*
- ----------------------------------- Director July 21, 1998
Carleton A. Holstrom
/s/ DR. LEONARD S. SCHLEIFER*
- ----------------------------------- Director July 21, 1998
Dr. Leonard S. Schleifer
/s/ RODMAN W. MOORHEAD, III*
- ----------------------------------- Director July 21, 1998
Rodman W. Moorhead, III
/s/ JAMES E. THOMAS*
- ----------------------------------- Director July 21, 1998
James E. Thomas
*By: /s/ SHERYLE J. BOLTON
- -----------------------------------
Sheryle J. Bolton
Attorney-in-Fact
(Signing under the authority of a
Power of Attorney previously filed
with the Securities and Exchange
Commission)
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- -------- -----------------------------------------------------------------------
<C> <S>
1.1+ Form of Underwriting Agreement.
3.1+ Amended and Restated Certificate of Incorporation of the Company.
3.2+ Bylaws of the Company.
3.3+ Form of Restated Certificate of Incorporation of the Company to be
filed upon completion of this Offering.
3.4+ Form of Amended and Restated Bylaws of the Company to be effective upon
the closing of this Offering.
4.1 Reference is made to Exhibits 3.1 through 3.4.
4.2+ Registration Rights Agreement among the Company and the parties
indicated therein, dated as of October 1, 1996, as amended on
November 14, 1996.
4.3+ Specimen stock certificate.
5.1 Opinion of Cooley Godward LLP as to the legality of the securities
being registered.
10.1+ Form of Indemnity Agreement between the Company and each its directors
and executive officers, with related schedules.
10.2+ 1998 Equity Incentive Plan (the "Incentive Plan").
10.3+ Form of Stock Option Agreement under the Incentive Plan.
10.4+ Form of Stock Option Grant Notice under the Incentive Plan.
10.5+ 1998 Non-Employee Directors' Stock Option Plan ("Directors' Plan").
10.6+ Form of Nonstatutory Stock Option Agreement under the Directors' Plan
(Initial Grant).
10.7+ Form of Nonstatutory Stock Option Agreement under the Directors' Plan
(Annual Grant).
10.8+ 1998 Employee Stock Purchase Plan ("ESP Plan").
10.9+ Form of Employee Stock Purchase Plan Offering under the ESP Plan.
10.10+ Letter agreement, dated as of October 31, 1996, between Sheryle J.
Bolton and the Company.
10.11+ Consulting Agreement, dated as of September 20, 1996, between Dr.
Michael M. Merzenich and the Company, as modified on January 19,
1998.
10.12+ Consulting Agreement, dated as of September 19, 1996, between Dr. Paula
A. Tallal and the Company, as modified on January 22, 1998.
10.13* Exclusive License Agreement, dated September 27, 1996, between the
Company and the Regents of the University of California.
10.14+ Loan and Security Agreement, dated as of February 13, 1998, between the
Company and Silicon Valley Bank.
10.15+ Revolving Loan Agreement, dated as of June 4, 1998, between the Company
and BankBoston, N.A.
10.16+ Lease Agreement, dated as of July 31, 1997, between the Company and
GBC-University Associates, L.P.
10.17+ Securities Purchase Agreement, dated September 24, 1996, between the
Company and Warburg, Pincus Ventures, L.P.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Cooley Godward LLP. Reference is made to Exhibit 5.1.
24.1+ Power of Attorney. Reference is made to page II-5.
27.1 Financial Data Schedule.
</TABLE>
- --------------------------
+ Filed previously
* Certain portions of this exhibit have been omitted based upon the Company's
request for confidential treatment pursuant to Rule 406 for portions of the
referenced exhibit.
<PAGE>
[LETTERHEAD]
July 21, 1998
Scientific Learning Corporation
1995 University Avenue, Suite 400
Berkeley, CA 94701
Ladies and Gentlemen:
You have requested our opinion with respect to certain matters in connection
with the filing by Scientific Learning Corporation (the "Company") of a
Registration Statement on Form S-1 (the "Registration Statement") with the
Securities and Exchange Commission, including a related prospectus filed with
the Registration Statement (the "Prospectus"), covering an underwritten public
offering of up to 2,760,000 shares of the Company's common stock, including
360,000 shares of common stock that may be sold pursuant to the exercise of an
over-allotment option, of which 193,658 shares may be sold by certain selling
stockholders (collectively, the "Shares").
In connection with this opinion, we have (i) examined and relied upon the
Registration Statement and related Prospectus, the Company's Amended and
Restated Certificate of Incorporation and Amended and Restated Bylaws, and the
originals or copies certified to our satisfaction of such records, documents,
certificates, memoranda and other instruments as in our judgment are necessary
or appropriate to enable us to render the opinion expressed below, and (ii) that
the shares of Common Stock will be sold by the underwriters at a price
established by the Pricing Committee of the Board of Directors of the Company.
On the basis of the foregoing, and in reliance thereon, we are of the opinion
that the Shares to be sold by the selling stockholders are validly issued, fully
paid and non-assessable and that the Shares to be sold by the Company, when sold
and issued in accordance with the Registration Statement and related Prospectus,
will be validly issued, fully paid and nonassessable.
We consent to the reference to our firm under the caption "Legal Matters" in the
Prospectus included in the Registration Statement and to the filing of this
opinion as an exhibit to the Registration Statement.
Very truly yours,
Cooley Godward LLP
By: /s/ Jeffrey S. Zimman
-----------------------------------------
Jeffrey S. Zimman
<PAGE>
CERTAIN CONFIDENTIAL INFORMATION
CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAD BEEN OMITTED AND FILED
SEPARATELY WITH THE SECURITIES AND
EXCHANGE COMMISSION PURSUANT TO RULE
406 OF THE SECURITIES ACT OF 1933, AS
AMENDED.
EXHIBIT 10.13
EXCLUSIVE LICENSE AGREEMENT
BETWEEN
THE REGENTS OF THE UNIVERSITY OF CALIFORNIA
AND
SCIENTIFIC LEARNING PRINCIPLES CORPORATION
FOR
TRAINING AIDS FOR REMEDIATION OF LEARNING DISABILITIES
UC CASE NO. 94-069-1
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1. DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2. LIFE OF PATENT EXCLUSIVE GRANT . . . . . . . . . . . . . . . . . . . . 3
3. SUBLICENSES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4. PAYMENT TERMS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
5. LICENSE-ISSUE FEE. . . . . . . . . . . . . . . . . . . . . . . . . . . 6
6. MILESTONE PAYMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . 7
7. EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES. . . . . . . . . . . . . 7
8. DUE DILIGENCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
9. PROGRESS AND ROYALTY REPORTS . . . . . . . . . . . . . . . . . . . . . 9
10. BOOKS AND RECORDS. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
11. LIFE OF THE AGREEMENT. . . . . . . . . . . . . . . . . . . . . . . . . 10
12. TERMINATION BY THE REGENTS . . . . . . . . . . . . . . . . . . . . . . 11
13. TERMINATION BY THE LICENSEE. . . . . . . . . . . . . . . . . . . . . . 11
14. DISPOSITION OF LICENSED PRODUCTS ON HAND UPON TERMINATION. . . . . . . 12
15. USE OF NAMES AND TRADEMARKS. . . . . . . . . . . . . . . . . . . . . . 12
16. LIMITED WARRANTY . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
17. PATENT PROSECUTION AND MAINTENANCE . . . . . . . . . . . . . . . . . . 14
18. PATENT MARKING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
19. PATENT INFRINGEMENT. . . . . . . . . . . . . . . . . . . . . . . . . . 16
20. INDEMNIFICATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
21. NOTICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
22. ASSIGNABILITY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
23. NO WAIVER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
24. FAILURE TO PERFORM . . . . . . . . . . . . . . . . . . . . . . . . . . 20
25. GOVERNING LAWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
26. GOVERNMENT APPROVAL OR REGISTRATION. . . . . . . . . . . . . . . . . . 20
27. EXPORT CONTROL LAWS. . . . . . . . . . . . . . . . . . . . . . . . . . 21
28. SECRECY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
i
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
PAGE
29. MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
</TABLE>
ii
<PAGE>
EXCLUSIVE LICENSE AGREEMENT
THIS LICENSE AGREEMENT (the "Agreement") is made effective this 27th day of
September, 1996 (the "Effective Date") between THE REGENTS OF THE UNIVERSITY OF
CALIFORNIA, a California corporation having its statewide administrative offices
at 300 Lakeside Drive, 22nd Floor, Oakland, California 94612-3550, ("The
Regents"), and SCIENTIFIC LEARNING PRINCIPLES CORPORATION, a California
corporation having a principal place of business at One Kearney Street, Suite
501, San Francisco, California 94108, (the "Licensee").
BACKGROUND
1. Certain inventions, generally characterized as "Training Aids for the
Remediation of Learning Disabilities" (collectively the "Invention"), were made
in the course of research at the University of California, San Francisco by Drs.
Michael Merzenich, William Jenkins, Christoph Schreiner and by Drs. Paula Tallal
and Steven Miller at Rutgers-the State University of New Jersey ("Rutgers") and
are covered by Regents' Patent Rights as defined below;
2. The Regents and Rutgers have entered into an inter-institutional
agreement whereby The Regents is authorized to enter into this Agreement on
behalf of both The Regents and Rutgers;
3. The Licensee and The Regents have executed a Letter of Intent (U.C.
Control No. 96-30-0452) dated January 9, 1996;
4. The Licensee wishes to obtain rights from The Regents for the
commercial development, use, and sale of products from the Invention, and The
Regents is willing to grant those rights so that the invention may be developed
to its fullest and the benefits enjoyed by the
1.
<PAGE>
general public; and
5. The Licensee is a "small business firm" as defined in 15 U.S.C.
Section 632;
6. Both parties recognize and agree that royalties due under this
Agreement will be paid on both pending patent applications and issued patents:
In view of the foregoing, the parties agree:
1. DEFINITIONS
1.1 "REGENTS' PATENT RIGHTS" means any subject matter claimed in or
covered by any of the following: Pending U.S. Patent Application Serial No.
08/351,803 entitled "Method and Device for Enhancing the Recognition of Speech
Among Speech-Impaired Individuals" filed December 8, 1994 by Drs. Merzenich,
Jenkins, Schreiner, Tallal, and Miller and assigned to The Regents and to
Rutgers; and continuing applications thereof including divisions and
substitutions but excluding continuation-in-part applications except to the
extent that the claims are enabled by the parent case; any patents issuing on
said applications including reissues, reexaminations and extensions; and any
corresponding foreign applications or patents.
1.2 "LICENSED PRODUCT" means any material that is either covered by
Regents' Patent Rights, that is produced by the Licensed Method, or that the use
of which would constitute, but for the license granted to the Licensee under
this Agreement, an infringement of any pending or issued claim within Regents'
Patent Rights.
1.3 "LICENSED METHOD" means any method that is covered by Regents' Patent
Rights, the use of which would constitute, but for the license granted to the
Licensee under this Agreement, an infringement of any pending or issued claim
within Regents' Patent Rights.
2.
<PAGE>
1.4 "NET SALES" means the total of the gross invoice prices of Licensed
Products sold or Licensed Methods performed by the Licensee, an Affiliate or a
sublicensee, less the sum of the following actual and customary deductions where
applicable: cash, trade, or quantity discounts; sales, use, tariff,
import/export duties or other excise taxes imposed on particular sales;
transportation charges and allowances; reserves for bad debts (not to exceed 3
%) or credits to customers because of rejections or returns. For purposes of
calculating Net Sales, transfers to an Affiliate or sublicensee for end use by
the Affiliate or sublicensee will be treated as sales at list price.
1.5 "AFFILIATE" means any corporation or other business entity in which
the Licensee owns or controls, directly or indirectly, at least fifty percent
(50%) of the outstanding stock or other voting rights entitled to elect
directors, or in which the Licensee is owned or controlled directly or
indirectly by at least fifty percent (50%) of the outstanding stock or other
voting rights entitled to elect directors; but in any country where the local
law does not permit foreign equity participation of at least fifty percent
(50%), then an "Affiliate" includes any company in which the Licensee owns or
controls or is owned or controlled by, directly or indirectly, the maximum
percentage of outstanding stock or voting rights permitted by local law.
2. LIFE OF PATENT EXCLUSIVE GRANT.
2.1 Subject to the limitations set forth in this Agreement, The Regents
grants to the Licensee a world-wide license under Regents' Patent Rights to
make, have made, use, sell, offer to sell and import Licensed Products and to
practice Licensed Methods.
2.2 Except as otherwise provided in this Agreement, the license granted in
Paragraph 2.1 is exclusive for the life of the Agreement.
3.
<PAGE>
2.3 The Regents and Rutgers reserves the right to use the Invention for
educational and research purposes.
3. SUBLICENSES.
3.1 The Regents also grants to the Licensee the right to issue sublicenses
to third parties to make, have made, use, sell, offer to sell and import
Licensed Products and to practice Licensed Method, as long as the Licensee has
current exclusive rights thereto under this Agreement. Throughout the term of
each sublicense, the Licensee shall ensure compliance by sublicensee with, to
the extent applicable, all of the rights and obligations due to the Regents and
Rutgers contained in this Agreement.
3.2 The Licensee shall promptly provide The Regents with a copy of each
sublicense issued; collect and guarantee payment of all payments due The Regents
based on sublicensee's sales; and summarize and deliver all reports due The
Regents based on sublicensee's sales.
3.3 Upon termination of this Agreement for any reason, The Regents, at its
sole discretion, shall determine whether the Licensee shall cancel or assign to
The Regents any and all sublicenses.
3.4 Licensee shall pay to The Regents consideration from sublicensing or
transferring the rights licensed to Licensee as follows:
3.4.1 ROYALTIES - the greater of: (i) [ * ] of the royalty income
received by Licensee and/or its Affiliates from any sublicensee in
consideration of the sublicense grant or rights transfer; or (ii) the
royalty based on sublicensee's Net Sales in accordance with the royalty
schedule in Article 7 (EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES).
[ * ]Confidential Treatment Requested
4.
<PAGE>
3.4.2 NON-ROYALTY CONSIDERATION - [ * ] of all non-royalty
consideration, received by Licensee and its Affiliates in consideration of
the sublicense grant or rights transfer, except for the portion thereof
which is designated and demonstrably used by Licensee solely for its
development of Licensed Products and Licensed Methods, excluding equity
payments, bona fide loans and other payments not associated with the
sublicense.
4. PAYMENT TERMS.
4.1 Paragraphs 1.1, 1.2, and 1.3 define Regents' Patent Rights, Licensed
Products and Licensed Methods so that royalties are payable on products and
methods covered by both pending patent applications and issued patents.
Royalties will accrue in each country for the duration of Regents' Patent Rights
in that country and are payable to The Regents when Licensed Products are
invoiced. or if not invoiced, when delivered to a third party.
4.2 Licensee shall pay earned royalties quarterly on or before February
28, May 31, August 31 and November 30 of each calendar year. Each payment will
be for earned royalties accrued within the Licensee's most recently completed
calendar quarter.
4.3 All monies due The Regents are payable in United States dollars. When
Licensed Products are sold for monies other than United States dollars, the
Licensee shall first determine the earned royalty in the currency of the country
in which Licensed Products were sold and then convert the amount into equivalent
United States funds, using the exchange rate quoted in the Wall Street Journal
on the last business day of the reporting period.
4.4 Royalties earned on sales occurring in any country outside the United
States may not be reduced by any taxes, fees, or other charges imposed by the
government of such country on the payment of royalty income. The Licensee is
also responsible for all bank transfer charges.
[ * ]Confidential Treatment Requested
5.
<PAGE>
Notwithstanding this, all payments made by the Licensee in fulfillment of The
Regents' tax liability in any particular country will be credited against earned
royalties or fees due The Regents for that country.
4.5 If at any time legal restrictions prevent the prompt remittance of
royalties by the Licensee from any country where a Licensed Product is sold, the
Licensee shall convert the amount owed to The Regents into United States funds
and shall pay The Regents directly from its U.S. source of funds for as long as
the legal restrictions apply.
4.6 If any patent or patent claim within Regents' Patent Rights is held
invalid in a final decision by a court of competent jurisdiction and last resort
and from which no appeal has or can be taken, all obligation to pay royalties
based on that patent or claim or any claim patentably indistinct therefrom will
cease as of the date of final decision. The Licensee will not, however, be
relieved from paying any royalties that accrued before the final decision or
that are based on another patent or claim not involved in the final decision. or
that are based on The Regents' property rights.
4.7 In the event payments, rebillings or fees are not received by The
Regents when due, the Licensee shall pay to The Regents interest charges at a
rate of [ * ] per annum. Interest is calculated from the date payment was due
until actually received by The Regents.
5. LICENSE-ISSUE FEE.
5.1 The Licensee shall pay to The Regents a LICENSE-ISSUE FEE of Two
Hundred Thousand dollars ($200,000) payable as follows: Fifty Thousand
dollars ($50,000) within seven days after the Effective Date; Fifty Thousand
dollars ($50,000) on August 31, 1997 and One Hundred Thousand dollars
($100,000) on February 28, 1998. This fee is non-refundable, non-cancelable,
and is not an advance against royalties.
[ * ]Confidential Treatment Requested
6.
<PAGE>
5.2 The Licensee shall also grant to Rutgers three hundred ninety-three
thousand five hundred seventy-six (393,576) shares of series A preferred stock
within thirty (30) days of execution of this Agreement.
6. MILESTONE PAYMENTS.
6.1 The Licensee shall also pay to The Regents a royalty in the form of a
milestone payments of [ * ] Dollars ($[ * ]) upon Licensee reaching [ * ]
Dollars ($[ * ]) in cumulative Net Sales of Licensed Products or Licensed
Methods: [ * ] Dollars ($[ * ]) upon Licensee reaching [ * ] Dollars ($[ *]) in
cumulative Net Sales of Licensed Products or Licensed Methods; and [ * ] Dollars
($[ * ]) upon Licensee reaching [ * ] Dollars ($[ * ]) in cumulative Net Sales
of Licensed Products and Licensed Methods. Milestone payments are non-refundable
and not an advance against earned Royalties.
7. EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES.
7.1 The Licensee shall also pay to The Regents AN EARNED ROYALTY as
follows: [ * ] of the first [ * ] Dollars ($[ * ]) of cumulative Net Sales of
Licensed Products or Licensed Methods; [ * ] thereafter until cumulative Net
Sales reaches [ * ] Dollars ($[ * ]); and [ * ] of the cumulative Net Sales of
Licensed Products and Licensed Methods in excess of [ * ] Dollars ($[ * ]).
7.2 The Licensee shall pay to The Regents a MINIMUM ANNUAL ROYALTY of
[ *] Dollars ($[ * ]) beginning with the year of the first commercial sale of
Licensed Product; [ * ] dollar ($[ * ]) in the second year of first commercial
sale and [ * ] Dollars ($[ * ]) per year for the life of Regents Patent Rights.
For the first year of commercial sales, the Licensee's obligation to pay the
minimum annual royalty will be pro-rated for the number of months remaining in
that calendar year when commercial sales commence and will be due the following
February 28, to
[ * ]Confidential Treatment Requested
7.
<PAGE>
allow for crediting of the pro-rated year's earned royalties. For subsequent
years, the minimum annual royalty will be paid to The Regents by February 28 of
each year and will be credited against the earned royalty due for the calendar
year in which the minimum payment was made.
8. DUE DILIGENCE.
8.1 The Licensee, on execution of this Agreement, shall diligently proceed
with the development, manufacture and sale of Licensed Products and shall
earnestly and diligently endeavor to market the same within a reasonable time
after execution of this Agreement and in quantities sufficient to meet market
demands.
8.2 The Licensee shall endeavor to obtain all necessary governmental
approvals for the manufacture, use and sale of Licensed Products.
8.3 The Licensee shall:
8.3.1 complete a second round of financing by April 30, 1997;
8.3.2 commence beta-testing of Licensed Products by December 31,
1996:
8.3.3 make commercially reasonable efforts to market and sell
Licensed Products in the United States by November 30, 1997;
and
8.3.4 act in a commercially reasonable manner to fill the market
demand for Licensed Products following commencement of
marketing at any time during the exclusive period of this
Agreement.
8.4 If the Licensee is unable to perform any of the above provisions, then
The Regents has the right and option to either terminate this Agreement or
reduce the Licensee's exclusive license to a nonexclusive license. This right,
if exercised by The Regents, supersedes the rights granted in Article 2 (GRANT).
8.
<PAGE>
8.5 In addition to the obligations set forth above, the Licensee shall
spend an aggregate of not less than [ * ] Dollars ($[ * ]) for the development
of Licensed Products during the first year of this Agreement.
9. PROGRESS AND ROYALTY REPORTS.
9.1 Beginning February 28, 1997 and semi-annually thereafter, the Licensee
shall submit to The Regents a progress report covering the Licensee's (and any
Affiliate or sublicensee's) activities related to the development and testing of
all Licensed Products and the obtaining of the governmental approvals necessary
for marketing. Progress reports are required for each Licensed Product until the
first commercial sale of that Licensed Product occurs in the United States and
shall be again required if commercial sales of such Licensed Product are
suspended or discontinued.
9.2 Progress reports submitted under Paragraph 9.1 shall include, but are
not limited to, the following topics:
* summary of work completed
* key scientific discoveries
* summary of work in progress
* current schedule of anticipated events or milestones
* market plans for introduction of Licensed Products, and
* a summary, of resources (dollar value) spent in the
reporting period.
9.3 The Licensee has a continuing responsibility to keep The Regents
informed of the large/small business entity status (as defined by the United
States Patent and Trademark Office) of itself and its sublicensees and
Affiliates.
9.4 The Licensee shall report to The Regents in its immediately subsequent
progress and royalty report the date of first commercial sale of a Licensed
Product in each country.
[ * ]Confidential Treatment Requested
9.
<PAGE>
9.5 After the first commercial sale of a Licensed Product anywhere in the
world, the Licensee shall make quarterly royalty reports to The Regents on or
before each February 28, May 31, August 31, and November 30 of each year. Each
royalty report will cover the Licensee's most recently completed calendar
quarter and will show (a) the gross sales and Net Sales of Licensed Products
sold during the most recently completed calendar quarter; (b) the number of each
type of Licensed Product sold; (c) the royalties, in U.S. dollars, payable with
respect to sales of Licensed Products; (d) the method used to calculate the
royalty; and (e) the exchange rates used.
9.6 If no sales of Licensed Products have been made during any reporting
period, a statement to this effect is required.
10. BOOKS AND RECORDS.
10.1 The Licensee shall keep accurate books and records showing all
Licensed Products manufactured, used, and/or sold under the terms of this
Agreement. Books and records must be preserved for at least five (5) years from
the date of the royalty payment to which they pertain.
10.2 Books and records must be open to inspection by representatives or
agents of The Regents at reasonable times. The Regents shall bear the fees and
expenses of examination but if an error in royalties of more than five percent
(5 %) underpayment of the total royalties due for any year is discovered in any
examination then the Licensee shall bear the fees and expenses of that
examination.
11. LIFE OF THE AGREEMENT.
11.1 Unless otherwise terminated by operation of law or by acts of the
parties in accordance with the terms of this Agreement, this Agreement will be
in force from the Effective
10.
<PAGE>
Date until the last-to-expire patent licensed under this Agreement; or until the
last patent application licensed under this Agreement is abandoned and no patent
in Regents' Patent Rights ever issues.
11.2 Any termination of this Agreement will not affect the rights and
obligations set forth in the following Articles:
Article 10 Books and Records
Article 14 Disposition of Licensed Products on Hand on
Termination
Article 15 Use of Names and Trademarks
Article 20 Indemnification
Article 24 Failure to Perform
Article 28 Secrecy
12. TERMINATION BY THE REGENTS.
12.1 If the Licensee fails to perform or violates any term of this
Agreement, then The Regents may give written notice of default (Notice of
Default) to the Licensee. If the Licensee fails to repair the default within
sixty (60) days of the effective date of Notice of Default, The Regents may
terminate this Agreement and its licenses by a second written notice (Notice of
Termination). If a Notice of Termination is sent to the Licensee, this Agreement
will automatically terminate on the effective date of that notice. Termination
will not relieve the Licensee of its obligation to pay any fees owing at the
time of termination and will not impair any accrued right of The Regents. These
notices are subject to Article 21 (Notices).
13. TERMINATION BY THE REGENTS.
13.1 The Licensee has the right at any time to terminate this Agreement in
whole or as to any portion of Regents' Patent Rights by giving notice in writing
to The Regents. Notice of termination will be subject to Article 21 (Notices)
and termination of this Agreement will be effective sixty (60) days from the
effective date of notice.
11.
<PAGE>
13.2 Any termination under the above paragraph does not relieve the
Licensee of any obligation or liability accrued under this Agreement prior to
termination or rescind any payment made to The Regents or anything done by
Licensee prior to the time termination becomes effective. Termination does not
affect in any manner any rights of The Regents arising under this Agreement
prior to termination.
14. DISPOSITION OF LICENSED PRODUCTS ON HAND UPON TERMINATION.
14.1 Upon termination of this Agreement the Licensee is entitled to dispose
of all previously made or partially made Licensed Products, but no more, within
a period of one hundred and twenty (120) days provided that the sale of those
Licensed Products is subject to the terms of this Agreement, including but not
limited to the rendering of reports and payment of royalties required under this
Agreement.
15. USE OF NAMES AND TRADEMARKS.
15.1 Nothing contained in this Agreement confers any right to use in
advertising, publicity, or other promotional activities any name, trade name,
trademark, or other designation of either party hereto (including contraction,
abbreviation or simulation of any of the foregoing). Unless required by law, the
use by the Licensee of the name "The Regents of the University of California" or
the name of any campus of the University of California is prohibited.
16. LIMITED WARRANTY.
16.1 The Regents warrants to the Licensee that it has the lawful right to
grant this license.
16.2 This license and the associated Invention are provided WITHOUT
WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR ANY OTHER
WARRANTY, EXPRESS OR IMPLIED. THE REGENTS AND RUTGERS MAKE NO
12.
<PAGE>
REPRESENTATION OR WARRANTY THAT THE LICENSED PRODUCTS OR LICENSED METHODS WILL
NOT INFRINGE ANY PATENT OR OTHER PROPRIETARY RIGHT.
16.3 IN NO EVENT MAY THE REGENTS OR RUTGERS BE LIABLE FOR ANY INCIDENTAL,
SPECIAL OR CONSEQUENTIAL DAMAGES RESULTING FROM EXERCISE OF THIS LICENSE OR THE
USE OF THE INVENTION OR LICENSED PRODUCTS.
16.4 This Agreement does not:
16.4.1 express or imply a warranty or representation as to the
validity or scope of any of Regents' Patent Rights;
16.4.2 express or imply a warranty or representation that anything
made, used, sold, offered for sale or imported or otherwise
disposed of under any license granted in this Agreement is
or will be free from infringement of patents of third
parties;
16.4.3 obligate The Regents or Rutgers to' bring or prosecute
actions or suits against third parties for patent
infringement except as provided in Article 19;
16.4.4 confer by implication, estoppel or otherwise any license or
rights under any patents of The Regents other than Regents'
Patent Rights as defined in this Agreement, regardless of
whether those patents are dominant or subordinate to
Regent's Patent Rights: or
16.4.5 obligate The Regents to furnish any know-how not provided in
Regents' Patent Rights.
13.
<PAGE>
17. PATENT PROSECUTION AND MAINTENANCE.
17.1 As long as the Licensee has paid patent costs as provided for in this
Article, The Regents shall diligently endeavor to prosecute and maintain the
United States and foreign patents comprising Regents' Patent Rights using
counsel of its choice, and The Regents shall provide the Licensee with copies of
all relevant documentation so that the Licensee may be informed of the
continuing prosecution and the Licensee agrees to keep this documentation
confidential. The Regent' counsel will take instructions only from The Regents,
and all patents and patent applications under this Agreement will be assigned
solely to The Regents.
17.2 The Regents shall use all reasonable efforts to amend any patent
application to include claims reasonably requested by the Licensee to protect
the products contemplated to be sold under this Agreement.
17.3 The Licensee shall apply for an extension of the term of any patent
included within Regents' Patent Rights if appropriate under the Drug Price
Competition and Patent Term Restoration Act of 1984 and/or European, Japanese
and other foreign counterparts of this Law. The Licensee shall prepare all
documents, and The Regents agrees to execute the documents and to take
additional action as the Licensee reasonably requests in connection therewith.
17.4 If either party receives notice pertaining to infringement or
potential infringement of any issued patent included within Regents' Patent
Rights under the Drug Price Competition and Patent Term Restoration Act of 1984
(and/or foreign counterparts of this Law), that party shall notify the other
party within ten (10) days after receipt of notice of infringement.
17.5 The Licensee shall bear the costs of preparing, filing, prosecuting
and maintaining all United States and foreign patent applications contemplated
by this Agreement. Costs billed by The Regents' counsel will be rebilled to the
Licensee and are due within thirty (30) days of
14.
<PAGE>
rebilling by The Regents. These costs include patent prosecution costs for the
Invention incurred by The Regents prior to the execution of this Agreement and
any patent prosecution costs that may be incurred for patentability opinions,
re-examination, re-issue, interferences, or inventorship determinations. Prior
costs will be due on execution of this Agreement and billing by The Regents and
are at least approximately $7,798.00.
17.6 The Licensee may request The Regents to obtain patent protection on
the Invention in foreign countries if available and if it so desires. The
Licensee shall notify The Regents of its decision to obtain or maintain foreign
patents not less than sixty (60) days prior to the deadline for any payment,
filing, or action to be taken in connection therewith. This notice concerning
foreign filing must be in writing, must identify the countries desired, and must
reaffirm the Licensee's-obligation to underwrite the costs thereof. The absence
of such a notice from the Licensee to The Regents will be considered an election
not to obtain or maintain foreign rights.
17.7 The Licensee's obligation to underwrite and to pay patent prosecution
costs will continue for so long as this Agreement remains in effect, but the
Licensee may terminate its obligations with respect to any given patent
application or patent upon three (3) months written notice to The Regents. The
Regents will use its best efforts to curtail patent costs when a notice of
termination is received from the Licensee. The Regents may prosecute and
maintain such application(s) or patent(s) at its sole discretion and expense,
but the Licensee will have no further right or licenses thereunder. Non-payment
of patent costs may be deemed by The Regents as an election by the Licensee not
to maintain application(s) or patent(s).
17.8 The Regents may file, prosecute or maintain patent applications at its
own expense in any country in which the Licensee has not elected to file,
prosecute, or maintain
15.
<PAGE>
patent applications in accordance with this Article, and those applications and
resultant patents will not be subject to this Agreement.
18. PATENT MARKING.
18.1 The Licensee shall mark all Licensed Products made, used or sold under
the terms of this Agreement, or their containers, in accordance with the
applicable patent marking laws.
19. PATENT INFRINGEMENT.
19.1 If the Licensee or The Regents learns of the substantial infringement
of any patent licensed under this Agreement, that party shall call the other
party's attention thereto in writing and provide them with reasonable evidence
of infringement. Neither party will notify a third party of the infringement of
any of Regents' Patent Rights without first obtaining consent of the other
party, which consent will not be unreasonably denied. Both parties shall use
their best efforts in cooperation with each other to terminate infringement
without litigation.
19.2 The Licensee may request that The Regents take legal action against
the infringement of Regents' Patent Rights. Request must be in writing and must
include reasonable evidence of infringement and damages to the Licensee. If the
infringing activity has not abated within ninety (90) days following the
effective date of request, The Regents then has the right to:
19.2.1 commence suit on its own account; or
19.2.2 refuse to participate in the suit,
and The Regents shall give notice of its election in writing to the Licensee by
the end of the one-hundredth (100th) day after receiving notice of written
request from the Licensee. The Licensee may thereafter bring suit for patent
infringement, at its own expense, if and only if The Regents elects not to
commence suit and if the infringement occurred during the period and in a
jurisdiction where the Licensee had exclusive rights under this Agreement.
Licensee may join
16.
<PAGE>
The Regents' suit unless The Regents determine that there are conflict of
interest or other institutional issues involved in the suit. If, however, the
Licensee elects to bring suit in accordance with this paragraph, The Regents may
thereafter join that suit at its own expense. If Licensee elects to bring suit,
it may defer payment of up to fifty percent (50%) of the earned royalties, due
under this Agreement from Net Sales in the county in which the suit is brought,
to fund the suit. Licensee shall promptly remit payment to The Regents of any
such deferred royalties no later than sixty (60) days after settlement;
dismissal; or other termination of the trial court action.
19.3 Legal action as is decided on will be at the expense of the party
bringing suit and all damages recovered thereby will belong to the party
bringing suit, but legal action brought jointly by The Regents and the Licensee
and fully participated in by both will be at the joint expense of the parties
and all recoveries will be allocated in the following order: (I) to each party
reimbursement in equal amounts of the attorney's costs, fees, and other related
expenses to the extent each party paid for such costs, fees and expenses until
all such costs, fees, and expenses are consumed for each party; and (ii) any
remaining amount will be shared as follows: of any recoveries recovered for
direct damages, twenty-five percent (25%) shall be paid to the Regents and
seventy-five percent (75%) shall be paid to the Licensee; of any recoveries
recovered for enhanced damages, one-half shall be paid to the Regents and
one-half shall be retained by the Licensee.
19.4 Each party shall cooperate with the other in litigation proceedings
instituted hereunder, but at the expense of the party bringing suit except for
suits brought jointly. Litigation
17.
<PAGE>
will be controlled by the party bringing the suit except for suits brought
jointly, except that The Regents may be represented by counsel of its choice in
any suit brought by the Licensee.
20. INDEMNIFICATION.
20.1 The Licensee shall indemnify, hold harmless and defend The Regents and
Rutgers, their respective officers, employees, and agents; the sponsors of the
research that led to the Invention; and the inventors of the patents and patent
applications in Regents' Patent Rights and their employers against any and all
claims, suits, losses, liabilities, damages, costs. fees, and expenses resulting
from or arising out of exercise of this license or any sublicense. This
indemnification includes, but is not limited to, any product liability.
20.2 The Licensee, at its sole cost and expense, shall insure its
activities in connection with the work under this Agreement and obtain, keep in
force and maintain insurance as follows, or an equivalent program of self
insurance:
20.3 Comprehensive or commercial form general liability insurance
(contractual liability included) with limits as follows:
* Each Occurrence $1,000,000
* Products/Completed Operations Aggregate $2,000,000
* Personal and Advertising Injury $1,000,000
* General Aggregate (commercial form only) $3,000,000
Licensee agrees to review whether these limits should be increased in accordance
with the level of sales of Licensed Product; such review to be conducted every,
five (5) years from the effective date of this Agreement in coordination with
The Regents. The coverage and limits referred to under the above do not in any
way limit the liability of the Licensee. The Licensee shall furnish The Regents
with certificates of insurance showing compliance with all requirements.
Certificates must:
18.
<PAGE>
* Provide for thirty (30) days' advance written notice to The
Regents and Rutgers of any modification.
* Indicate that The Regents and Rutgers has been endorsed as
an additional Insured under the coverage referred to under
the above.
* Include a provision that the coverage will be primary. and
will not participate with nor will be excess over any valid
and collectable insurance or program of self-insurance
carried or maintained by The Regents or by Rutgers.
20.4 The Regents shall notify the Licensee in writing of any claim or suit
brought against The Regents or Rutgers in respect of which The Regents or
Rutgers intends to invoke the provisions of this Article. The Licensee shall
keep The Regents and Rutgers informed on a current basis of its defense of any
claims under this Article. There shall be no settlement of a claim for which
indemnification is sought under this Article 20 without the consent of the
indemnifying party, such consent not to be unreasonably withheld.
21. NOTICES.
21.1 Any notice or payment required to be given to either party is properly
given and effective (a) on the date of delivery if delivered in person or (b)
five (5) days after mailing if mailed by first-class certified mail, postage
paid, to the respective addresses given below, or to another address as is
designated by written notice given to the other party.
In the case of the Licensee: SCIENTIFIC LEARNING PRINCIPLES CORPORATION
One Kearney Street, Suite 501
San Francisco, CA 94108
Attention: Controller
In the case of The Regents: THE REGENTS OF THE UNIVERSITY OF CALIFORNIA
Office of Technology Transfer
1320 Harbor Bay Parkway, Suite 150
Alameda, California 94502
Attention: Executive Director
Research Administration and
Technology Transfer
19.
<PAGE>
Referring to: UC Case No. 94-069
22. ASSIGNABILITY.
22.1 The payments under this Agreement may be assigned by The Regents. This
Agreement is personal to the Licensee and assignable by the Licensee only with
the written consent of The Regents, which consent will not be unreasonably
withheld. This Agreement is assignable by the Licensee to the surviving entity
of a merger.
23. NO WAIVER.
23.1 No waiver by either party of any default of this Agreement may be
deemed a waiver of any subsequent or similar default.
24. FAILURE TO PERFORM.
24.1 If either party finds it necessary to undertake legal action against
the other on account of failure of performance due under this Agreement, then
the prevailing party is entitled to reasonable attorney's fees in addition to
costs and necessary disbursements.
25. GOVERNING LAWS.
25.1 THIS AGREEMENT WILL BE INTERPRETED AND CONSTRUED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF CALIFORNIA, but the scope and validity of any patent or
patent application will be governed by the applicable laws of the country of the
patent or patent application.
26. GOVERNMENT APPROVAL OR REGISTRATION.
26.1 Licensee shall notify The Regents if it becomes aware that this
Agreement is subject to any U.S. or foreign government reporting or approval
requirement. Licensee shall make all necessary filings and pay all costs
including fees, penalties, and all other out-of-pocket costs associated with
such reporting or approval process.
20.
<PAGE>
27. EXPORT CONTROL LAWS.
27.1 The Licensee shall observe all applicable United States and foreign
laws with respect to the transfer of Licensed Products and related technical
data to foreign countries, including, without limitation, the International
Traffic in Arms Regulations (ITAR) and the Export Administration Regulations.
28. SECRECY.
28.1 With regard to confidential information ("Data"), which can be oral or
written or both, received from The Regents regarding this Invention, the
Licensee agrees:
28.1.1 not to use the Data except for the sole purpose of
performing under the terms of this Agreement;
28.1.2 to safeguard Data against disclosure to others with the same
degree of care as it exercises with its own data of a
similar nature;
28.1.3 not to disclose Data to others (except to its employees,
agents or consultants who are bound to the Licensee by a
like obligation of confidentiality) without the express
written permission of The Regents, except that the Licensee
is not prevented from using or disclosing any of the Data
that:
28.1.3.1 the Licensee can demonstrate by written records
was previously known to it;
28.1.3.2 is now, or becomes in the future, public knowledge
other than through acts or omissions of the
Licensee; or
28.1.3.3 is lawfully obtained by the Licensee from sources
independent of The Regents; and
21.
<PAGE>
28.1.4 that the secrecy obligations of the Licensee with
respect to Data will continue for a period ending
five (5) years from the termination date of this
Agreement.
29. MISCELLANEOUS.
29.1 The headings of the several sections are inserted for convenience of
reference only and are not intended to be a part of or to affect the meaning or
interpretation of this Agreement.
29.2 This Agreement is not binding on the parties until it has been signed
below on behalf of each party. It is then effective as of the Effective Date.
29.3 No amendment or modification of this Agreement is valid or binding on
the parties unless made in writing and signed on behalf of each party.
29.4 This Agreement embodies the entire understanding of the parties and
supersedes all previous Communications, representations or understandings,
either oral or written, between the parties relating to the subject matter
hereof.
29.5 In case any of the provisions contained in this Agreement is held to
be invalid, illegal, or unenforceable in any respect, that invalidity,
illegality or unenforceability will not affect any other provisions of this
Agreement, and this Agreement will be construed as if the invalid, illegal, or
unenforceable provisions had never been contained in it.
29.6 This Agreement will be governed by the laws of the State of California
and the United States of America.
IN WITNESS WHEREOF, both The Regents and the Licensee have executed this
Agreement, in duplicate originals, by their respective and duly authorized
officers on the day and year written.
22.
<PAGE>
SCIENTIFIC LEARNING PRINCIPLES THE REGENTS OF THE UNIVERSITY OF
CORPORATION: CALIFORNIA:
By:/s/ [signature] By:/s/ [signature]
---------------------------- -----------------------------
(Signature) (Signature)
Name:David E. Charron Name: Director, OTM
-------------------------- University of California,
(Please Print) San Francisco
Title:Vice President Date: September 27, 1996
------------------------- ---------------------------
Date:September 27, 1996
---------------------------
23.
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected Financial
Data" and "Experts" and to the use of our report dated April 9, 1998 in the
Registration Statement (Amendment No. 2 to Form S-1, No. 333-56545) and related
Prospectus of Scientific Learning Corporation for the registration of 2,760,000
shares of its Common Stock.
/S/ ERNST & YOUNG LLP
Walnut Creek, California
July 21, 1998
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<PAGE>
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<INTEREST-EXPENSE> 1 32 8 79
<INCOME-PRETAX> (2,497) (5,058) (2,190) (4,272)
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