<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1999
REGISTRATION NO. 333-77133
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
AMENDMENT NO. 5
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
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
ISOBEL A. JONES KIMBERLEY E. HENNINGSEN
LAURA RANDALL WOODHEAD COLBY R. GARTIN
STEVE R. DAETZ 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 WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL HEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JUNE 22, 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
PROSPECTUS
2,300,000 SHARES
[LOGO]
COMMON STOCK
--------------
This is Scientific Learning Corporation's initial public offering of common
stock and consequently no public market currently exists for the shares.
We expect the public offering price to be between $14.00 and $16.00 per
share. After pricing of the offering, we expect that the common stock will be
quoted on the Nasdaq National Market System under the symbol "SCIL."
INVESTING IN THE COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE 7 OF THIS PROSPECTUS.
-----------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- ---------
<S> <C> <C>
Public Offering Price................................................ $ $
Underwriting Discount................................................ $ $
Proceeds, before expenses, to Scientific Learning Corporation........ $ $
</TABLE>
The underwriters may also purchase up to an additional 345,000 shares, at
the public offering price, less the underwriting discount, within 30 days from
the date of this prospectus to cover over-allotments.
Neither the Securities and Exchange Commission nor any other state
securities commission has approved or disapproved of these securities or
determined if this prospectus is truthful or complete. Any representation to the
contrary is a criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about , 1999.
-------------------
MERRILL LYNCH & CO.
THOMAS WEISEL PARTNERS LLC
PACIFIC GROWTH EQUITIES, INC.
-------------------
The date of this prospectus is , 1999.
<PAGE>
[Scientific Learning
A Neuroscience Company]
<TABLE>
<S> <C>
[Fast ForWord Logo with the following [Fast ForWord Two Logo with the following
caption: "Intensive computer-based caption: "Computer-based training program
training program that builds that continues to build language and
the oral language skills critical for reading skills."]
learning to read or becoming a
better reader."]
[Away We Go Logo with the following [Away We Go Bookshelf Logo with the
caption: "Research-based software games following caption: "Proprietary stories
that build key language and cognitive in books, CD-ROM and CD formats for
skills needed in pre-K to grade 2."] children ages 4 to 7 to supplement Away
We Go! software games."]
[BrainConnection.com Logo with the [Professional Development Logo with
following caption: "Internet site that the following caption: "Professional
provides information on how the development training for educators and
brain functions and on learning products other professionals on learning,
and services."] language and reading and brain
research."]
</TABLE>
[ScientificLearning.com Logo with the
following caption: "Internet site that
provides information about Scientific Learning and
its products and services and facilitates the
performance monitoring of Fast ForWord participants."]
<PAGE>
[Inside Gatefold]
[Picture of boy reading with the following caption: "Fast ForWord programs for
language and reading."]
[Picture of man and woman with a young child who is pointing to a book that the
woman is holding with the following caption appearing as an overlay to a portion
of the picture: "Away We Go! software and books."]
[Picture of three children and a woman standing next to a globe with the
following captions appearing as an overlay to a portion of the picture:
"BrainConnection.com," "ScientificLearning.com" and "Professional Development."]
[Picture of children in a classroom with their hands raised to ask questions.]
[Picture of a girl in front of a computer.] [Scientific Learning]
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY MAY NOT CONTAIN ALL THE INFORMATION THAT MAY BE IMPORTANT TO
YOU. YOU SHOULD READ THE ENTIRE PROSPECTUS, INCLUDING THE FINANCIAL DATA AND
RELATED NOTES, BEFORE MAKING AN INVESTMENT DECISION. UPON COMPLETION OF THIS
OFFERING, THE ONLY CLASS OF OUR CAPITAL STOCK OUTSTANDING WILL BE OUR COMMON
STOCK. EXCEPT WHERE OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS (A)
ASSUMES A TWO-FOR-THREE REVERSE STOCK SPLIT OF OUR COMMON STOCK AND PREFERRED
STOCK TO BE EFFECTED PRIOR TO THIS OFFERING, (B) ASSUMES THE AUTOMATIC
CONVERSION OF OUR OUTSTANDING PREFERRED STOCK INTO COMMON STOCK ON A ONE-FOR-ONE
BASIS UPON CLOSING OF THIS OFFERING AND (C) ASSUMES THE UNDERWRITERS' OPTION TO
PURCHASE ADDITIONAL SHARES IN THIS OFFERING WILL NOT BE EXERCISED. SEE
"DESCRIPTION OF CAPITAL STOCK" AND "UNDERWRITING."
INVESTMENT RISKS
An investment in this offering involves risk. The market for
neuroscience-based products is new and emerging. Our company has a limited
operating history and a history of operating losses. Our losses were $10.7
million for the year ended December 31, 1998 and were $3.5 million for the
quarter ended March 31, 1999. At March 31, 1999, we had an accumulated deficit
since inception of approximately $21.8 million. We expect to incur additional
significant losses. Please see "Risk Factors" for a further discussion of
investment risks.
OUR COMPANY
We develop, market and sell proprietary, neuroscience-based software and
other educational products and services, designed to increase human learning and
performance. Language and reading skills are the foundation for all learning,
and we have developed products to help children learn how to read or become
better readers. Our Fast ForWord products are intensive, computer-based training
programs that focus on improving critical language and reading skills. Our
current products, Fast ForWord and Fast ForWord Two, focus primarily on the
learning needs of children aged four to 13. We have developed these products
based on scientific research and have field tested them using scientific
methods. In research studies conducted by our founders in 1994 and 1995 as well
as in field studies organized by us in 1996, 90% of participants identified as
having language or reading difficulties showed gains in language comprehension
skills that were statistically significant, meaning the results were not likely
to have occurred due to random chance. On average, these children achieved one
to two years of improvement in language and reading skills after completion of
Fast ForWord programs in four to eight weeks. Based upon more than 25 years of
research by our founders on the brain's ability to adapt to stimuli, our Fast
ForWord family of products uses computer-controlled, repetitive training
exercises that automatically adapt to each user's performance to modify the
manner in which the brain processes language. We have an exclusive license from
The Regents of the University of California to technology underlying most of our
products. Our failure to maintain that license would cause material harm to our
business. Our research and results have been published in prestigious,
peer-reviewed scientific journals, including SCIENCE and NATURE.
We also offer professional development seminars in which educators, speech
and language professionals and other professionals can learn about recent
developments in brain research and the practical application of our programs, as
well as earn continuing education credit. In addition, our software products
have secure links to our web site, ScientificLearning.com, which enable parents,
educators and other professionals to upload performance data from our Fast
ForWord products and track progress daily to maximize the benefit of our
products and services. We recently launched BrainConnection.com to provide
Internet users with recent developments in brain research and the opportunity to
purchase learning products. We believe that BrainConnection.com will
significantly expand our Internet presence, interactions with consumers and
e-commerce activities.
3
<PAGE>
We intend to continue expanding our product offerings through new products
and services, as well as extensions of our current product lines. We have an
additional five language-learning products which are in the process of being
launched during June 1999 as components of our Away We Go! family of products.
In addition, we have five new Fast ForWord products and a screening/assessment
product targeted for launch in the year 2000. These new Fast ForWord products
are based on the same underlying research on how the brain works as our existing
Fast ForWord products and are being targeted to new markets, including children
in grades pre-K through 2, adolescents, adults and non-native English speakers.
Our products are delivered through a variety of distribution channels,
including sales to public schools, speech and language professionals in private
practice and direct-to-consumer channels, such as the Internet. Our existing
Fast ForWord programs are designed to integrate with school curricula and
support educators, parents and speech and language and other professionals to
help children improve their language and reading skills. As of June 30, 1999, we
have sold more than 17,000 copies of Fast ForWord and Fast ForWord Two and have
trained more than 4,400 individuals in administering our programs. We have sold
our programs in more than 400 school districts, including districts in Chicago,
Orlando, Las Vegas, New Orleans, Houston, Detroit and Los Angeles. The majority
of our public school sales have occurred since we formed a dedicated sales force
in the fall of 1998. To date, substantially all of our revenues have come from
the sale of Fast ForWord programs and related seminars and services, which we
expect to continue to be the case for the foreseeable future.
OUR MARKET
While we believe our products and services can benefit children and adults
of virtually all ages and capabilities, we are currently concentrating on
schools with students in kindergarten through high school, or K-12, in the
United States in order to reach the largest number of children who are learning
to read or need to become better readers. Based on data from the U.S. Department
of Education, we estimate that more than 52.7 million students attend over
110,000 K-12 public and private schools in the United States in the 1998-99
school year. Our initial focus is children between the ages of four and 13.
Based on Bureau of the Census data, there are approximately 40 million children
in this age group. According to the National Institute of Child Health and Human
Development, as much as 40% of the population, or 16,000,000 of these children,
have reading problems. With ten grade levels represented by children between the
ages of four and 13, we estimate that one-tenth of this group, or 1,600,000
children, enter this category each year.
Consistent with our strategy to reach the broadest market, we are developing
and plan to introduce products for improving the reading and language
comprehension skills of adolescents and adults, including those who are
functionally illiterate, have limited English proficiency or suffer from
language loss due to stroke. According to the National Adult Literacy Study
conducted in 1992, more than 40 million adults in the United States are
functionally illiterate. In October 1996, the National Center on Adult Literacy
estimated that among functionally illiterate adults there were 12 to 14 million
non-native English speaking adults living in the United States with limited
proficiency in the English language. According to 1998 National Stroke
Association data, nearly four million people in the United States were living
with the after effects of a stroke.
OUR STRATEGY
Our goal is to establish Scientific Learning as the leading provider of
proprietary software and other education and training products and services
based on neuroscience, the study of how the brain functions. Key elements of our
growth strategy include:
- INTRODUCE ADDITIONAL NEUROSCIENCE-BASED SOFTWARE PRODUCTS AND SERVICES. We
believe our expertise in neuroscience, language learning and technology
will be instrumental to the successful introduction of new education and
training products and services.
4
<PAGE>
- RAPIDLY EXPAND OUR SALES AND MARKETING EFFORTS. We intend to continue to
hire sales people, implement additional direct-to-consumer e-commerce
capabilities and explore and develop other channels of distribution,
including potential strategic alliances with for-profit educational
companies, day care providers and private schools.
- IMPLEMENT EXPANDED INTERNET STRATEGY. Our web site,
ScientificLearning.com, is a resource for people using, or seeking
information about, our products or interested in how language and reading
are learned. We recently launched BrainConnection.com as a resource on
brain research in order to significantly expand our web presence and
e-commerce capabilities.
- BUILD A TRUSTED BRAND. We intend to further build recognition of our
company and product brands among parents and education professionals and
to use that recognition to successfully commercialize other
neuroscience-based products.
THE OFFERING
<TABLE>
<S> <C>
Common stock offered:.................... 2,300,000 shares
Shares outstanding after this
offering:................................ 10,341,573 shares (1)
Use of Proceeds.......................... Sales and marketing, research and product
development and other general corporate
purposes. See "How We Intend to Use the
Proceeds from this Offering."
Risk Factors............................. See "Risk Factors" for a discussion of
factors you should carefully consider
before deciding to invest in the shares
of the common stock.
Proposed Nasdaq National Market symbol... SCIL
</TABLE>
- ------------------------
(1) Based on the number of shares outstanding as of March 31, 1999. Excludes:
- 1,400,306 shares of common stock issuable upon exercise of options and
warrants outstanding as of March 31, 1999 with a weighted average
exercise price of $2.57 per share;
- 763,590 shares of additional common stock reserved for issuance under
our 1999 Equity Incentive Plan;
- 75,000 shares of common stock reserved for issuance under our 1999
Non-Employee Directors' Stock Option Plan; and
- 350,000 shares of common stock reserved for issuance under our 1999
Employee Stock Purchase Plan. See "Management--Employee Benefit Plans,"
"Transactions and Relationships with Related Parties" and "Description
of Capital Stock."
Prior to this offering, there has not been any public market for our common
stock. We cannot assure you that a trading market for our common stock will
develop, nor can we assure you how liquid that market might be. You may not be
able to re-sell your shares at or above the initial public offering price.
CORPORATE INFORMATION
We are a Delaware corporation. We incorporated in 1995 in California under
the name Scientific Learning Principles Corporation and reincorporated in 1997
in Delaware under our present name. Our principal executive office is located at
1995 University Avenue, Suite 400, Berkeley, California 94704 and our telephone
number is (510) 665-9700. We maintain World Wide Web sites at
www.ScientificLearning.com and www.BrainConnection.com. The reference to our
World Wide Web sites does not constitute incorporation by reference of the
information contained at the sites. In this prospectus, the "Company,"
"Scientific Learning," "we," "us" and "our" refer to Scientific Learning
5
<PAGE>
Corporation but not to the underwriters listed in this prospectus. In addition,
"common stock" refers to our common stock, $0.001 par value per share. See
"Description of Capital Stock."
Fast ForWord-Registered Trademark-, Fast ForWord Two-TM-, Language Takes Us
Everywhere-TM-, A Bridge to Reading-TM-, Away We Go!-TM-, Away We Go!
Bookshelf-TM-, ScientificLearning.com-TM-, BrainConnection.com-TM-, the Fast
ForWord logo and the names of products and services we offer are trademarks,
registered trademarks, service marks or registered service marks of Scientific
Learning. This prospectus also includes product names, trade names and
trademarks of other companies that are their property.
SUMMARY FINANCIAL DATA
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................. $ -- $ 2,962 $ 5,166 $ 647 $ 1,340
Gross profit................................... -- 2,013 3,768 486 1,007
Operating loss................................. (2,611) (5,135) (9,918) (1,768) (3,625)
Net loss....................................... (2,497) (5,058) (10,748) (1,748) (3,537)
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------------
AS ADJUSTED
ACTUAL (1)
--------- -------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................ $ 7,249 $ 38,434
Working capital (deficit)............................ 5,003 36,188
Total assets......................................... 10,421 41,606
Long-term debt, including current portion............ 319 319
Redeemable convertible preferred stock............... 23,836 --
Stockholders' equity (deficit) (2)................... (17,393) 37,628
</TABLE>
- ------------------------
(1) As adjusted to reflect our sale of 2,300,000 shares of common stock at an
assumed initial public offering price of $15.00 per share after deducting
the underwriting discount and estimated offering expenses and the
application of the estimated net proceeds from this sale and the conversion
of outstanding preferred stock into 5,232,146 shares of common stock upon
completion of this offering. See "How We Intend to Use the Proceeds from
this Offering" and "Capitalization."
(2) We have paid no cash dividends since our inception.
6
<PAGE>
RISK FACTORS
INVESTING IN OUR COMMON STOCK WILL PROVIDE YOU WITH AN EQUITY OWNERSHIP
INTEREST IN SCIENTIFIC LEARNING CORPORATION. AS A STOCKHOLDER, YOUR INVESTMENT
MAY BE SUBJECT TO RISKS INHERENT IN OUR BUSINESS. THE PERFORMANCE OF YOUR SHARES
WILL REFLECT THE PERFORMANCE OF OUR BUSINESS RELATIVE TO, AMONG OTHER THINGS,
OUR COMPETITION, GENERAL ECONOMIC AND MARKET CONDITIONS AND INDUSTRY CONDITIONS.
THE VALUE OF YOUR INVESTMENT MAY INCREASE OR DECLINE AND COULD RESULT IN A LOSS.
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS AS WELL AS OTHER INFORMATION
CONTAINED IN THIS PROSPECTUS BEFORE DECIDING TO INVEST IN SHARES OF THE COMMON
STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL
CONDITION OR RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED.
IN SUCH CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY
LOSE ALL OR PART OF YOUR INVESTMENT.
WE RELY PRIMARILY ON A SINGLE FAMILY OF PRODUCTS AND ANY FAILURE TO INCREASE OUR
SALES OF THE FAST FORWORD FAMILY OF PRODUCTS COULD CAUSE OUR BUSINESS TO SUFFER
Since our formation, sales of our Fast ForWord family of products have
accounted for more than 80% of our revenues. The remaining revenues are
primarily from seminars regarding how the brain works and use of Fast ForWord.
We anticipate that most of our revenues will be related to our Fast ForWord
family of products for the foreseeable future. Our business will suffer if we
are unable to increase our sales of the Fast ForWord family of products.
WE ONLY HAVE A LIMITED HISTORY UPON WHICH YOU CAN GAUGE THE SUCCESS OF THE FAST
FORWORD FAMILY OF PRODUCTS
We only recently expanded our Fast ForWord family of products beyond Fast
ForWord, through the introduction of Fast ForWord Two. Consequently, we only
have a limited history upon which you can gauge the success of the Fast ForWord
family of products. We also have not yet introduced other product line
extensions planned for Fast ForWord. We cannot assure you that our Fast ForWord
family of products will receive the same or greater level of commercial
acceptance as Fast ForWord.
OUR BUSINESS DEPENDS ON WHETHER WE CAN ACHIEVE AND MAINTAIN MARKET ACCEPTANCE
AND INCREASE THE NUMBER OF PROGRAMS WE COMMERCIALLY INTRODUCE AND SELL
Our future success depends on acceptance of the Fast ForWord family of
products and our other products by public schools, administrators, educators,
parents and speech and language and other professionals. Sales of our products
depend on many factors, including:
- our ability to incorporate our products into traditional school programs;
- the willingness of educators and speech and language and other
professionals to adopt new teaching and training methods;
- the cost of our programs compared to other available programs;
- the availability of government funding;
- competitive developments;
- our ability to continue to demonstrate the efficacy and acceptance of our
products;
- our ability to adapt to evolving technology and standards; and
- the public's ability and willingness to use the Internet.
Our business will suffer if we do not achieve and maintain market acceptance
for our existing products or if we fail to increase the number of programs we
commercially introduce and sell.
7
<PAGE>
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO INTRODUCE NEW PRODUCTS AS SCHEDULED
OR IF NEW PRODUCTS ARE UNSUCCESSFUL
Our future success will significantly depend on whether we are able to
enhance our existing products and develop new products based on our proprietary
technology. While we have five language-learning products scheduled for
commercial launch in the second quarter of 1999 and six more targeted for
commercial launch in the year 2000, we cannot assure you that we will be
successful in developing and marketing these or any other new products or that
we will be able to introduce new products as scheduled. We may not have
sufficient resources to make the investments to develop and market the products
necessary to maintain our competitive position. Our business will suffer if we
are unable to introduce new products as scheduled, or if new products are
unsuccessful.
ANY DIFFICULTY IN PENETRATING NECESSARY MARKETS COULD ADVERSELY AFFECT OUR
BUSINESS
Our target markets include public schools, speech and language professionals
in private practice and direct sales to parents. Any difficulty in penetrating
these markets could adversely affect our business. We began selling Fast ForWord
to public schools in April 1997 and initiated our public schools sales force in
the fall of 1998. We believe that our success in the public school market will
depend largely on the following factors:
- our ability to continue to hire and retain experienced sales personnel;
- convincing educators and other key public school decision-makers to use
our products even though the learning methods required by our products
differ from the way schools have traditionally addressed language and
learning problems; and
- convincing schools and teachers to incorporate our intensive training
programs into their curriculum since our products are generally designed
to be used for 90 to 100 minutes per day, five days per week.
Our ability to penetrate the market of speech and language professionals in
private practice may not occur as quickly or as broadly as we would like, for
the following reasons:
- our programs require use of computers and other technology; and
- we may be unable to convince speech and language professionals that our
programs are a tool that can be used in their practice and will enable
them to supervise multiple clients at a time.
We also have had limited experience selling our products directly to parents
and may have difficulty doing so for the following reasons:
- we may be unable to develop a remote or at-home course delivered by video,
CD Rom and/or the Internet to train parents in supervising and
administering our products; and
- our ability to sell programs to parents and other private customers
depends upon word-of-mouth referrals which could take considerable time to
develop.
OUR QUARTERLY OPERATING RESULTS ARE SUSCEPTIBLE TO FLUCTUATIONS WHICH COULD
CAUSE OUR STOCK PRICE TO DECLINE
Since our formation, our quarterly operating results have fluctuated
significantly. For example, our operating revenues for each fiscal quarter
commencing March 31, 1997 and ending March 31, 1999, in sequence, have been
approximately $154,000, $536,000, $1,398,000, $874,000, $647,000, $1,153,000,
$2,365,000, $1,001,000 and $1,340,000. We expect these fluctuations to continue
for a number of reasons, including factors described elsewhere in this "Risk
Factors" section of the prospectus. One
8
<PAGE>
reason we expect quarterly operating results to fluctuate is the long sales
cycle for our products, which is the result of many factors, including the
following:
- the nature of our products requires us to provide a significant level of
education to prospective educators, parents and speech and language and
other professionals regarding the use and benefits of our programs and
services;
- prospective purchasers need to consider that our programs involve a
significant commitment of time and resources;
- sales to schools are subject to budgeting constraints, which may require
schools to find available discretionary funds, obtain grants or wait until
subsequent budget cycles; and
- school-wide or district-wide sales can require multiple levels of
approval.
As a result, our sales cycle generally takes several months and in some cases
can take a year or longer.
An additional reason we expect our quarterly operating results to fluctuate
is that demand for our programs and services is subject to seasonal influences.
We believe that demand for our programs from speech and language professionals
in private practice will be lower during the school year than in the summer,
because the intensive nature of Fast ForWord is more conducive to training
during school vacation. We also believe we will experience seasonality in the
public school market due to public school calendars and budget cycles. We do not
have sufficient operating experience to predict the overall effect of various
seasonal factors and their effect on future quarterly operating results.
Any significant shortfall of revenues in relation to our expectations could
cause significant fluctuations in quarterly operating results, and our stock
price could suffer. Prediction of future revenues and expenses is difficult
because of our limited operating history and the emerging nature of our market.
Our expense levels are based on our expectations of future revenues and are
primarily fixed in the short term. We cannot guarantee that we will be able to
predict our future revenues accurately or that we will be able to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall.
WE HAVE GENERATED LIMITED REVENUES TO DATE AND HAVE A HISTORY OF OPERATING
LOSSES
We started operations in February 1996 and began generating revenues in the
first quarter of 1997. Because we have generated limited revenues to date, we
have incurred significant operating losses and negative cash flow since
inception. Our net operating losses were approximately $2.5 million for the year
ended December 31, 1996, $5.1 million for the year ended December 31, 1997,
$10.7 million for the year ended December 31, 1998 and $3.5 million for the
quarter ended March 31, 1999. Our cash flows used in operating activities were
approximately $1.7 million for the year ended December 31, 1996, $4.0 million
for the year ended December 31, 1997, $6.8 million for the year ended December
31, 1998 and $3.7 million for the quarter ended March 31, 1999. We have an
accumulated deficit of approximately $21.8 million from inception through March
31, 1999.
WE EXPECT TO INCUR ADDITIONAL LOSSES FOR AT LEAST THE NEXT 18 MONTHS
We expect to incur additional losses for at least the next 18 months,
because of substantial increases in sales and marketing and research and
development expenses. We cannot assure you that our cash resources after this
offering will be sufficient to fund our negative cash flow and expected capital
expenditures for this period.
9
<PAGE>
WE CANNOT GUARANTEE THAT WE WILL EVER GENERATE SUFFICIENT REVENUES TO ACHIEVE OR
SUSTAIN PROFITABILITY
We cannot guarantee that we will ever generate sufficient revenues to
achieve or sustain profitability or generate positive cash flow. As a result, we
may need to obtain additional equity or debt financing in the future, which may
not be available on acceptable terms, if at all.
OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR CURRENT
BUSINESS AND PROSPECTS
It is difficult for us to evaluate our current business and prospects
because we have a limited operating history of approximately three years and
limited experience penetrating necessary markets and selling our products.
Companies with limited operating histories, including ours, encounter high risks
and uncertainties, particularly in new and rapidly evolving markets such as
technology-based educational products and services. These risks include, but are
not limited to, (1) uncertain demand for technology-based learning products and
our products and services in particular; (2) attracting and retaining key
personnel and managing growth; (3) failure to select an appropriate growth
strategy; (4) institutions or other barriers that hinder our ability to
penetrate our target markets; and (5) competition. To address these risks, we
must, among other things:
- successfully gain market acceptance for our Fast ForWord family of
products, particularly in the public school market;
- successfully introduce and gain market acceptance for related new products
and services;
- respond to competitive developments and execute our growth strategy;
- attract, integrate, retain and motivate qualified personnel, particularly
sales and marketing professionals; and
- address new or evolving technologies and standards.
We cannot assure you that we will be successful in addressing the risks we
face and our failure to address those risks will materially and adversely affect
our business and financial condition.
OUR BUSINESS WILL SUFFER IF CUSTOMERS DELAY OR FOREGO PURCHASES OF OUR PRODUCTS
BECAUSE OF OUR PRODUCT ENHANCEMENTS OR NEW PRODUCTS OR BECAUSE OF COMPETITORS'
SUPERIOR PRODUCTS
The demand for our existing products may be reduced or eliminated by our own
enhancements or new products and any resulting loss of revenues from our
existing products may not be adequately offset by the revenues generated from
our enhancements or new products. Customers may also delay their purchases of
our products in anticipation of the release of our product enhancements or new
products. Finally, products introduced by our competitors may be superior to the
products we offer and reduce the demand for our products. Our business will
suffer if customers delay or forego purchases of our products because of our own
enhancements or new products or because of our competitors' products.
OUR REVENUES DEPEND ON GOVERNMENT FUNDING AVAILABLE TO PUBLIC SCHOOLS AND ANY
SUBSTANTIAL DELAYS OR REDUCTIONS IN GOVERNMENT BUDGETS OR FUNDING FOR
EDUCATIONAL SOFTWARE OR TECHNOLOGY WOULD HARM OUR BUSINESS
To date, we have generated limited revenues from sales to public schools.
However, our future revenues will depend, in part, on our ability to increase
revenues from public schools. This, in turn, depends largely on federal, state
and local government funding. Federal funding for educational technology is
available primarily through legislation, including Title I of the Elementary and
Secondary Education Act of 1965, the Individuals with Disabilities Education
Act, Goals 2000, Technology Literacy Challenge Grants and the education rate
discount authorized by the Telecommunications Act of 1996. Many states have
enacted similar legislation. Substantial delays or reductions in government
budgets or
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<PAGE>
funding for educational software or technology would have a material adverse
effect on our business and financial condition.
WE ARE GROWING RAPIDLY AND MAY BE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH
We have recently experienced a period of significant expansion. We have
grown from five employees at April 1, 1996 to 139 full-time and 24 part-time
employees at March 31, 1999. Our historical growth has placed, and any further
growth will place, a significant strain on our managerial, operational,
financial and other resources. Our future success will depend, in part, upon
whether our senior management can manage growth effectively. This will require
us to implement additional management information systems and to develop
additional operating, administrative, financial and accounting systems and
controls. We will also have to maintain close coordination among our accounting,
finance, marketing, sales, customer support and professional service
organizations. If we are unsuccessful in managing growth, our business and
financial condition will be materially and adversely affected.
WE RELY ON OUR INTELLECTUAL PROPERTY RIGHTS AND MAY BE UNABLE TO PROTECT THESE
RIGHTS
Our ability to compete effectively will depend in part on whether we are
able to develop and maintain the proprietary aspects of our technology and to
operate without infringing on the proprietary rights of others. We rely on a
combination of patents, trademarks, copyrights, trade secret laws,
confidentiality procedures and contractual provisions to protect our proprietary
rights in our products and technology. We have filed patent applications in the
United States and internationally relating to our technology, including, as of
March 31, 1999, 38 applications with the U. S. Patent and Trademark Office, or
USPTO. Of these 38 patent applications, 33 are exclusively owned by us, four are
jointly owned by us and The Regents of the University of California and one is
jointly owned by us and an individual inventor. We cannot assure you that
additional pending patent applications will result in the issuance of any
patents or that any issued patents will offer protection against competitors
with similar technology. In addition, any patents issued to us or our licensors
could be challenged, invalidated or circumvented in the future.
As a patent holder, it is possible we may become subject to patent
infringement claims and litigation or interference proceedings conducted in the
USPTO to determine the priority of inventions. 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 patents issued to us, to protect
trade secrets or know-how that we own or to determine the enforceability, scope
and validity of the proprietary rights of others. Any litigation or interference
proceedings will result in substantial expense and significant diversion of
effort by our technical and management personnel. An adverse determination in
litigation or interference proceedings to which we may become a party could
subject us to significant liabilities to third parties or require us to seek
licenses from third parties which may not be available on commercially
reasonable terms or at all.
FAILURE TO MAINTAIN OUR EXCLUSIVE LICENSE WOULD MATERIALLY HARM OUR BUSINESS BY
DELAYING OR PREVENTING NEW PRODUCT INTRODUCTIONS AND NECESSITATING PRODUCT
RECALLS.
We hold the exclusive license to develop commercial products based on
technology owned by The Regents of the University of California ("The Regents"),
and by Rutgers, the State University of New Jersey ("Rutgers"), which technology
is the subject of a patent issued in September 1998, covering the basic speech
and sound modification algorithms used in most of our programs. We obtained this
license under a license agreement with The Regents.
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<PAGE>
Our primary products, Fast ForWord and Fast ForWord Two, incorporate this
licensed technology. In addition, the professional version of our recently
launched Away We Go! Bookshelf CD ROM and CD Storybooks incorporates this
licensed technology. To date, more than 80% of our revenues have come from
selling programs using the licensed technology. While our seminars and other
services and some of our new Away We Go! Products do not make use of this
licensed technology, virtually all of our revenues from programs and services
relate to the base products which do use the licensed technology and its loss
would likely cause material harm to our business.
In fiscal 1998, we had approximately $356,000 in royalty expense under the
license, on program revenues subject to royalties of approximately $4.5 million.
In the first quarter of 1999, we had approximately $64,000 in royalty expense,
on program revenues of approximately $1.1 million, of which approximately
$800,000 was subject to royalties under the license. In 1999 and each year
thereafter during the term of the license, the minimum royalty expense necessary
to maintain the license will be $150,000. We expect royalties as a percentage of
program revenues to decline over time as additional programs are sold and, as a
consequence, the royalty rate under the license steps down. It may also decline
to the extent that our product mix becomes less reliant on licensed technology,
although we cannot predict our future product mix.
If we lose or are unable to maintain the license agreement during the term
of the underlying patents, it would materially harm our business. It could delay
or prevent the introduction of new products and would likely require the recall
of most of our products from the market. Even if we could identify and license
or develop non-infringing equivalent technology, which is far from certain, the
cost and delays from such a changeover in our base technology would likely cause
material harm to our business.
The Regents may terminate the license agreement if we fail to perform or
violate its terms without curing the violation within 60 days of receiving
written notice of the violation. For example, The Regents could terminate the
agreement if we fail to perform any of the following obligations:
- make royalty and milestone payments;
- provide periodic progress reports;
- bear the costs to prepare, file and prosecute U.S. and foreign patent
applications;
- provide indemnification;
- insure our activities in connection with work under the agreement; and
- maintain the confidentiality of information received from The Regents
relating to the agreement.
WE COULD LOSE REVENUES AS A RESULT OF SOFTWARE ERRORS OR DEFECTS
Software programs frequently contain errors or defects, especially when
first introduced or when new versions are released. We could, in the future,
lose revenues as a result of software errors or defects. We cannot assure you
that errors will not be found in new products or releases, even though products
are tested prior to release. Any errors could result in loss of revenue or delay
in market introduction or acceptance, diversion of development resources, damage
to our reputation or increased service and warranty costs.
OUR REFUND POLICY COULD ADVERSELY AFFECT OUR REVENUES AND FINANCIAL CONDITION
We have adopted a refund policy under which we provide a refund if a child's
performance on Fast ForWord products indicates, based on criteria we set forth
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. Also, we allow refunds and cancellations from time
to time due to special circumstances such as inability to complete training due
to illness. We cannot guarantee
12
<PAGE>
that these policies will not have a material adverse effect in the future on our
business and financial condition.
WE COULD BE SUBJECT TO PRODUCT AND PROFESSIONAL LIABILITY CLAIMS FROM THE SALE
OF OUR PRODUCTS AND SERVICES
Because we market products to the public we face an inherent business risk
of financial exposure to product liability claims. In addition, to the extent we
provide professional or similar services, we may also face a risk of exposure to
professional liability claims. We currently carry product and professional
liability insurance that, in general, covers product and professional liability
claims up to the policy limits. We cannot assure you that we will continue to
have access to this insurance at a reasonable cost, if at all, or that the
insurance will be adequate to satisfy any liability or litigation expenses. Any
claim or claims against us, regardless of their merit or eventual outcome, could
materially and adversely affect our business.
THERE IS ACADEMIC DEBATE REGARDING THE SCIENTIFIC BASIS UNDERLYING OUR PRODUCTS
WHICH COULD SIGNIFICANTLY AFFECT THE MARKET FOR OUR PROGRAMS AND SERVICES
Our Fast ForWord family of products is based on particular theories of
neuroscience, the study of how the brain functions, and theories of language
acquisition. Our founders are actively involved in academic debate about their
own and opposing scientific theories of neuroscience and language acquisition.
As a result, the theories on which the Fast ForWord family of products are based
have been, and are likely to be, subject to public debate and challenges.
Although we believe that the Fast ForWord family of products is based primarily
upon non-controversial scientific theories, some of the principles and
methodologies underlying and associated with our products are opposed by some
academicians and educators, any of whom could influence the market for our
products and services. Consequently, academic publications and debate
challenging the theories of neuroscience and language acquisition propounded by
the founders and others could adversely affect the market for our products and
services.
OUR BUSINESS WILL SUFFER IF INTERNET USE FAILS TO DEVELOP WITHIN SCHOOLS AND
AMONG SPEECH AND LANGUAGE PROFESSIONALS IN PRIVATE PRACTICE
One of the key features of the Fast ForWord family of products is its daily
uploading and downloading of information to and from our proprietary database
via the Internet. If the use of the Internet, particularly within schools and
among speech and language professionals in private practice, fails to develop or
develops more slowly than expected, our business will suffer.
ANY DELAYS OR MALFUNCTIONS OF THE INTERNET ON WHICH WE RELY FOR THE EFFECTIVE
FUNCTIONING OF OUR PRODUCTS AND THE GENERATION OF OUR REVENUE STREAMS COULD
ADVERSELY AFFECT OUR BUSINESS
We depend on technology, particularly on the Internet, for the effective
functioning of our products. One of the key features of the Fast ForWord family
of products is its daily uploading and downloading of information to and from
our proprietary database via the Internet. Additionally, the revenues we expect
to generate from electronic commerce depend on the availability of the Internet.
If commercially available browsers fail to provide access to the Internet due to
unexpected user demand or other delays or malfunctions, access to our
ScientificLearning.com and BrainConnection.com web sites, or other web sites we
develop or launch, could be harmed. Internet performance or reliability
problems, including those resulting from the "Year 2000 Problem," could
adversely affect our business.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE EDUCATIONAL TECHNOLOGY MARKET
The educational technology market in which we operate is very competitive.
We compete primarily with providers of traditional methods of remediation for
language and reading problems, which typically require several years of
one-on-one training for children with identified language and reading problems.
13
<PAGE>
In addition, we compete to some extent with other companies offering educational
software products and reading and language skill building programs to schools
and to speech and language professionals in private practice. Existing
competitors may continue to broaden their product lines, and potential
competitors, including large software developers and educational publishers, may
enter or increase their focus on the school market. Moreover, we expect that we
will face additional competition from new entrants into the market. Many
competitors have substantially greater technical, marketing and distribution
resources than we do. We cannot assure you that we will continue to be able to
compete effectively in the educational technology market.
IF WE FAIL TO RETAIN OUR KEY PERSONNEL OR ATTRACT AND RETAIN KEY EMPLOYEES, OUR
BUSINESS WILL SUFFER
Our success depends to a significant extent upon the continued active
participation of key members of our management, including Sheryle J. Bolton, our
Chief Executive Officer, and Frank M. Mattson, our Chief Financial Officer, as
well as others identified in the Management section of this prospectus. While we
do not believe that any of our employees are irreplaceable, we recognize that we
are in an extremely competitive market for executives and the loss of one or
more of these persons could have a material adverse effect on our business,
financial condition and results of operations. We believe that our future
success will depend upon our ability to continue to attract, motivate and retain
highly skilled managerial, sales and marketing and product development
personnel. Competition for such personnel is intense. Our failure in attracting
or retaining the necessary personnel could materially and adversely affect our
business.
WE FACE A NUMBER OF RISKS ASSOCIATED WITH TRYING TO BECOME YEAR 2000 COMPLIANT
Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because these computer programs would not properly recognize a year that begins
with "20" instead of "19." This, in turn, could result in major system failures
or miscalculations that could disrupt our business. Although we believe that our
products and internal systems are compliant, we utilize third-party equipment
and software that may not be compliant. If any third-party equipment or software
is not Year 2000 compliant, we may have to incur unanticipated expenses to
remedy any problems. Year 2000 compliance issues could also affect the
purchasing patterns of existing or potential customers as educational
institutions expend significant resources to correct their current systems for
compliance. These expenditures may result in reduced funds available to purchase
our products and services.
WE ARE SUBJECT TO GOVERNMENT REGULATIONS THAT COULD IMPOSE ADDITIONAL COSTS ON
THE CONDUCT OF OUR BUSINESS
Our business is potentially subject to or affected by a variety of federal,
state and local laws and regulations. These include, without limitation, laws
and regulations relating to:
- education;
- licensing of speech and language professionals in private practice and
delivery of speech and language testing and remediation services;
- consumer protection and anti-fraud and related protections, including the
regulation of referrals by professionals; and
- government funding.
Compliance with these and other laws and regulations impose additional costs on
the conduct of our business, and failure to comply with these laws and
regulations, changes in these laws and regulations, or in their applicability to
our business may impose additional costs.
Although we believe our existing products are educational training tools not
subject to regulation by the U.S. Food and Drug Administration, we cannot assure
you that the U.S. Food and Drug
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<PAGE>
Administration will not make a contrary determination in the future with respect
to our existing products or other products we may develop to treat the effects
of stroke, repetitive stress syndrome or ringing in the ears. Our business could
suffer in the event we became subject to such regulation.
OUR EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES EFFECTIVELY CONTROL
THE VOTING POWER OF OUR COMPANY
Following the completion of this offering, our executive officers and
directors and their respective affiliates will beneficially own approximately
65.1% of the outstanding common stock (63.1% 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. This concentration of ownership may also
delay, prevent or deter a change in control of our company. In addition, we may
be required after this offering to nominate up to two individuals affiliated
with Warburg, Pincus Ventures, L.P. for election to the Board of Directors which
could increase the influence of Warburg, Pincus Ventures, L.P. over the
direction of our company.
THE MARKET PRICE OF OUR STOCK MAY BE HIGHLY VOLATILE
The market price of our common stock is likely to be highly volatile and
could be subject to wide fluctuations for the following reasons, among others:
- the fluctuation of our quarterly results for reasons including the
seasonal demand for our products and our long sales cycle;
- the release of (or the failure to release) product enhancements or new
products;
- the timing of our competitors' product releases or variations in their
quarterly financial results;
- conditions in the economy in general or in our industry in particular,
including conditions that affect the resources available to schools,
speech and language professionals, and private parties to purchase our
products;
- publicity regarding our products or those of our competitors, including
publicity relating to new scientific studies about how the brain
functions;
- general economic conditions that influence stockholder interest in stocks
of companies with Internet or technology applications;
- changes in applicable laws and regulations affecting us or the educational
technology industry; and
- changes by financial research analysts in their estimates of our future
earnings.
WE MAY BE SUBJECT TO LITIGATION IF OUR STOCK PRICE IS VOLATILE
Broad market fluctuations or a downturn in our competitive prospects may
adversely affect the market price of our common stock and result in class action
litigation. This litigation could result in substantial costs and would, at a
minimum, divert our management's attention and resources, which could materially
and adversely affect our business. Any adverse determination in this litigation
could also subject us to significant liabilities.
SALES OF OUR SHARES AFTER THIS OFFERING COULD NEGATIVELY AFFECT THE MARKET PRICE
OF OUR STOCK AND RESULT IN FURTHER DILUTION
Sales of substantial amounts of shares in the public market following this
offering could have a material adverse effect on the market price of our common
stock. Immediately following this offering, we will have 10,341,573 shares of
common stock outstanding assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options or warrants after
March 31, 1999. Of these shares, all the shares sold in this offering will be
freely tradable without restrictions or further
15
<PAGE>
registration under the Securities Act of 1933. The remaining 8,041,573 shares of
common stock will be restricted securities as defined by Rule 144 adopted under
the Securities Act of 1933. 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 adopted under the Securities Act of 1933. We cannot predict the
effect that future sales made under Rule 144, Rule 701 or otherwise will have on
the market price of our common stock.
In addition, following closing of this offering we intend to register shares
of common stock issuable upon the exercise of stock options granted under our
stock option plans. After the effective date of this registration, shares issued
upon the exercise of stock options generally will be available for sale in the
public market. Our executive officers and directors and stockholders
beneficially owning in the aggregate 7,992,457 shares of common stock as of
April 30, 1999 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 Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") 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 Merrill Lynch, with or without
notice. The holders of approximately 4,285,711 shares of common stock are
entitled to register their shares.
OUR CHARTER PROVISIONS COULD HAVE THE EFFECT OF DELAYING OR PREVENTING CORPORATE
TAKEOVERS
Our certificate of incorporation authorizes our board of directors to issue
up to 1,000,000 shares of preferred stock and to determine the price, rights,
preferences and privileges, including voting rights, of those shares without any
further vote or action by the stockholders. The rights of the holders of common
stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The authority
to issue this preferred stock could enable our board of directors to deter
acquisitions of our company. Additionally, our certificate of incorporation and
bylaws also contain the following features which could have the effect of
delaying or preventing corporate takeovers:
- a board of directors classified into three classes, which makes it more
difficult to acquire immediate control of our board of directors because
only one third of the directors are elected each year;
- requiring stockholder actions to occur only at duly called meetings of the
stockholders, thereby reducing the ability of the stockholders to act
contrary to the interests of the board of directors;
- disallowing cumulative voting in the election of directors, which means
that the majority owner(s) of our voting common stock controls the
election of all directors; and
- requiring advance notice from stockholders for director nominations or
other stockholder proposals.
OUR MANAGEMENT HAS BROAD DISCRETION TO DETERMINE HOW TO USE THE FUNDS RAISED IN
THIS OFFERING AND MAY USE THEM IN WAYS THAT MAY NOT INCREASE OUR OPERATING
RESULTS OR MARKET VALUE
We plan 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 these expenditures will depend on business and
market developments. The remaining net proceeds have not been allocated for a
particular purpose. We intend to use the remaining net proceeds for general
corporate purposes, including working capital. As a result, our management will
have significant discretion as to the use of the net proceeds of this offering
and you will not have the opportunity, as part of your investment decision, to
assess whether the proceeds are being used appropriately. These proceeds may be
applied to uses that may not increase our operating results or our market value.
A decrease in our operating results or our market value may also occur.
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<PAGE>
YOU SHOULD NOT RELY ON FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROSPECTUS
This prospectus contains forward-looking statements. In some cases you can
identify forward-looking statements by terminology such as "may," "will,"
"should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential" or continue or the negative of these terms or other
comparable terminology. The outcome of the events described in these
forward-looking statements is subject to known and unknown risks and you should
not rely on these forward-looking statements. These risks include, among other
things, those identified in this "Risk Factors" section of this prospectus. Our
actual results could differ materially from those discussed in the
forward-looking statements contained in this prospectus. We also undertake no
obligation to publicly update any forward-looking statement and the
forward-looking events discussed in this prospectus could change or might not
occur. This section and the sections entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business"
contain a discussion of some of the factors that could contribute to those
differences.
HOW WE INTEND TO USE THE PROCEEDS FROM THIS OFFERING
The net proceeds from the sale of the 2,300,000 shares of common stock we
are offering, at an assumed initial public offering price of $15.00 per share,
are estimated to be approximately $31,185,000 ($35,998,000 if the underwriters'
over-allotment option is exercised in full), after deducting the underwriting
discount and estimated offering expenses that we will pay.
We expect to use the net proceeds of this offering for sales and marketing,
research and product development and other general corporate purposes. 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.
DIVIDEND POLICY
We have never paid cash dividends and do not anticipate paying any cash
dividends in the foreseeable future. Any future determination to pay dividends
will be at the discretion of our board of directors and will be dependent upon
then existing conditions, including our financial condition, results of
operations, contractual restrictions, capital requirements, business prospects
and other factors our board of directors deems relevant. Furthermore, our bank
line of credit with Silicon Valley Bank restricts the payment of dividends
without the bank's prior written consent.
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CAPITALIZATION
The following table sets forth our capitalization as of March 31, 1999, on
an actual basis and as adjusted to reflect: (i) our sale of the 2,300,000 shares
of common stock offered hereby at an assumed initial public offering price of
$15.00 per share after deducting the underwriting discount and estimated
offering expenses, and the application of the estimated net proceeds therefrom;
and (ii) the conversion of all outstanding shares of 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>
MARCH 31, 1999
-----------------------
ACTUAL AS ADJUSTED
---------- -----------
<S> <C> <C>
(IN THOUSANDS)
Long-term debt, including current portion................................................ $ 319 $ 319
Redeemable convertible preferred stock, $0.001 par value per share; 8,046,668 shares
authorized; 4,285,711 shares issued and outstanding actual, no shares issued and
outstanding as adjusted................................................................ 23,836 --
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value per share; 10,346,668 shares authorized
(including 8,046,668 shares designated as redeemable convertible preferred stock);
946,435 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; 37,346,668 shares authorized; 2,809,427 shares
issued and outstanding actual; 40,000,000 shares authorized, 10,341,573 shares issued
and outstanding as adjusted (1)........................................................ 3,504 60,880
Deferred compensation (2)................................................................ (1,412) (1,412)
Accumulated deficit...................................................................... (21,840) (21,840)
---------- -----------
Total stockholders' equity (deficit)................................................. (17,393) 37,628
---------- -----------
Total capitalization............................................................... $ 6,762 $ 37,947
---------- -----------
---------- -----------
</TABLE>
- ------------------------
(1) Based on the number of shares outstanding as of March 31, 1999. Excludes:
- 1,400,306 shares of common stock issuable upon exercise of options and
warrants outstanding as of March 31, 1999 with a weighted average exercise
price of $2.57 per share;
- 763,590 shares of additional common stock reserved for issuance under our
1999 Equity Incentive Plan;
- 75,000 shares of common stock reserved for issuance under our 1999
Non-Employee Directors' Stock Option Plan; and
- 350,000 shares of common stock reserved for issuance under our 1999
Employee Stock Purchase Plan. See "Management--Employee Benefit Plans,"
"Transactions and Relationships with Related Parties" and "Description of
Capital Stock."
(2) See Note 5 of Notes to the Financial Statements included elsewhere in this
prospectus.
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DILUTION
The pro forma net tangible book value at March 31, 1999 was approximately
$6,443,000 or $0.80 per share of common stock. Pro forma net tangible book value
per share represents the amount of our 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 5,232,146 shares of common stock. After giving effect
to the sale of the 2,300,000 shares of common stock offered in this offering at
an assumed initial public offering price of $15.00 per share after deducting the
underwriting discount and estimated offering expenses we pay and applying the
estimated net proceeds from this offering, our adjusted net tangible book value
as of March 31, 1999 would have been approximately $37,628,000 or $3.64 per
share of common stock. This represents an immediate increase in net tangible
book value of $2.84 per share of common stock to existing stockholders and an
immediate dilution in net tangible book value of $11.36 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................................ $ 15.00
Pro forma net tangible book value (deficit) per share.............. $ 0.80
Increase per share attributable to new investors................... 2.84
---------
Net tangible book value per share, as adjusted for this offering..... 3.64
---------
Dilution per share to new investors.................................. $ 11.36
---------
---------
</TABLE>
The following table summarizes as of March 31, 1999, on the pro forma basis
described above, the number of shares of common stock sold by us, 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 $15.00 per share for shares purchased in this offering, before
deducting the underwriting discount and estimated offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- -------------------------- AVERAGE
NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE
------------ ----------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............................ 8,041,573 77.8% $ 27,174,000 44.1% $ 3.38
New investors.................................... 2,300,000 22.2% 34,500,000 55.9% $ 15.00
------------ ----- ------------- -----
Total............................................ 10,341,573 100.0% $ 61,674,000 100.0%
------------ ----- ------------- -----
------------ ----- ------------- -----
</TABLE>
The foregoing table assumes no exercise of outstanding stock options and
warrants and excludes: (1) 1,400,306 shares of common stock issuable upon
exercise of options and warrants outstanding as of March 31, 1999 with a
weighted average exercise price of $2.57 per share; (2) 763,590 additional
shares of common stock reserved for issuance under our 1999 Equity Incentive
Plan; (3) 75,000 shares of common stock reserved for issuance under our 1999
Non-Employee Directors' Stock Option Plan; and (4) 350,000 shares of Common
Stock reserved for issuance under our 1999 Employee Stock Purchase Plan. See
"Capitalization," "Management--Employee Benefit Plans," "Transactions and
Relationships with Related Parties" 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
The following table sets forth selected historical financial data as of and
for the years ended December 31, 1996, 1997 and 1998 and the three months ended
March 31, 1998 and 1999. The statement of operations data for the years ended
December 31, 1996, 1997 and 1998 and the balance sheet data as of December 31,
1997 and 1998 were derived from our Financial Statements that have been audited
by Ernst & Young LLP, independent auditors, and are included elsewhere in this
prospectus and are qualified by reference to these financial statements and the
notes thereto. The balance sheet data as of December 31, 1996 was derived from
audited financial statements not in this prospectus. The historical financial
data as of March 31, 1999 and for the three months ended March 31, 1998 and 1999
were derived from unaudited financial statements included elsewhere in this
prospectus. In the opinion of management, the historical financial data as of
March 31, 1999 and for the three months ended March 31, 1998 and 1999 have been
prepared on the same basis as the audited financial statements and include all
adjusting entries (consisting only of normal recurring adjustments) necessary
for a fair presentation of our financial position and results of operations for
those periods. The historical financial data presented below are not necessarily
indicative of the results of operations that may be expected for the year ending
December 31, 1999 or any other future period. When you read this selected
financial data, it is important that you also read the "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the Financial
Statements and related Notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Programs.............................................. $ -- $ 2,249 $ 4,462 $ 603 $ 1,076
Services.............................................. -- 713 704 44 264
--------- --------- --------- --------- ---------
Total revenues...................................... -- 2,962 5,166 647 1,340
Cost of revenues:
Programs.............................................. -- 481 784 127 181
Services.............................................. -- 468 614 34 152
--------- --------- --------- --------- ---------
Total cost of revenues.............................. -- 949 1,398 161 333
--------- --------- --------- --------- ---------
Gross profit............................................ -- 2,013 3,768 486 1,007
Operating expenses:
Sales and marketing................................... 164 2,646 6,057 768 2,730
Research and development.............................. 1,514 1,965 2,880 666 762
General and administrative............................ 933 2,537 4,749 820 1,140
--------- --------- --------- --------- ---------
Total operating expenses............................ 2,611 7,148 13,686 2,254 4,632
--------- --------- --------- --------- ---------
Operating loss.......................................... (2,611) (5,135) (9,918) (1,768) (3,625)
Interest income (expense), net.......................... 70 162 (832) 20 88
Other income (expense), net............................. 44 (85) 2 -- --
--------- --------- --------- --------- ---------
Net loss................................................ $ (2,497) $ (5,058) $ (10,748) $ (1,748) ($ 3,537)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic and diluted net loss per share.................... $ (1.02) $ (1.90) $ (3.87) $ (0.64) $ (1.26)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used in computing basic and diluted net loss per
share................................................. 2,453 2,657 2,777 2,737 2,805
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Pro forma basic and diluted net loss per share (1)...... $ (1.74) $ (0.44)
--------- ---------
--------- ---------
Shares used in computing pro forma net loss per share
(1)................................................... 6,179 8,000
--------- ---------
--------- ---------
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
MARCH 31,
1996 1997 1998 1999
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................................... $ 3,822 $ 2,699 $ 6,362 $ 7,249
Working capital............................................... 3,562 1,569 3,543 5,003
Total assets.................................................. 4,306 4,456 9,121 10,421
Long-term debt, including current portion..................... 35 330 417 319
Redeemable convertible preferred stock........................ 4,002 8,002 18,940 23,836
Stockholders' (deficit) (2)................................... (85) (5,064) (14,082) (17,393)
</TABLE>
- --------------------------
(1) The pro forma net loss per share data gives effect to the conversion of all
outstanding shares of preferred stock into 5,232,146 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) We have paid no cash dividends since our inception.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH "SELECTED FINANCIAL DATA" AND THE
FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS.
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION, STATEMENTS OF OUR PLANS,
OBJECTIVES, EXPECTATIONS AND INTENTIONS. OUR 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
We develop, market and sell proprietary software and other educational
products and services. Our products and services are based on research on how
the brain learns and are designed to increase human learning and performance.
Language and reading skills are the foundation for all learning, and we have
developed products to help children learn how to read or become better readers.
Our Fast ForWord products are intensive, computer-based training programs that
focus on improving critical language and reading skills. Our current products,
Fast ForWord and Fast ForWord Two, focus primarily on the learning needs of
children aged four to 13 and are based on scientific research and have been
field tested using scientific methods. We also offer professional development
seminars in which educators, speech and language professionals and other
professionals can learn about recent developments in brain research and the
practical application of our programs as well as earn continuing education
credit. Our products are delivered through a variety of distribution channels,
including sales to public schools, referrals from speech and language
professionals in private practice and direct-to-consumer channels.
We commenced operations in February 1996, and, until April 1997, we devoted
substantially all of our efforts to developing the Fast ForWord program,
performing a field trial, recruiting and training personnel, establishing
relationships with and training educators and speech and language professionals
and raising capital. Since the commercial launch of Fast ForWord in April 1997,
we have also devoted efforts to sales and marketing activities. We have an
accumulated deficit of $21.8 million from inception through March 31, 1999. We
expect to incur additional losses for at least the next 18 months, due primarily
to substantial increases in sales and marketing related to increased
personnel-related costs and expenditures for travel, advertising, promotion, new
product launches and other activities, and increases in research and development
expenses due to continued increases in product development costs. We expect that
losses will fluctuate from quarter to quarter and that these fluctuations may be
substantial.
REVENUES. We derive revenues from program sales and service fees. Program
revenues are derived from the sale of programs including Fast ForWord and Fast
ForWord Two, which generally list for $850 per child and are typically
discounted for volume sales and in connection with the bundling of different
products. Customers license the right to use our program software during the
program period and do not acquire or otherwise gain unlimited rights to use the
software. The total value of products and services invoiced during a particular
period is recorded as deferred revenues until recognized. Revenues on sales of
our current programs are recognized only upon program activation and then
ratably over the average training period. Service revenues are derived from
training seminars for learning facilitators, from software installation at large
sites such as schools and from services provided to consumers who buy directly
from us. Revenues from services are recognized when the services are provided.
We only recently began offering our programs directly to consumers and revenues
to date have been minimal. Cancellations and refunds are allowed in limited
circumstances, and these amounts have not been significant. Our policy is to
grant refunds if the child's performance on Fast ForWord products indicates,
based on criteria we set forth in the policy, that the program is too difficult
or too
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<PAGE>
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. Also, we allow refunds
and cancellations from time to time due to special circumstances such as
inability to complete training due to illness. Provisions are made for
cancellations and refunds as revenue is recorded.
Our revenues have been derived almost exclusively from the sale of Fast
ForWord programs and related seminars and services. While we are developing
additional products based upon our proprietary technology and neuroscience
expertise, there can be no assurance that we will be successful in doing so. In
addition, to date, the substantial majority of our sales of Fast ForWord have
been through public schools and speech and language professionals, with the
majority of the public school revenues recorded in the last nine months.
Furthermore, due to the inherent complexity of selling to schools and school
districts, we expect that our sales cycle could be significantly longer than
that experienced historically as we increasingly focus on sales to this market.
As a result, we may have limited visibility on our future revenues, and such
revenues may fluctuate substantially.
COST OF REVENUES. Cost of revenues consists of program costs and service
costs. Program costs consist of costs associated with program sales, including
royalties, manufacturing, packaging, documentation, fulfillment, Internet
hosting and technical support costs. Service costs consist primarily of the
costs of providing training seminars and installations and services to consumers
who buy directly from us, including personnel, materials, facilities and travel.
These costs of revenues are generally recognized as incurred. We generally
recognize significantly higher gross margins on our program revenues than on our
service revenues.
OPERATING EXPENSES. Our operating expenses consist of sales and marketing,
research and development and general and administrative expenses. Sales and
marketing expenses principally consist of salaries and compensation paid to
employees engaged in sales and marketing activities, advertising and promotional
materials, public relations costs and travel. Research and development expenses
principally consist of salaries and compensation paid to employees and
consultants engaged in research and product development activities, product
testing, and software and equipment costs. We expense all software development
costs associated with a product until technological feasibility is established,
after which time all these associated costs are capitalized until the product is
available for commercial release and are amortized over the estimated lives of
the related products. Technological feasibility is deemed established upon
completion of a working version. 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.
We recorded deferred compensation of $2.1 million during the two years ended
December 31, 1998 and $571,000 during the three months ended March 31, 1999,
representing the difference between the exercise price and the deemed fair value
of certain stock options granted to employees. These amounts are being amortized
by charges to operations over the vesting periods of the individual stock
options. This amortization amounted to $1.0 million for the two years ended
December 31, 1998 and $223,000 for the three months ended March 31, 1999. The
remaining aggregate deferred compensation of $1.4 million will be amortized over
the remainder of the vesting periods of the options (generally five years).
23
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, various financial
data expressed as a percentage of revenues (unless otherwise noted). We
commenced operations, and were in the development stage, in 1996. As a result,
there were no revenues, cost of revenues or gross profits in 1996.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH
YEAR ENDED DECEMBER 31, 31,
-------------------------- --------------------------
1997 1998 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Programs................. 75.9% 86.4% 93.2% 80.3%
Services................. 24.1 13.6 6.8 19.7
------------ ------------ ------------ ------------
Total revenues......... 100.0 100.0 100.0 100.0
Cost of revenues:
Programs (1)............. 21.4 17.6 21.1 16.8
Services (2)............. 65.6 87.2 77.3 57.6
------------ ------------ ------------ ------------
Total cost of
revenues............. 32.0 27.1 24.9 24.9
------------ ------------ ------------ ------------
Gross margin................. 68.0% 72.9% 75.1% 75.1%
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
- ------------------------
(1) Program costs are expressed as a percentage of program revenues.
(2) Service costs are expressed as a percentage of service revenues.
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31,
1998.
REVENUES. Revenues increased to $1.3 million in the three months ended
March 31, 1999 from $647,000 in the comparable period of 1998, an increase of
107.1%. Program revenues increased to $1.1 million from $603,000, an increase of
78.4%, due to increased program activations in speech and language professional
and public school markets. Services revenues increased to $264,000 from $44,000,
an increase of 500.0%, due to increased revenue from professional development
seminars for both public schools and speech and language professionals in
private practice.
COST OF REVENUES. Cost of revenues increased to $333,000 in the three
months ended March 31, 1999 from $161,000 in the comparable period of 1998, an
increase of 106.8%. As a percentage of revenues, cost of revenues was unchanged
at 24.9%. Cost of program revenues, as a percentage of revenues, declined to
16.8% from 21.1% due to lower royalties and because technical support and
Internet hosting costs declined as a percentage of revenues, reflecting growth
in program volume. Cost of services revenues, as a percentage of revenues,
declined to 57.6% from 77.3%, due to a higher volume of services in the current
period.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to
$2.7 million in the three months ended March 31, 1999 from $768,000 in the
comparable period in 1998, an increase of 255.5%. This increase was primarily
attributable to increased personnel, marketing and travel costs. We expect to
substantially increase sales and marketing expenses in the future as we increase
marketing efforts for current and future products.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $762,000 in the three months ended March 31, 1999 from $666,000 in
the comparable period in 1998, an increase of 14.4%. This increase was primarily
attributable to increased personnel and contractor costs. We expect to
substantially increase research and development expenses in the future as we
continue to refine current products and develop additional products based upon
our proprietary technology and neuroscience expertise.
24
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $1.1 million in the three months ended March 31, 1999 from $820,000
in the comparable period in 1998, an increase of 39.0%. This increase was
primarily attributable to increased personnel, consulting, legal and travel
costs.
PROVISION FOR INCOME TAXES. We recorded no provision for income taxes in
the quarters ended March 31, 1999 and March 31, 1998 as we incurred losses
during such periods.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES. Revenues increased to $5.2 million in 1998 from $3.0 million in
1997, an increase of 74.4%. Program revenues increased to $4.5 million from $2.2
million, an increase of 98.4%, due to increased program activations in speech
and language professional and public school markets. Services revenues were
$704,000, a slight decrease from $713,000 in the prior year, reflecting a
planned decline in professional development seminars for speech and language
professionals in private practice, offset partially by growth in public school
services revenues.
COST OF REVENUES. Cost of revenues increased to $1.4 million in 1998 from
$949,000 in 1997, an increase of 47.3%. As a percentage of revenues, cost of
revenues declined to 27.1% from 32.0%, due to growth in program revenues as a
percentage of total revenues. Cost of program revenues, as a percentage of
revenues, declined to 17.6% from 21.4%, due to a decline in costs of materials,
technical support and Internet hosting as a percentage of revenues, reflecting
growth in program volume. Cost of services revenues, as a percentage of
revenues, grew to 87.2% from 65.6% in 1997, due to introductory pricing of
professional development and installation services offered to schools.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to
$6.1 million in 1998 from $2.6 million in 1997, an increase of 128.9%. This
increase was primarily attributable to personnel, advertising and promotion,
travel and public relations costs.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $2.9 million in 1998 from $2.0 million in 1997, an increase of
46.6%. This increase was primarily attributable to increased personnel and to a
lesser extent to consulting, software and equipment-related costs.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $4.7 million in 1998 from $2.5 million in 1997, an increase of
87.2%. This increase was primarily attributable to fees and expenses related to
a proposed initial public offering withdrawn in 1998, personnel, facilities,
legal and travel costs.
INTEREST INCOME (EXPENSE). Interest expense, net of interest income, was
$832,000 in 1998, compared to interest income, net of interest expense, of
$162,000 in 1997. Interest expense in 1998 resulted principally from charges of
$780,000 which represented the fair value of warrants to acquire preferred and
common stock issued to a significant preferred stockholder in connection with a
loan from the stockholder and a bank loan guarantee provided by the stockholder.
PROVISION FOR INCOME TAXES. We recorded no provision for income taxes in
the years ended December 31, 1998 and 1997 as we incurred losses during such
periods. At December 31, 1998, we had net operating loss carryforwards for
federal income tax purposes of approximately $14.0 million. The net operating
loss carryforwards will expire in years 2011 through 2018. Utilization of the
net operating losses may be subject to a substantial annual limitation due to
the ownership change limitations provided by the Internal Revenue Code of 1986.
Previous or contemplated equity transactions may result in such an ownership
change. The annual limitation may result in the expiration of net operating
losses before becoming available to reduce future tax liabilities. We have not
determined whether completion of this offering will result in such an ownership
change. At December 31, 1998, we had
25
<PAGE>
approximately $6.6 million of deferred tax assets, comprised primarily of net
operating loss carryforwards. Realization of deferred tax assets is dependent
upon future earnings, if any, the timing and amount of which are uncertain.
Accordingly, the net deferred tax assets have been fully offset by a valuation
allowance.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues were $3.0 million in 1997. Program revenues were $2.2
million following the commercial release of Fast ForWord in April 1997. Services
revenues of $713,000 were primarily attributable to training seminars which were
introduced in January 1997. We were 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. We were 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. We were in the development stage during 1996
and did not incur significant sales and marketing expenses.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $2.0 million in 1997 from $1.5 million in 1996, an increase of
29.8%. 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, an increase of 171.9%.
This increase was primarily attributable to personnel costs and facilities costs
related to our move to a new headquarters facility in September 1997.
PROVISION FOR INCOME TAXES. We recorded no provision for income taxes in
the years ended December 31, 1996 and 1997 as it incurred losses during these
periods.
QUARTERLY RESULTS OF OPERATIONS
Our 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 our control. Factors that may affect our
quarterly operating results include among others:
- the demand for technology-based education and training products;
- the size and timing of product orders and implementation;
- the revenue mix between our products and services;
- the timely development, introduction and market acceptance of our existing
and future products, if any;
- the pricing of our programs and services:
- seasonality in product purchase and usage;
- competitive conditions;
- our ability to attract and retain experienced personnel;
26
<PAGE>
- the availability of government funding for public schools;
- public school calendars and budget cycles;
- the number and timing of Fast ForWord training seminars for educators,
speech and language professionals and other professionals; and
- general economic and market conditions.
We cannot assure you that we will be able to predict our future revenues
accurately, and we may not be able to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall of revenues in relation to our expectations could cause significant
fluctuations in quarterly operating results, which would have an adverse effect
on our business, financial condition and results of operations.
Demand for our programs and services is subject to various seasonal
influences which can vary depending on the distribution channel being employed.
We do not have sufficient operating experience in our various distribution
channels to predict the overall effect of various seasonal factors and their
effect on future quarterly operating results. We believe that, because of the
intensive nature of Fast ForWord, demand for our programs from speech and
language professionals in private practice may be lower during the school year
than in the summer. To the extent we penetrate the public school market, we may
experience seasonality due to public school calendars and budget cycles.
Due to all of the foregoing factors, our quarterly revenues and operating
results are difficult to forecast, and we believe that period-to-period
comparisons of our 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 March 31, 1999, we used approximately $16.2 million
of cash for operating activities, resulting primarily from operating losses of
$21.8 million and increases in accounts receivable of $1.0 million, partially
offset by increases in accounts payable of $630,000, depreciation and
amortization charges of $1.9 million and amortization of deferred compensation
of $1.3 million.
During this same period, we used $2.8 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 our existing equipment lines of credit
with Silicon Valley Bank, under which we had a balance of $306,000 outstanding
as of March 31, 1999 at an interest rate of prime rate plus 3.0%. These
equipment lines were fully drawn and we had no available borrowings under any
line of credit with Silicon Valley Bank as of March 31, 1999. As of March 31,
1999, we had cash and cash equivalents of $7.2 million.
In June 1998, we obtained a $3.0 million unsecured line of credit with
BankBoston N.A. Borrowings under the line of credit bore interest, at our
election, at the bank's base rate, or the adjusted LIBOR plus 1.75%. Borrowings
under the line of credit were repaid and the line of credit was terminated in
December 1998. There were no available borrowings under any lines of credit with
BankBoston N.A. as of March 31, 1999.
We believe that the net proceeds from this offering will be sufficient to
finance our presently anticipated operating losses, planned capital expenditure
requirements and internal growth for at least the next 18 months. However, we
cannot be certain that our cash resources following this offering will be
sufficient to fund negative cash flow and expected capital expenditures beyond
that period. We therefore may need to obtain additional equity or debt financing
in the future. We may not be able to obtain the additional financing to satisfy
our cash requirements on acceptable terms or at all.
We currently have no significant long-term obligations which extend beyond
18 months except in connection with the lease of our corporate office facility
which requires minimum lease payments of approximately $80,000 per month through
September 2002. See Note 6 of Notes to Financial Statements. During the next 18
months, we may need to expand our corporate office facilities which would
require us to commit to additional lease obligations.
27
<PAGE>
YEAR 2000 ISSUES
Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because these computer programs would not properly recognize a year that begins
with "20" instead of "19." This, in turn, could result in major system failures
or miscalculations that could disrupt our business. We have formulated a Year
2000, otherwise referred to as Y2K, plan to address our Y2K issues and have
created a Y2K task force headed by our Director of Information Technology to
implement the plan. Our Y2K plan has six phases:
1. Organizational Awareness--educate our employees, senior management
and the board of directors about the Y2K issue;
2. Inventory--complete inventory of internal business systems and their
relative priority to continuing business operations. In addition,
this phase includes a complete inventory of critical vendors,
suppliers and services providers and their Y2K compliance status. Our
products have been Y2K compliant since they were developed and we
will continue to ensure Y2K compliance in future products;
3. Assessment--assessment of internal business systems and the Y2K
compliance status of our important vendors, suppliers and service
providers;
4. Planning--preparing the individual project plans and project teams
and other required internal and external resources to implement the
required solutions for Y2K compliance;
5. Execution--implementation of the solutions and fixes; and
6. Validation--testing the solutions for Y2K compliance.
Our Y2K plan will apply to two areas:
1. Internal business systems and our products; and
2. Compliance by external customers and providers.
INTERNAL BUSINESS SYSTEMS AND OUR PRODUCTS
Our internal business systems and workstation business applications will be
a primary area of focus. Since we began our business in 1996, we have
implemented and will continue to implement new enterprise-wide business
software. These solutions are represented by their vendors as being fully Y2K
compliant. All of our applications were developed after our formation in 1996.
Therefore, we do not have problems with more aged applications that will need to
be evaluated for Y2K compliance.
We completed the inventory, assessment and planning phases of substantially
all critical internal business systems in August 1998. We expect that the
execution and validation phases will be completed by August 31, 1999. We expect
to be Y2K compliant on all critical systems that rely on the calendar year,
before December 31, 1999.
We may not address the Y2K compliance of some non-critical systems until
after January 1, 2000. However, we believe these systems will not cause
significant disruptions in our operations.
Our product lines are already Y2K compliant and no patches will need to be
applied by our customers.
COMPLIANCE BY EXTERNAL PROVIDERS AND CONTRACTORS
We are in the inventory and assessment phases of our Y2K Plan with respect
to suppliers, service providers and contractors to determine the extent to which
our systems are susceptible to those third parties' failure to remedy their own
Y2K issues. We expect that assessment will be complete by mid-1999. To the
extent that responses to Y2K readiness are unsatisfactory, we intend to change
28
<PAGE>
suppliers, service providers or contractors to those that have demonstrated Y2K
readiness. We cannot assure you that we will be successful in finding such
alternative suppliers, service providers and contractors.
RISKS ASSOCIATED WITH Y2K
We believe the major risk associated with the Y2K issue is the ability of
our key business partners and vendors to resolve their own Y2K issues. We will
spend a great deal of time over the next several months working closely with
suppliers and vendors to assure their compliance.
Should a situation occur where a key partner or vendor is unable to resolve
its Y2K issues, we expect to be in a position to change to Y2K compliant
partners and vendors.
COSTS TO ADDRESS Y2K ISSUES
Because we are in the position of implementing new enterprise-wide business
solutions, there are few, if any, Y2K changes required to existing business
applications. We believe that all of the new business applications implemented,
or in the process of being implemented in 1999, are represented as being Y2K
compliant.
We currently believe that the cost of implementing our Y2K plan will not
exceed $500,000 and will not have a material effect on our financial position.
CONTINGENCY PLAN
We have not formulated a contingency plan at this time but expect to have
specific contingency plans in place prior to September 30, 1999.
SUMMARY
We anticipate that the Y2K issue will not have a material adverse effect on
our financial position or results of our operations. We can give no assurance,
however, that the systems of other companies or government entities, on which we
rely for supplies, cash payments and future business, will be timely converted
or that a failure to convert by another company or government entities would not
have a material adverse effect on our business. If third party suppliers,
service providers and contractors, due to Y2K issues, fail to provide us with
components, materials or services that are necessary to deliver our service and
product offerings, our business will suffer.
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates primarily
to the increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of interest
expense we must pay with respect to our various outstanding debt instruments.
The risk associated with fluctuating interest expense is limited, however, to
the exposure related to those debt instruments and credit facilities which are
tied to market rates. We do not use derivative financial instruments in our
investment portfolio. We ensure the safety and preservation of our invested
principal funds by limiting default risks, market risk and reinvestment risk. We
mitigate default risk by investing in safe and high-credit quality securities. A
hypothetical increase or decrease in market interest rates by 10% from the
market interest rates at March 31, 1999 would not cause the fair value of our
short-term investments or the interest expense paid with respect to our
outstanding debt instruments to change by a material amount. Declines in
interest rates over time will, however, reduce our interest income while
increases in interest rates over time will increase our interest expense.
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BUSINESS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN
THIS PROSPECTUS. FACTORS THAT MAY CAUSE OR CONTRIBUTE TO A DIFFERENCE INCLUDE,
BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS," AS WELL AS THOSE
DISCUSSED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
We develop, market and sell products and services that are based on brain
research and are designed to increase human learning and performance. To date,
our primary focus has been on the language and reading skills that are the
foundation for learning. We have developed, have field tested and are selling
software to help children learn how to read or become better readers.
Because primary education involves a great deal of oral instruction, a child
with poor language comprehension is likely to have difficulty not only in
reading, but in all areas of learning. Poor oral language comprehension and
subsequent reading problems are often associated with low self esteem and
behavioral problems. Children identified as having the most severe language and
reading problems are often placed in multi-year remediation programs. Children
with less severe problems often go unidentified and their needs go unaddressed.
Our Fast ForWord family of products uses computer-controlled, repetitive
training exercises that automatically adapt to each user's performance to modify
the manner in which the brain processes language. Our initial products, Fast
ForWord and Fast ForWord Two, principally focus on the learning needs of
children aged four to 13. In field studies, 90% of participants identified as
having language or reading difficulties showed statistically significant gains
in language comprehension skills, achieving, on average, one to two years of
improvement in language and reading skills after completion of Fast ForWord
programs in four to eight weeks. Additionally, based on extensive interviews
with parents and educators, children who have completed the Fast ForWord program
are generally reported to have shown substantial improvements in both self
esteem and confidence as their communication skills improve.
THE SCIENTIFIC LEARNING SOLUTION
We combine more than 25 years of brain and language research with the power
of technology to create innovative language and reading programs. Our initial
Fast ForWord products, which focus primarily on the learning needs of children
aged four to 13, help build the language comprehension skills that are critical
to learning to read or becoming a better reader. We believe that the proprietary
technology and processes underlying our products have applications beyond
language and reading problems in children and can be used to build reading and
language comprehension skills in children, adolescents and adults. Moreover, we
believe the proprietary technology and processes underlying our products can
address additional challenges, such as adult literacy, greater English language
proficiency for non-native English speakers and language reacquisition for
individuals who have suffered from a stroke or other brain injury.
We believe the primary advantages of the products we develop are as follows:
- RESEARCH-BASED PROGRAMS. Our programs are based on more than 25 years of
research on how the brain works as well as on language and reading
problems. Many problems children encounter with language and reading can
be attributed to difficulty in understanding oral language, including
distinguishing among phonemes. Phonemes are the smallest units of sound
that affect the meaning of words and are the basic building blocks of
language. We use repetitive computer-based training exercises to enable a
child to build better oral language skills, including the ability to
differentiate among sounds, before teaching the relationship between
letters and
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sounds. In contrast to traditional exercises, our programs combine
electronically modified speech with cross-training in critical language
skills. These skills include (1) vocabulary, (2) grammar, (3) morphology,
which is the system of word formation, (4) syntax, which is the way in
which words are put together to form phrases, clauses or sentences, (5)
semantics, which relates to meaning in language and (6) executive function
skills, which are the organizational skills necessary for thinking such as
short-term memory and determining the sequence of events.
- PROVEN, RAPID AND MEASURABLE RESULTS. We design products that produce
demonstrable results that can be easily measured. Field studies of our
Fast ForWord program show that 90% of participants identified as having
language and reading problems showed statistically significant gains in
language comprehension skills, achieving, on average, one to two years of
improvement in language and reading skills after completion of Fast
ForWord programs in four to eight weeks.
- INTEGRATED APPROACH. We assist educators, parents and speech and language
and other professionals with integrating our programs into existing
educational programs. We provide professional training, installation and
implementation services and technical and other support. Through the
Internet, our programs automatically provide those supervising the
participants with performance tables and templates, enabling them to
establish a baseline analysis and monitor each participant's skill level
on a daily basis.
- EFFECTIVE ALLOCATION OF RESOURCES. We believe that effective use of our
programs 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 educators 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
programs enable schools to more effectively use resources for remediation
programs.
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PROGRAMS AND SERVICES
A summary of our programs and services currently being offered and those
under development is outlined below:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
TARGET AUDIENCE
----------------
PROGRAM/SERVICE CHILDREN ADULTS DESCRIPTION
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------
FAST FORWORD PRODUCT
FAMILY
- -------------------------------------------------------------------------------------------
FAST FORWORD X Intensive, computer-based training program, which
Launch: March 1997 has the look and feel of a computer game. Fast
ForWord is designed to keep children engaged and
entertained during the thousands of repetitions
necessary to improve a child's language skills.
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
difficult, driving the child to continually
increase his or her rate of oral language
processing. At the most difficult level of each
exercise, the child is presented with natural,
unmodified speech. The exercises also cross-train
the child in other critical language skills and
executive function skills. These skills are
necessary for a solid foundation for learning to
read or becoming a better reader. The program
adjusts to the child's skill level and ongoing
performance so that the child is making correct
responses approximately 80% of the time. This
adjustment is designed to keep the program
challenging and engaging, while allowing the
child to generate a feeling of accomplishment and
to avoid repetitive failure, which can be
discouraging and detrimental to learning.
The Fast ForWord program is designed to be used
for 100 minutes per day, five days a week for
four to eight weeks. Results from each child's
Fast ForWord exercises are uploaded daily via the
Internet to our 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 those supervising the
children, enabling them to monitor performance.
These charts and templates can also be used by
professionals to provide parents and children
with measurable results of the child's progress.
- ------------------------------------------------------------------------------------------------------
FAST FORWORD TWO X Computer-based training program that helps
Launch: October 1998 children practice and refine the language
comprehension skills they learned in Fast
ForWord, but at the more complex level necessary
for reading. Fast ForWord Two introduces new
skills that are now accessible to children who
have developed basic oral language proficiency.
Fast ForWord Two develops skills that are
critical to reading such as word decoding,
sound-letter recognition and visual tracking.
Word decoding enables a child to build
associations between word sounds, written
representations of words and meaning.
Sound-letter recognition is the ability to
translate letters into spoken words. We believe
that being able to process rapid sound-letter
associations is critical to being able to read.
Fast ForWord Two also provides training exercises
that reinforce left-to-right reading patterns for
children who may have visual tracking problems.
The Fast ForWord Two program is designed to be
used for 90 minutes per day, five days a week for
four to eight weeks. As with Fast ForWord, Fast
ForWord Two results are uploaded daily via the
Internet to our proprietary database which
automatically analyzes the data and creates
performance charts and reports.
- ------------------------------------------------------------------------------------------------------
</TABLE>
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<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
TARGET AUDIENCE
----------------
PROGRAM/SERVICE CHILDREN ADULTS DESCRIPTION
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD PRODUCT FAMILY
(CONTINUED)
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD THREE X Computer-based reading comprehension program that combines the
Anticipated Launch: Year 2000 essential components of word recognition and decoding with
reading comprehension skills. This product is still in the
design stage.
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD FOR INCREASED X X Computer-based language specific program that focuses on
ENGLISH PROFICIENCY training the language skills found in English that are the
Anticipated Launch: Year 2000 most difficult for non-native English speakers to learn.
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD FOR ADOLESCENTS X X Computer-based training program with adolescent-tailored
Anticipated Launch: Year 2000 graphics, story lines and content. Fast ForWord for
adolescents combines electronically modified speech with
cross-training in critical language skills in a manner that
automatically adjusts to each user's performance. This program
enables participants to track their daily progress.
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD FOR ADULTS X Computer-based training program with adult-tailored graphics,
Anticipated Launch: Year 2000 story lines and content. Fast ForWord for adults combines
electronically modified speech with cross-training in critical
language skills in a manner that automatically adjusts to each
user's performance. This program enables participants to track
their daily progress.
- ------------------------------------------------------------------------------------------------------------------
FAST FORWORD FOR LANGUAGE X Computer-based training program designed for rehabilitation
REACQUISITION specialists to provide individualized exercises that meet the
Anticipated Launch: Year 2000 specific needs of individuals who have suffered a stroke or
other brain injury.
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! PRODUCT FAMILY
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! X Software product that focuses on key skills needed for success
SKILL-BUILDING SOFTWARE in grades pre-K through 2, such as recognition of colors and
GAMES-- shapes, and provides practice in remembering, using and
HOME VERSION manipulating phonemes, fine motor control, and hand-eye
Launch: June 1999 coordination.
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! X This has the same features as the home version, and also
SKILL-BUILDING SOFTWARE allows multiple concurrent users, provides printouts of
GAMES-- performance data on each user and allows customized game
PROFESSIONAL VERSION sessions for individual users. This product is targeted only
Launch: June 1999 for delivery through certified professionals and educators.
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! BOOKSHELF X Proprietary stories in an interactive CD format, designed as a
CD ROM AND CD STORYBOOKS-- companion to the Away We Go! skill-building software games.
HOME VERSION These stories provide exposure to appropriate spoken and
Launch: June 1999 written language content, thereby supporting the training
related to phonemes in the Away We Go! skill-building software
games.
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! BOOKSHELF X This has the same features as the home version, and also
CD ROM AND CD STORYBOOKS - contains four different levels of patented speech
PROFESSIONAL VERSION. modification. This product is targeted only for delivery
Launch: June 1999 through certified professionals and educators.
- ------------------------------------------------------------------------------------------------------------------
AWAY WE GO! BOOKSHELF X Proprietary stories in a four-color printed format, designed
PRINTED STORYBOOKS as a companion to the Away We Go! skill-building software
Launch: June 1999 games. These stories provide exposure to appropriate spoken
and written language content, thereby supporting the training
related to phonemes in the Away We Go! skill-building software
games.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
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<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
TARGET AUDIENCE
----------------
PROGRAM/SERVICE CHILDREN ADULTS DESCRIPTION
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
PROFESSIONAL DEVELOPMENT X To assist educators, parents and speech and language and other
SEMINARS professionals, we provide educational seminars on the latest
Launch: January 1997 in brain research, the connection between language
comprehension and learning to read, and the practical
application of Fast ForWord. Typically, workshops are either
one- or two-day intensive training seminars for educators and
speech and language professionals and typically list at $695.
More than 3,600 individuals have been trained in administering
Fast ForWord through these seminars, including more than 1,400
educators in public schools and more than 2,200 speech and
language professionals in private practice. Participants in
the training seminars for the administration of the Fast
ForWord programs are eligible to receive continuing education
credit to support the ongoing educational certification
requirements of teachers and educators.
- ------------------------------------------------------------------------------------------------------------------
SCREENING / ASSESSMENT X X Computer-based screening and assessment product designed to
Anticipated Launch: Year 2000 evaluate language comprehension skills of children and adults.
This product is still in the design stage.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
MARKET OPPORTUNITY
While our software and other educational products and services are
applicable to children and adults of virtually all ages and capabilities, we
believe our largest market opportunity is school children. Based on data from
the U.S. Department of Education, we estimate that more than 52.7 million
students are attending over 110,000 K-12 schools in the United States in the
1998-99 school year. Our Fast ForWord and Away We Go! products are developed
primarily for children between the ages of four and 13. Based on Bureau of the
Census data, there are approximately 40 million children in this age group.
According to the National Institute of Child Health and Human Development, as
much as 40% of the population, or 16,000,000 of these children, have reading
problems. With ten grade levels represented by children between the ages of four
and 13, we estimate that one-tenth of this group, or 1,600,000 children, enter
this category each year. We believe that their language and reading difficulties
result in part from poor language comprehension skills.
Educators in public schools and speech and language professionals are our
target market for our Professional Development Seminars. Based on data from the
U.S. Department of Education, we estimate that as of 1997 there were 2.7 million
K-12 public school teachers in the United States. Based on American
Speech-Language-Hearing Association data, we estimate that there are
approximately 100,000 speech and language professionals practicing in the United
States, including 13,000 in private practice, 50,000 in public schools and
37,000 working part-time or in adult rehabilitation centers.
Public concern over the effectiveness of K-12 schools in teaching essential
academic skills, and the role of technology in the classroom, have created an
increased demand for technology-based educational programs. In addition, we
believe that the growing shortage of teachers in the United States will further
increase the demand for technology-based educational programs. According to the
Department of Education, schools in the United States will need to hire more
than 2,000,000 teachers over the next decade. According to reports from Quality
Education Data, while total spending on education in the United States has grown
at an average rate of five percent per year, spending on the technology in
public schools in the United States more than doubled between the 1991-92 and
1998-99 school years. Quality Education Data also reports that technology
spending is projected to reach $5.4 billion for the 1998-99 school year, a 12.5%
increase from the prior school year. These expenditures include computers,
Internet connections, other technology infrastructure components and software.
We expect public school spending on instructional software alone will be over
$500 million, an increase of approximately 70% over the 1997-98 school year.
According to Quality Education Data, this
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increased demand for instructional software is driven in part by plans to
increase the inventory of multimedia personal computers in public schools by
over 30% in 1998-99. We have identified more than $13 billion of specific
federal and state funding sources that can be used for our products and
services, including Title I of the Elementary and Secondary Education Act of
1965, the Individuals with Disabilities Education Act, Goals 2000, Technology
Literacy Challenge Grants and the education rate discount authorized by the
Telecommunications Act of 1996. In addition to the 47 states that have adopted
programs to support the use of technology in the classroom, special reading
initiative funds also are available in many states, including California,
Florida and Texas. We estimate that foundations and corporations have set aside
more than $700 million in funding sources that could be used to implement our
products in classrooms.
In addition to the K-12 market, we are developing, and plan to introduce,
products for improving the reading and language comprehension skills of
adolescents and adults. According to the National Adult Literacy Study conducted
in 1992, more than 40 million adults in the United States are functionally
illiterate. Recently, there has been an increased focus by educators, government
officials and labor groups on the literacy problem. This increased concern has
resulted in part because jobs are demanding increasingly higher levels of basic
skills from workers, while millions of workers have limited literacy skills. We
believe that a significant opportunity exists to address the adult literacy
problem in the United States.
According to the National Center on Adult Literacy in October 1996, an
estimated 12 to 14 million non-native English speaking adults living in the
United States had limited proficiency in the English language. Many of these
adults require assistance from government agencies for English language
training. The demand for these services far exceeds the available sources.
Additionally, educators have discovered that instructional methods developed for
first language literacy instruction are inappropriate for many immigrants. We
believe that a significant opportunity exists to address this market.
According to 1998 National Stroke Association data, there are nearly four
million people in the United States who have survived a stroke and are living
with the after effects, including aphasia, an impairment of language and
speaking skills. These individuals struggle, alone and through therapy with
rehabilitation specialists, to reacquire their language skills. We believe that
a significant opportunity exists in developing neuroscience-based products and
training programs to meet the skill needs of a brain injured patient attempting
to reacquire language skills.
GROWTH STRATEGY
Our goal is to establish Scientific Learning as the leading provider of
proven, neuroscience-based software and other educational products and services.
Key elements of our growth strategy include:
INTRODUCE ADDITIONAL NEUROSCIENCE-BASED SOFTWARE PRODUCTS AND SERVICES. We
believe our expertise in neuroscience, language learning and technology
positions us well for the successful introduction of new education and training
products applicable to children and adults of all ages and capabilities. After
extensive research and substantial field testing, we introduced Fast ForWord in
April 1997 and Fast ForWord Two in October 1998, and intend to do the following:
- Introduce the following five new language-learning products in the second
quarter of 1999: Away We Go! skill-building software games, home and
professional versions, Away We Go! Bookshelf CD ROM and CD storybooks,
home and professional versions, and Away We Go! Bookshelf printed
storybooks;
- Develop the following language-based products with a projected
introduction in the year 2000: Fast ForWord Three, Fast ForWord for
Increased Language Proficiency, Fast ForWord for Adolescents, Fast ForWord
for Adults, Fast ForWord for Language Reacquisition and a
Screening/Assessment product; and
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- Examine ways to leverage our expertise in brain research into potential
non-language-based products, including products addressing tinnitus
(ringing in the ears) and repetitive stress injury.
See "--Programs and Services" and "--Research and Development." We cannot assure
you that we will be able to introduce these new products and services as
scheduled, or that if introduced, these products and services will perform as
intended or be accepted by the marketplace.
RAPIDLY EXPAND OUR SALES AND MARKETING EFFORTS. We recently expanded our
outside sales force by targeting and hiring experienced professionals with
established relationships in the education sector. We currently have more than
28 sales professionals. We intend to continue to expand our sales and marketing
efforts to increase our penetration of the public school, private practice
speech and language professional, direct-to-consumer and other distribution
channels. As of March 31, 1999, we have sold more than 13,000 copies of Fast
ForWord and Fast ForWord Two, and we have trained more than 3,600 individuals in
administering Fast ForWord. Specifically, we intend to:
- hire additional salespeople to focus exclusively on sales to the K-12
school market;
- implement direct-to-consumer e-commerce capabilities on
ScientificLearning.com to allow the purchase of our products and services
online as well as on BrainConnection.com to allow the purchase of our and
other companies' products and services online;
- hire additional salespeople to target speech and language professionals in
private practice;
- expand our direct marketing campaign to parents and consumers;
- explore and develop other channels of distribution, including potential
strategic alliances with for-profit educational services companies, day
care providers and private schools; and
- expand our Education Advisory Board, which provides access to leaders in
the fields of education, neuroscience, behavioral science, health and
public policy.
IMPLEMENT EXPANDED INTERNET STRATEGY. We use technology and the Internet to
implement our learning programs, to track and evaluate participants and to
provide an online environment that builds a sense of community among individuals
using our products, as well as among individuals interested in neuroscience and
learning. Through our ScientificLearning.com web site, we offer parents,
educators and other learning facilitators a wide variety of information and
forums for the exchange of ideas on our products as well as how language and
reading are learned.
We intend to significantly expand our web presence and e-commerce activities
through our new BrainConnection.com web site, launched on June 11, 1999.
BrainConnection.com is designed to aggregate a vast library of information about
neuroscience and how the brain learns a variety of complex tasks, not just
language and reading, and to help people find information, products and services
through the use of sophisticated search technology. We also designed the site to
allow the purchase of our products and services online. We also have established
relationships with other companies so that consumers can purchase other products
and services online at BrainConnection.com. We intend to drive activity to
BrainConnection.com through relationships with education, scientific and medical
information web sites as well as with web search and retrieval services and
other high-traffic web sites.
In addition, we intend to leverage our proprietary Internet/database
capabilities to produce new products and services. Our database of performance
information is growing rapidly as our customer base grows. We intend to use our
database capabilities to further customize our training programs and to
facilitate the collection and analysis of data from a variety of sources.
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BUILD A TRUSTED BRAND. We intend to continue to build recognition of our
company and product brands among parents, educators and speech and language and
other professionals and leverage that recognition to successfully commercialize
other products based on neuroscience, the study of how the brain functions.
Specifically, we intend to:
- promote the publication of media articles and stories regarding Scientific
Learning, our Fast ForWord family of products and our other products and
research;
- engage in direct marketing campaigns to educators and other key public
school decision-makers, as well as to speech and language professionals
and parents;
- encourage people interested in how language and reading are learned to
build a community online at ScientificLearning.com, encourage people
interested in the brain and how it works to build a community online at
BrainConnection.com and establish a community of people interested in our
products and services through our newsletters;
- continue to publish field test results; and
- build expertise through collaboration with our Education Advisory Board.
SUPPORT SERVICES
SUPPORT FOR EDUCATORS, PARENTS AND PROFESSIONALS. We provide a number of
support services for educators, parents and speech and language and other
professionals involved in improving reading and language skills. Through our
ScientificLearning.com web site, we offer parents, educators and other learning
facilitators a wide variety of information and forums for the exchange of ideas
regarding our products as well as how language and reading are learned. We
provide two to three hour seminars for parents interested in learning more about
brain research, the connection between language comprehension skills and
learning to read and the science behind our Fast ForWord programs. In addition,
we mail a Fast ForWord newsletter that contains items of interest on the program
and language and reading problems to the parents of participating children, as
well as to educators and speech and language professionals. We have a
professional relations staff dedicated to answering questions from and providing
support to professional providers and parents. Our professional relations staff
provides support over the Internet and a toll-free telephone information line.
TECHNICAL SUPPORT. Because many of the parents, educators and speech and
language and other professionals who administer our programs have limited
computer knowledge and have limited technical support on-site to assist them, we
provide a variety of technical support services. We employ an experienced staff
of technical service representatives to answer technical questions regarding our
programs, computer hardware and networks. In addition, at large sites such as
schools, we provide on-site software installation, technical training and
technical support.
SALES AND MARKETING
We market and sell our products through two primary channels of
distribution: public schools and speech and language professionals in private
practice. In addition, we are in the process of expanding direct-to-consumer
distribution channels, such as the Internet and other alternative distribution
channels. As of June 30, 1999, we have sold more than 17,000 copies of Fast
ForWord and Fast ForWord Two, including more than 5,000 copies to public schools
and more than 12,000 copies to speech and language professionals in private
practice. We have recently expanded our outside sales force, and currently have
23 sales representatives focused on the public school market and five sales
representatives focused on speech and language professionals in private
practice. Our hiring process has targeted experienced professionals who have
established relationships with prospective customers.
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PUBLIC SCHOOLS. As of March 31, 1999, we have sold our programs to over 500
schools in more than 300 school districts. The majority of our public school
sales have occurred since the formation in the fall of 1998 of a dedicated sales
force focused on that market. To date we have trained more than 1,900 teachers
and speech and language professionals in public schools in the administration of
Fast ForWord. We believe that, to date, the majority of leads have arisen from
our sales force and decision-makers within schools and districts who have
contacted us after learning about Fast ForWord from publications in industry
journals or the general press, presentations at education conferences,
attendance at our training seminars or from colleagues or parents. To more
rapidly introduce our products into public schools, we have undertaken a model
site program, in which participating schools agree to provide services in
exchange for a program discount. These services include acting as a reference
for other educators interested in our products, hosting tours, speaking at
events and with the press about program results, participating in studies and
cooperating in the publication of results. These sites provide educators and
administrators with the opportunity to see our products in use, which we believe
helps shorten the sales cycle in schools. As of March 31, 1999, we had
established more than 50 model school sites. Our Fast ForWord products generally
list for $850 per child and are typically discounted for volume sales and in
connection with the bundling of different products, such as purchases of Fast
ForWord and Fast ForWord Two or the purchase of our products together with
installation services or training programs. In addition, we intend to market and
sell our Away We Go! family of products to schools to use with their students
prior to, and as a complement to, the Fast ForWord programs.
SPEECH AND LANGUAGE PROFESSIONALS. We have experienced positive
year-over-year retention rates with speech and language professionals operating
in private practice. Our year-over-year retention rates for professionals who
have two or more clients using our programs is 93%, and our overall year-over-
year retention rate is 76%. We intend to continue to expand the marketing of our
products to speech and language professionals operating in private practice,
private schools and hospitals and clinics.
To administer our products, we currently require that a speech and language
professional attend a training seminar. To date, these training seminars have
been held in more than 20 cities across the United States. We have trained more
than 2,500 speech and language professionals in private practice on how to
administer Fast ForWord and Fast ForWord Two. Generally, these seminars
currently involve two days of training and generally list for $695 per person.
Trained speech and language professionals in private practice recommend the use
of our products to parents in appropriate cases and then administer the program
in connection with providing traditional services. In such instances, Fast
ForWord and Fast ForWord Two are typically sold to parents for a list price of
$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. Our products could be used as supplemental to, or
potentially as a partial replacement of, traditional private reading remediation
programs provided by speech and language professionals, which we estimate
typically cost between $15,000 and $20,000. We believe that our programs
generally do not decrease the earnings of speech and language professionals who
use them in their practice because they allow the professionals to reach more
children in need of services and to focus their professional services on each
child's specific areas of need. In addition, we intend to market and sell our
Away We Go! family of products to the private speech and language professionals
for use by their students prior to and as a complement to the Fast ForWord
program.
We began marketing our Fast ForWord programs to speech and language
professionals in March of 1997 and have developed a proprietary database of
information regarding thousands of speech and language professionals. We contact
speech and language professionals through telesales and other direct marketing
efforts to encourage them to attend our seminars and use Fast ForWord programs
in their practices. In addition, speech and language professionals learn of our
programs through our
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participation in trade conferences, publications in journals and the general
press and the distribution of our informational videos and practice kits.
DIRECT-TO-CONSUMER SALES AND MARKETING. We believe that there is a
significant market for our products in sales directly to consumers. We are
currently focusing our direct distribution efforts on direct mail channels and
Internet-based sales. We currently market to consumers directly through mailings
to parents of Fast ForWord participants and other parents in select target
markets. We are developing a product catalog that would be sent directly to
parents and consumers enabling them to purchase products directly from us. For
our electronic-based sales, we are extending the capabilities of our web sites,
to make purchasing of products and services online easier.
OTHER CHANNELS OF DISTRIBUTION. We are exploring and developing other
channels of distribution, including strategic alliances with for-profit
educational services companies, day care providers and private schools.
Our future success is, in part, dependent on acceptance of our products by
public schools, administrators, educators, parents and speech and language and
other professionals and on penetration of the public school, speech and language
professional and parental markets. We may not be successful in developing and
penetrating these markets. See "Risk Factors--Our business depends on whether we
can achieve and maintain market acceptance and increase the number of programs
we commercially introduce and sell," "--Any difficulty in penetrating necessary
markets could adversely affect our business," and "--Our quarterly operating
results are susceptible to fluctuations which could cause our stock price to
decline."
INTERNET STRATEGY
Our current web site, ScientificLearning.com, is an important method of
daily communication between us and users of Fast ForWord and Fast ForWord Two
and enables our users to maximize the benefit of our Fast Forward programs. The
site includes:
- For everyone--a variety of information for anyone interested in learning
more about our products and services, how the brain learns language and
reading, upcoming seminars, professional meetings and parent meetings;
- For parents--a description of behaviors often exhibited by children who
could benefit from our products, and a searchable index to help find local
providers of our programs;
- For children--a section that includes coloring books and games on line;
- For educators in schools--information about public and private funding
sources, assistance in writing grants, help in selecting children for Fast
ForWord programs, tips from other educators on the use of Fast ForWord in
classrooms;
- For Fast ForWord providers in private practice--business support, such as
advice from other professionals on marketing Fast ForWord and effectively
running off-site programs for people training at home;
- For parents, educators and providers--chat sessions, forums and communal
e-mail lists where they can share information and experiences, ask
questions of other parents or providers, share tips and anecdotes about
the progress of Fast ForWord participants, or ask questions of our
scientists; and
- For Fast ForWord learning facilitators and parents--performance reports
and summary progress reports for each of the individuals or groups
participating in Fast ForWord, based on daily Internet transmission of
detailed training results.
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We recently launched a separate web site, BrainConnection.com, to provide
parents, children, educators, researchers and speech and language and other
professionals with trusted educational resources and services.
BrainConnection.com focuses on how the brain functions generally, not just on
how the brain learns language and reading, and is designed to provide the latest
neuroscience research and other related topics. By aggregating global education
resources and information onto one site, we believe BrainConnection.com enables
parents, children, educators, professionals, researchers and others interested
in reliable information on educational development to communicate and interact,
creating a community online.
BrainConnection.com is designed to provide an individualized experience that
allows access to, and interaction with, information that is tailored to each
visitor's particular interests and goals. The site contains a magazine/journal
component providing a means through which new material may be presented and
written materials may be purchased. We plan to add community services, such as
forums and chat rooms, to the site to allow users to receive periodic updates on
new information and material that can be accessed on the site.
BrainConnection.com also allows visitors to purchase products and services of
other companies online, and we plan to make some of our products available for
purchase online in the future.
TECHNOLOGY
Our products are cross-platform, software-based programs available for a
variety of hardware and software configurations. Our products are designed to
work with the computer technology widely available in schools and homes,
minimizing the need for users to purchase new equipment. We offer the programs
in a variety of configurations, including an on-site model where educators and
speech and language and other professionals supervise children in their offices,
an off-site model where children can train from their homes and a
client/server-based model for larger scale deployments. All of our existing
products link to the ScientificLearning.com web site via standard, secure
Internet connections for data transfer and updates. Parents, educators and other
learning professionals can use any web browser to upload program results to our
database and monitor individuals under their supervision.
Products are typically delivered via a CD ROM which can be activated only by
receiving user access code delivered via the ScientificLearning.com web site.
Continued access to the program requires periodic uploads of performance data
over the Internet. If users do not upload data within a required time period,
access to the program is denied.
We use an object-oriented authoring environment for all our software
products. New products and product extensions can be built off our core object
model, allowing all products to benefit from improvements in the core code and
reducing new product development time. The Scientific Learning database
maintains a performance history on every user of a Fast ForWord product. The
database is unique and highly scalable, built on database technology from Oracle
Corporation, and capable of dynamic information queries. Using a proprietary set
of analytical tools, we automatically generate summaries and reports for use by
the educator, parent and speech and language or other professional. We can also
generate custom demographic reports from specific groups of users by defining
search characteristics such as school, classroom or common primary language. The
resulting reports show exactly how a given user is performing and what
challenges remain. The Fast ForWord databases at the client site are tightly
integrated with our databases to provide seamless service from professional and
technical support to accounting.
RESEARCH AND DEVELOPMENT
Approximately one third of our employees are engaged in research and
development activities, which include both product development and outcomes
research. Our research and development organization includes neuroscientists,
psychologists, engineers, programmers, statisticians, graphic artists and
animators. We believe that our future success depends in large part on our
ability to develop new products and maintain and enhance our current product
line. Our success also depends on our ability
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to enhance our market positioning by leveraging our expertise in neuroscience
and technology, which we believe has broad applicability. Accordingly, we plan
to expand our research and development activities with respect to present and
future products based on our expertise in neuroscience. We also are examining
ways to leverage our expertise in neuroscience research into other potential
non-language-based products, including computer-based remediation programs for
repetitive stress injury and tinnitus (ringing in the ears).
We can not assure you that: (1) we will be successful in developing and
marketing new products or responding to technological developments, evolving
industry standards or changing customer requirements; (2) we will not experience
difficulties that could delay or prevent the successful development,
introduction and sale of new products; or (3) 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, our business,
operating results and financial condition could be materially and adversely
affected. See "Risk Factors--Our business will suffer if we are unable to
introduce new products as scheduled or if new products are unsuccessful."
THE LANGUAGE LEARNING PROCESS
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. 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 reading. 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. 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 these phonemes with the three letters "d," "o" and
"g." Our founders 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. These individuals frequently
have difficulty with other language skills, including morphology, syntax,
semantics and grammar, and executive function skills, such as short-term memory
and event sequencing capabilities. In a 1998 published study, the National
Institute of Child Health and Human Development at the National Institutes of
Health has found that there is a strong correlation between these language-based
learning problems and difficulties in learning to read.
Our scientific founders working at UCSF noted that the human brain changes
in response to stimuli, a trait known as brain plasticity. Their work
demonstrated that specific 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, our 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. The scientists used the
computers and their knowledge of language learning techniques and neuroscience
to design exercises that continually adjust to challenge each child
appropriately with customized training. Through thousands of repetitions of
individualized exercises focused on important aspects of language, these
children could gradually master natural speech sounds and develop other language
skills, such as morphology, syntax, semantics and grammar, and executive
function skills, such as short-term memory and event sequencing capabilities,
critical to learning to read and to becoming a better reader. Our founders
established our company to move this research as rapidly as possible from
laboratories into products and services designed to improve human learning and
performance.
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Our scientific founders postulated that the gain in oral language
comprehension skills demonstrated by children in the initial study, 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 many language difficulties. We
believe that the manner in which the brain processes speech and language is not
yet fully understood. When we refer 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--There is
academic debate regarding the scientific basis underlying our products which
could significantly affect the market for our programs and services."
EFFICACY STUDIES
We were founded by scientists who have spent over 25 years researching
neuroscience and the causes of language-based learning problems at UCSF and
Rutgers. The original research studies combining the work of our 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" 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.
We have 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 we mandated and supply pre- and
post-assessment testing data on each child. Most of the children in the study
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 used 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 performance gains of one to two years on
standardized tests.
The independent speech and language professionals involved in the 1996 field
trial were asked to test the children before and after the trial on those
standardized tests which the independent professionals typically used to measure
language performance. The largest number of children were tested on the TOLD-I:2
and TOLD-P:2 tests, which are individually administered comprehensive language
tests. These Tests of Language Development or TOLD tests are widely accepted
tests among speech and language professionals that assess a child's performance
in various aspects of language performance, such as listening, speaking,
semantics and syntax, and compare those results to results of the general
population. A total of 196 children in the study were tested before and after
the Fast ForWord training on these TOLD tests. Other standardized tests used by
professionals involved in the 1996 field trials were generally less
comprehensive and administered to fewer 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. As indicated by the following
chart, prior to participation in the Fast ForWord program, only 19% of the
children scored at or above the average performance level of the general
population, or the population mean. After completion of the Fast ForWord
program, 52% of the children scored at or above the population mean.
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[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 TOLD-P:2 tests. Statisticians
express this group's result as t(195)=18.21, p < .0001, to communicate that
the changes in the scores reflected in the above graphs, or histograms,
indicate with more than 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
from factors of chance.
2 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 which indicates that on average
these children achieved a score higher than only 15% of the general
population. Counting those children who performed at the same level as the
average of the general population as well as those performing above that
level, we can say that before the training, some 19% scored at or above the
average of the general population, or the population mean.
3 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 which indicates that on
average these children achieved a score higher than 41% of the general
population. Counting those children who performed at the same level as the
average of the general population as well as those performing above that
level, we can say that some 52% scored at or above population mean. The bell
curve indicates that after training, the group's results approximated those
found in the general population.
4 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, test scores are
converted by statistical methods 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. In the general population, 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. A bell curve
is superimposed on the results to show the normal distribution of results in
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. This second study 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
the traditional classroom
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curriculum for the same amount of time. The children trained for 100 minutes a
day, five days a week for four to eight weeks. Again, more than 90% of the
children who tested as language learning impaired (and more than 70% of the
children overall) and who completed the Fast ForWord training demonstrated gains
of one to two years on standardized tests, consistent with the results in
earlier studies. On average, children in the control group showed less than a
third of those gains on standardized tests. Similar results have also been
observed in the overall group of children who have used the Fast ForWord program
commercially.
INTELLECTUAL PROPERTY
We have a broad intellectual property strategy addressing both product
technology and product concepts. We aggressively protect our proprietary rights
in our products and technology through a combination of patents, trademarks,
copyrights, trade secret laws, confidentiality procedures and contractual
provisions. As of March 31, 1999, we have filed patent applications in the
United States and internationally relating to our technology, including 38 with
the USPTO. Of these 38 patent applications, 33 are exclusively owned by us, four
are jointly owned by us and The Regents of the University of California and one
is jointly owned by us and an individual inventor. To date, one patent has been
granted and we have received notification of allowance on five additional
patents.
Pursuant to a license with The Regents of the University of California, we
are 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 subject of a patent issued in September
1998.
Our primary products, Fast ForWord and Fast ForWord Two, incorporate this
licensed technology. In addition, the professional version of our recently
launched Away We Go! Bookshelf CD ROM and CD Storybooks incorporates this
licensed technology. To date, more than 80% of our revenues have come from
selling programs using the licensed technology. While our seminars and other
services and some of our new Away We Go! Products do not make use of this
licensed technology, virtually all of our revenues from programs and services
relate to the base products which do use the licensed technology and its loss
would likely cause material harm to our business.
If we lose or are unable to maintain the license agreement during the term
of the underlying patents, it would materially harm our business. It could delay
or prevent the introduction of new products and would likely require the recall
of most of our products from the market. Even if we could identify and license
or develop non-infringing equivalent technology, which is far from certain, the
cost and delays from such a changeover in our base technology would likely cause
material harm to our business.
We cannot be certain that any of our or the licensor's additional pending
patent applications will result in the issuance of any patents, or that, if
issued, any of these patents will offer protection against competitors with
similar technology. We cannot assure you that any patents issued to us or the
licensors will not be challenged, invalidated or circumvented in the future or
that the rights created thereunder will provide a competitive advantage. In
addition, our competitors may apply for and obtain patents covering technologies
that are more effective than our technologies. This could render our
technologies or products obsolete or uncompetitive or prevent, limit or
interfere with our ability to make, use or sell our products either in the
United States or in international markets.
Our current products incorporate technologies which are the subject of
patents issued to, and patent applications filed by, others. We have obtained
licenses for certain of these technologies and may be required to obtain
licenses for others. We do not believe that we are currently using technology
that is subject to patents held by third parties without a license. However, if
needed we may not be able to obtain licenses for technology patented by others
on commercially reasonable terms, or at all. We also may not be able to develop
alternative approaches if we are unable to obtain necessary licenses. We cannot
assure you that our current and future licenses will be adequate for the
operation
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of our business. The failure to obtain necessary licenses or identify and
implement alternative approaches could have a material adverse effect on our
business, financial condition and results of operations.
Under the terms of the license with The Regents of the University of
California, we must pay royalties and milestone payments based upon cumulative
net sales of our products, subject to certain minimum royalty amounts. In
connection with this license, we issued 114,526 shares of Series A preferred
stock, which is convertible into 114,526 shares of common stock upon completion
of this offering, to Rutgers and made other up-front payments. In fiscal 1998,
we had approximately $356,000 in royalty expense under the license, on program
revenues subject to royalties of approximately $4.5 million. In the first
quarter of 1999, we had approximately $64,000 in royalty expense, on program
revenues of approximately $1.1 million, of which approximately $800,000 was
subject to royalties under the licence. In 1999 and each year thereafter during
the term of the license, the minimum royalty expense necessary to maintain the
license will be $150,000. We expect royalties as a percentage of program
revenues to decline over time as additional programs are sold and, as a
consequence, the royalty rate under the license steps down. It may also decline
to the extent that our product mix becomes less reliant on licensed technology,
although we cannot predict our future product mix.
Unless otherwise terminated by operation of law or acts of the parties, the
license remains in effect until the later of the expiration of the
last-to-expire patent licensed or the abandonment of the last patent application
licensed. The Regents may terminate the license agreement if we fail to perform
or violate its terms without curing the violation within 60 days of receiving
written notice of the violation. For example, The Regents could terminate the
agreement if we fail to perform the following obligations:
- make royalty and milestone payments;
- provide periodic progress reports;
- bear the costs to prepare, file and prosecute U.S. and foreign patent
applications;
- provide indemnification;
- insure our activities in connection with work under the agreement; and
- maintain the confidentiality of information received from The Regents
relating to the agreement.
If we lose or are unable to maintain the license agreement, this could delay
our introduction of new products or could require the recall of our products
from the market. Even if we could identify and license technology equivalent to
the technology covered by the license agreement, developing and integrating
alternative technology would likely delay our product line.
We also rely upon trade secrets, technical know-how and continuing invention
to develop and maintain our competitive position. There is some risk that others
may independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets or disclose this
technology. We may also be unable to meaningfully protect our right to our trade
secrets. Any of these could have a material adverse effect on our business,
financial condition and results of operations. See "Risk Factors--We rely on our
intellectual property rights and may be unable to protect these rights."
COMPETITION
The educational technology market in which we operate is very competitive.
We believe that the principal competitive factors in the industry are efficacy,
ability to deliver measurable results, cost, efficiency of delivery, ability to
provide training to educators, parents and speech and language and other
professionals and ability to complement and supplement public school curriculum.
We believe that we compete favorably on the basis of these factors. We compete
primarily against providers of traditional methods of remediation for language
and reading problems, which typically require several
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years of one-on-one training for children with identified language and reading
problems. Although the traditional approach to language and reading problems is
fundamentally different from the approach we take, these programs are more
widely known and accepted and, therefore, represent significant competition. In
addition, we compete to some extent with other companies offering educational
software products to schools and to speech and language professionals in private
practice. Existing competitors may continue to broaden their product lines, and
potential competitors, including large software developers and educational
publishers, may enter or increase their focus on the school market, resulting in
greater competition. Moreover, we expect that we will face additional
competition from new entrants into the market. Many competitors have
substantially greater technical, marketing and distribution resources than we
do. There can be no assurance that we will continue to be able to market our
products successfully or compete effectively in the educational technology
market. See "Risk Factors--Our business will suffer if customers delay or forego
purchases of our products because of our product enhancements or new products or
because of competitors' superior products."
EMPLOYEES
As of March 31, 1999, we had 139 full-time and 24 part-time employees. We
believe our relations with employees are good. None of our employees is
represented by a union or subject to collective bargaining agreements. See "Risk
Factors--If we fail to retain our key personnel or attract and retain key
employees, our business will suffer."
PROPERTIES
We lease a 34,257 square-foot facility in Berkeley, California under a
five-year lease that expires in September 2002. We believe our facilities are
adequate for our current operations but we may need to seek additional space
within the next 18 months.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth various information concerning our directors,
executive officers and certain key employees as of March 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------------------- ----------- ------------------------------------------------------------
<S> <C> <C>
Sheryle J. Bolton............................ 52 President, Chief Executive Officer and Member of the Board
of Directors
Dr. Michael M. Merzenich..................... 56 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............................. 44 Chief Financial Officer, Vice President, Finance, and
Secretary
Diane H. Church.............................. 52 Vice President, Sales
Bernard G. Fraenkel.......................... 40 Vice President, Engineering
Dr. William M. Jenkins....................... 48 Vice President, Product Development
Dr. Steven L. Miller......................... 35 Vice President, Outcomes Research
James A. Mills............................... 43 Vice President, Marketing
Patricia A. Murphy........................... 43 Vice President, Human Resources
Dr. Bret E. Peterson......................... 36 Vice President, Internet and Database Systems
Dr. Kathleen M. Hocker....................... 58 Director, Public School Sales
Carleton A. Holstrom (1)(2).................. 63 Member of the Board of Directors
Rodman W. Moorhead, III (1).................. 55 Member of the Board of Directors
James E. Thomas (2).......................... 38 Member of the Board of Directors
David A. Tanner (2).......................... 40 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 our Chief Executive Officer and as a
director since November 1996 and as our President since June 1997. From January
1994 to July 1995, Ms. Bolton served as President and Chief Operating Officer of
Physicians' Online, Inc., a physicians' online service provider. From June 1993
to December 1994 and from July 1995 to October 1996, Ms. Bolton consulted for a
number of international companies, including many in the Internet, 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 is a director of
HealthCentral.com, a private Internet consumer healthcare information company.
Ms. Bolton holds a B.A. in English and an M.A. in Linguistics from the
University of Georgia, and an M.B.A. from Harvard Business School.
DR. MICHAEL M. MERZENICH is one of our founders. He has served as our Chief
Scientific Officer since November 1996 and as a director since inception. From
January 1996 to November 1996, Dr. Merzenich served as the Chief Executive
Officer and President of the Company. During 1997, Dr. Merzenich worked
full-time with us during a sabbatical from his faculty position at UCSF. In
January 1998, Dr. Merzenich returned to his faculty position at UCSF, but
continues to direct our research and development activities under a consulting
agreement. Since 1971, Dr. Merzenich has been
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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 one of our founders. She has served as our Executive
Vice President and Chairman of the board of directors since January 1996 and as
a director since our inception. During 1997, Dr. Tallal worked full-time with us
during a sabbatical from her faculty position at Rutgers. In January 1998, Dr.
Tallal returned to her faculty position at Rutgers, but continues to consult
with us pursuant to a consulting agreement. Since 1988, Dr. Tallal has served as
co-director of the Center for Molecular and Behavioral Neuroscience at Rutgers.
Dr. Tallal is an active participant in many scientific advisory boards and
governmental committees for both developmental language disorders and learning
disabilities. Dr. Tallal has over 20 years experience managing multi-site,
multi-disciplinary federally funded contracts and grants that have resulted in
over 150 publications, as well as national and international honors. Dr. Tallal
holds a B.A. in Art History from New York University and a Ph.D. in Experimental
Psychology from Cambridge University with additional training from The Johns
Hopkins University.
FRANK M. MATTSON has served as our Chief Financial Officer and Vice
President, Finance since January 1997 and as our Secretary 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.
DIANE H. CHURCH has served as our Vice President, Sales since June 1999,
having previously served as Vice President, Private Channel Sales since August
1997. From February 1997 to August 1997, Ms. Church was Georgia Account Team
Manager with Compuware Corporation, an information systems software and services
company. Ms. Church was Mid-Atlantic Regional Director and Regional Director for
Telecommunications Accounts at Candle Corporation from April 1994 to September
1995 and at Legent Corporation Regional Director for Mid-Atlantic and then
South-Eastern Regional Director from April 1990 to April 1994, both of which are
information systems software and services companies. Prior to that time, Ms.
Church held senior management positions with Wang Laboratories, a computer and
office equipment company. Ms. Church also worked as an educator in public
schools in the State of Georgia. Ms. Church holds a B.A. in English and
Education from Georgia Southwestern College and an M.B.A. from Emory University.
BERNARD G. FRAENKEL has served as our Vice President, Engineering since
April 1999. From August 1996 until April 1999, Mr. Fraenkel served as Vice
President of Engineering at One Touch Systems, a joint venture of Hughes Network
Systems and Apollo Group, Inc., which is a leading provider of interactive
distance learning systems. From January 1996 until July 1996, he was a founder
of Pixel Engines, a developer of DVD authoring systems. From December 1993 until
December 1995, Mr. Fraenkel was Director of Research and Development with Sigma
Designs, a provider of MPEG
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products and integrated circuits for personal computers. He previously served as
Director of Engineering with Teknekron Communications Systems, where he led an
engineering team on consulting projects in the areas of data and wireless
communications, multimedia and VLSI design. Mr. Fraenkel holds Graduate Engineer
degrees from Ecole Polytechnique and Ecole National Superieure des University
Paris IX and an M.S. in Electrical Engineering and Computer Science from the
University of California at Berkeley.
DR. WILLIAM M. JENKINS is a founder and has served as our Vice President,
Product Development since June 1997. From March 1996 to June 1997, Dr. Jenkins
was our Vice President, Research and Development. Since 1990, Dr. Jenkins has
also served as an Adjunct Associate Professor at UCSF. Dr. Jenkins currently
serves on the editorial board in the Systems Plasticity section of RESTORATIVE
NEUROLOGY AND NEUROSCIENCE. Dr. Jenkins is the principal developer of our
current training programs. Dr. Jenkins holds a B.S. in Psychology, an M.A. in
Psychobiology and a Ph.D. in Psychobiology from Florida State University, with
additional post-doctoral training from UCSF.
DR. STEVEN L. MILLER is a founder and has served as our Vice President,
Outcomes Research since June 1997. From May 1996 to June 1997, Dr. Miller was
our Vice President, Professional Relations and Outcomes. From September 1991 to
May 1996, he held research appointments at the Center for Molecular and
Behavioral Neuroscience at Rutgers. Dr. Miller has extensive experience in
organizing clinical research studies and conducting longitudinal studies of
children and adults who have language and reading problems. Dr. Miller holds a
B.A. in Psychology from Bloomsburg University of Pennsylvania, an M.A. in
Neuroscience from the University of Hartford and a Ph.D. in Psychology from the
University of North Carolina at Greensboro. He received additional training in
Clinical Neuropsychology at the Bowman Gray School of Medicine at Wake Forest
University.
JAMES A. MILLS has served as our Vice President, Marketing, since April,
1999, having previously served as Director of Marketing since August, 1998. He
joined our company in July, 1997, as Director, Business Development. Prior to
joining our company, Mr. Mills was a consultant advising California-based
clients on financial and operational issues. From 1986 to 1996, Mr. Mills was
with Citibank, holding positions with various sales and marketing
responsibilities, most recently as a Vice President responsible for domestic and
overseas-based clients. Mr. Mills previously worked in cable television
marketing, promotion and public affairs for Viacom International, Inc., as well
as for a cable programming start-up venture and a national cable marketing trade
association. Mr. Mills holds a B.S. from Stanford University and an M.B.A. from
Harvard Business School.
PATRICIA A. MURPHY has served as our Vice President of Human Resources since
November 1998. From 1990 to November 1998, Ms. Murphy served as Vice President,
Human Resources with Broderbund Software, a leading publisher of educational
software and games. Ms. Murphy has also worked as Personnel Manager with
Lucasfilm Ltd, and as an organization development consultant to Kaiser
Permanente and local school districts offering management development, conflict
resolution and strategic planning. Ms. Murphy currently serves on the board of
the Carlston Foundation. Ms. Murphy holds a B.A. in Mass Communication and
Sociology from the University of California, Santa Cruz and an M.A. in Human
Resources and Organization Development from the University of San Francisco.
DR. BRET E. PETERSON has served as our Vice President, Internet and Database
Systems since June 1996. From January 1995 to March 1996, Dr. Peterson served as
a research scientist at Yale University and he was a post-doctoral fellow at Los
Alamos National Laboratory from January 1994 to December 1995. From September
1993 to November 1993, Dr. Peterson provided consulting services to Bio-Rad
Laboratories, Inc. Previously, 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. Dr. Peterson is the principal
developer of our Internet database performance tracking system.
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<PAGE>
DR. KATHLEEN M. HOCKER has served as our Director, Public School Sales,
since March 1998. From November 1996 to December 1997, Dr. Hocker was the
National Sales Manager, Interactive Products for Steck-Vaughn 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 United
States for Computer Curriculum Corporation, a division of Simon & Schuster. From
October 1993 to January 1995, she was Marketing Director for Ligature, Inc., 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. She also has eight years of
teaching experience at the elementary, special and higher education levels. 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.
CARLETON A. HOLSTROM is a founder and has been a director since February
1996. From February 1996 to January 1997, Mr. Holstrom also served as our 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 director 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 our Board in accordance with
rights held by Warburg, Pincus Ventures, relating 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 Board must nominate Mr.
Moorhead, or another individual designated by Ventures and reasonably acceptable
to the Board, and use its best efforts to cause Mr. Moorhead or such other
individual to be elected to the Board. See "Transactions and Relationships with
Related Parties--Board Representation Right." Mr. Moorhead is a director of
Coventry Health Care, Inc., ElderTrust, 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 from Harvard University and an M.B.A. from Harvard
Business School.
JAMES E. THOMAS has been a director since November 1996. Since 1989, he has
been employed by E.M. Warburg, 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 our Board in accordance with rights held by
Ventures, relating 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 Board must nominate Mr. Thomas, or another individual
designated by Ventures and reasonably acceptable to the Board, and use its best
efforts to cause Mr. Thomas or such other individual to be elected to the Board.
See "Transactions and Relationships with Related Parties--Board Representation
Right." Mr. Thomas is also a director of 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.
DAVID A. TANNER has been a director since January 1999. Since June 1998, Mr.
Tanner has been a Managing Director of Lazard Freres & Co. LLC. From 1993 until
1997, he served as a Managing Director at E.M. Warburg, having worked in other
capacities at E.M. Warburg since 1986. Mr. Tanner holds a J.D. from New York
University School of Law, a degree in Economics from the London School
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<PAGE>
of Economics and a B.A. from Princeton University. Mr. Tanner serves as a
director of several privately-held companies.
EDUCATION ADVISORY BOARD
We have established an Education Advisory Board consisting of members that
are leaders in the fields of education, neuroscience, behavioral science, health
and public policy. The advisory board provides us with experienced counsel on
matters relevant to ongoing research and development of our products. The
advisory board reflects our multi-disciplinary approach by offering a broad base
of knowledge, including research from neuroscience, cognitive neuropsychology,
education, reading and language, engineering, bioethics, public health and
medicine. Members of the advisory board are appointed for a three-year term.
The members of the advisory board are set forth below. Except as otherwise
noted, each of the members of the advisory board was appointed in April 1999.
JOAN ELIZABETH BALDWIN is an educator with more than 25 years of experience
focusing on early elementary reading instruction and childhood learning
disabilities. She is the recipient of the 1999 Outstanding Educator of the Year
Award from the Learning Disabilities Association of America, as well as the
recipient of the Pennsylvania Learning Disabilities Association's 1998
Outstanding Educator of the Year Award. Ms. Baldwin is also a Fellow in the
National Writing Project.
DR. CHARLES I. BERLIN is professor of Otorhinolaryngology and Physiology and
Director of the Kresge Hearing Research Laboratory of the South at LSU Medical
School in New Orleans. He is also a practicing licensed audiologist. His
clinical activities specialize in fitting hearing aids with real ear measurement
to children and adults. He is the recipient of numerous awards and a founding
member of the Advisory Board to the National Institute of Deafness and Other
Communications Disorders. He has authored numerous articles relating to hearing
and speech. Dr. Berlin will become an active participant on the Education
Advisory Board on June 1, 1999.
DR. FERNANDO A. GUERRA currently serves as Director of Health for the San
Antonio Metropolitan Health District. He is also a clinical professor at the
University of Texas in the Department of Pediatrics. In addition to his training
as a medical doctor, Dr. Guerra has served on numerous associations and task
forces as a public health professional. He is a frequent speaker on public
health matters affecting children, including immunization and disease
prevention, and has served in an advisory capacity to local, state and national
childhood development programs, including Head Start.
ALAN T. OLKES is a founder and chief of operations for Cambridge Academic, a
company that forms and operates private schools, and manages charter schools. He
has been a consultant to Haskell Education Services, where he wrote and
successfully attained charters for three schools. He is a former superintendent
of schools in Dade County, Florida, having served in the Dade County school
system for more than 30 years. He has taught music, mathematics, English and
social studies and has served in numerous administrative positions, including
principal, director of management information systems and supervisor of support
operations.
DR. ALBA A. ORTIZ is a professor in the Department of Special Education and
director of the Office of Bilingual Education at The University of Texas at
Austin. She has served as co-chair of the Exceptional Needs Standards Committee
for the National Board for Professional Teaching Standards and is a member of
the National Educational Research Policy and Priorities Board. Dr. Ortiz is a
former President of the International Council for Exceptional Children.
DR. CHARLES R. THOMAS has served in various educational and administrative
positions for more than 30 years. He is associated with Plath, Nielsen, Rodger
Associates, a management consulting firm, and has previously served as assistant
superintendent of the Illinois State Board of Education and superintendent of
both North Chicago Community Unit School District 187 and North Chicago
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Elementary School District 64. He is currently the Professor of Educational
Leadership at National Louis University in Evanston, Illinois.
P. MICHAEL TIMPANE currently serves as a Senior Advisor for Education Policy
with RAND. From 1994 to 1997, he served as Vice President and Senior Scholar at
the Carnegie Foundation for the Advancement of Teaching. He previously served at
Teachers College, Columbia University, as president, dean and professor of
education. He serves on the boards of Children's Television Workshop, the
Southern Education Foundation, Jobs for the Future and the Visiting Committee of
the Harvard Graduate School of Education.
OCTAVIO J. VISIEDO is currently an educational consultant with OV
Educational Concepts, having served as the superintendent of schools in Dade
County, Florida from 1990 until 1996. In his capacity as superintendent, Mr.
Visiedo managed the United States' fourth-largest school district with 330,000
K-12 students and 150,000 adult students.
BOARD OF DIRECTORS COMPOSITION
We currently have authorized seven directors. In accordance with the terms
of the certificate of incorporation that will become effective upon the closing
of this offering, the terms of office of the directors will be divided into
three classes: Class I, Class II and Class III. The terms for each class will
expire at the annual meetings of stockholders to be held in 2000, 2001 and 2002
(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
Mr. Tanner, 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 of an annual meeting, 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 of the third annual meeting. In addition, the certificate
of incorporation provides that the authorized number of directors may be changed
only by resolution of the 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. Although directors
may be removed for cause by the affirmative vote of the holders of a majority of
the common stock, the certificate of incorporation 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 our voting
stock.
BOARD COMMITTEES
The board of directors has an audit committee and a compensation committee.
The audit committee, currently composed of Messrs. Holstrom, Thomas and Tanner,
reviews our internal accounting procedures and consults with and reviews the
services provided by our independent auditors. The compensation committee,
currently composed of Messrs. Holstrom and Moorhead, reviews and recommends the
compensation and benefits matters to the board of directors. The compensation
committee also administers the issuance of stock options and other awards under
our equity incentive plans.
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DIRECTOR COMPENSATION
We currently provide cash compensation to directors who are not our
employees or consultants and do not hold five percent or more of our voting
securities for services as directors. This compensation includes $1,000 per
regular meeting of the board of directors attended in person and $500 per
committee meeting and per meeting of the board of directors attended by
telephone. Directors will also be reimbursed for various expenses in connection
with attendance at board and committee meetings. Directors are currently
eligible to participate in our stock option plan. Beginning with the completion
of this offering, employee directors will also be eligible to participate in our
1999 Employee Stock Purchase Plan and non-employee directors will be eligible to
participate in the 1999 Non-Employee Directors' Stock Option Plan. See
"--Employee Benefit Plans."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the compensation committee have been an officer or
employee, except that Mr. Holstrom served as our Chief Financial Officer from
February 1996 to March 1997. No executive officer serves as a member of the
board of directors or compensation committee of any entity that has one or more
executive officers serving on our board of directors or compensation committee.
EXECUTIVE COMPENSATION
The following table sets forth the compensation awarded or paid during the
fiscal year ended December 31, 1998 to our Chief Executive Officer and the other
most highly compensated officer receiving compensation in excess of $100,000 in
1998 (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE (1)
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION -------------------
SECURITIES
------------------------ UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION (2) SALARY ($) BONUS OPTIONS COMPENSATION ($)
- ------------------------------------------------------ ----------- ----------- ------------------- -------------------
<S> <C> <C> <C> <C>
Sheryle J. Bolton, Chief Executive Officer............ 220,000 -- 16,666 225(3)
Frank M. Mattson, Chief Financial Officer............. 166,000 -- 19,000 --
Diane H. Church, Vice President, Sales................ 127,000 -- 2,333 368(4)
James A. Mills, Vice President, Marketing............. 103,757 -- 10,332 --
</TABLE>
- ------------------------
(1) In accordance with the rules of the Securities and Exchange 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 and various perquisites
and other personal benefits received by the Named Executive Officers, which
do not exceed the lesser of $50,000 or 10% of any officer's salary and bonus
disclosed in this table.
(2) In determining compensation packages for our officers, we currently take
into consideration the equity held by the officer. Accordingly, some
officers may receive smaller compensation packages than other officers with
comparable responsibilities.
(3) Represents the costs of membership in an airline club.
(4) Represents the costs of membership in a health club.
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<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options made during the
year ended December 31, 1998 to each of the Named Executive Officers:
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT
ASSUMED ANNUAL RATES
OF STOCK
NUMBER OF INDIVIDUAL GRANTS APPRECIATION FOR
SECURITIES % OF TOTAL OPTIONS ---------------------------- OPTION TERM (4)
UNDERLYING OPTIONS GRANTED IN FISCAL EXERCISE PRICE EXPIRATION ----------------------
NAME GRANTED (1) 1998 (2) ($/SHARE) (3) DATE 5% ($) 10% ($)
- ---------------------------------- ------------------- --------------------- --------------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Sheryle J. Bolton................. 16,666 4.8 $ 6.00 12/16/08 $ 307,488 $ 547,478
Frank M. Mattson.................. 15,000 4.3 2.25 4/30/08 333,000 549,000
4,000 1.2 6.00 12/16/08 73,800 131,400
Diane H. Church................... 2,333 0.7 6.00 12/16/08 43,044 76,639
James E. Mills.................... 333 0.1 0.75 1/13/08 7,892 12,687
9,999 2.9 6.00 12/16/08 184,482 328,467
</TABLE>
- ------------------------
(1) Each of the options was granted under our 1999 Equity Incentive Plan and has
a term of 10 years, subject to earlier termination upon the occurrence of
events related to termination of employment. The option grants for Ms.
Bolton and Mr. Mattson vest as to 1/48(th) of the total shares on a monthly
basis from the date of grant. The option grants for Ms. Church and Mr. Mills
vest as to 1/60(th) of the total shares on a monthly basis from the date of
grant.
(2) Based on an aggregate of 346,488 shares subject to options granted to our
employees in 1998, 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 on the date of grant.
(4) The potential realizable values are computed by (a) multiplying the number
of shares of common stock subject to a given option by an assumed initial
public offering price of $15.00 per share, (b) assuming that the aggregate
stock value derived from that calculation compounds at the annual 5% or 10%
rate shown in the table for the entire ten-year term of the option and (c)
subtracting from that result the aggregate option exercise price. The 5% and
10% assumed annual rates of stock price appreciation are mandated by the
rules of the SEC and do not represent our estimate or projection of future
common stock prices.
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<PAGE>
AGGREGATED OPTION EXERCISES IN FISCAL 1998
AND YEAR-END OPTION VALUES
The following table sets forth for each of the Named Executive Officers the
number and value of securities underlying unexercised options held by such Named
Executive Officer at December 31, 1998:
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES AT DECEMBER 31, 1998 (1) AT DECEMBER 31, 1998 (2)
ACQUIRED ON VALUE ------------------------------ -----------------------------
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------ ------------- ------------- ----------- ----------------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Sheryle J. Bolton............. -- -- 333,333 -- $ 1,899,999 $ --
16,666 0
Frank M. Mattson.............. 1,666 9,496 45,000 -- 256,500 --
8,333 44,998
15,000 56,250
4,000 0
Diane H. Church............... -- -- 33,333 -- 100,000 --
2,333 0
James E. Mills................ -- -- 10,000 -- 54,000 --
333 1,748
9,999 0
</TABLE>
- ------------------------
(1) Options may be exercised immediately under early exercise provisions
contained in option agreements. Any unvested shares issued under 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 terminates at a rate of 1/48th per month
for Ms. Bolton and Mr. Mattson and at a rate of 1/60th per month for Ms.
Church and Mr. Mills. See "Principal Stockholders."
(2) Based on the difference between the deemed fair market value of the common
stock at December 31, 1998 ($6.00 per share) and the exercise price.
EMPLOYEE BENEFIT PLANS
1999 EQUITY INCENTIVE PLAN. Our 1999 Equity Incentive Plan was adopted by
the board of directors in April 1999 and was approved by our stockholders in May
1999. The incentive plan amends and restates our existing option plan adopted in
February 1996 and amended in September 1996. As of April 30, 1999, there were
options outstanding to purchase an aggregate of 1,193,474 shares of our common
stock under the prior plan. The incentive plan will become effective upon
completion of this offering. There are currently 1,903,299 shares of common
stock reserved for future 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, to employees
(including officers). The incentive plan also provides for the grant of
nonstatutory stock options, restricted stock purchase awards, stock bonuses and
stock appreciation rights to employees (including officers), directors and
consultants. 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. The exercise price for an incentive
stock option cannot be less than 100% of the fair market value of
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<PAGE>
the common stock on the date of grant. Prior to our 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 us or any affiliate of ours ceases for
any reason may exercise vested options for the term provided in the option
agreement.
No incentive stock option (and prior to our 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 our total
combined voting power or any affiliate, 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 our plans and those of our affiliates) may not exceed
$100,000.
When we become subject to Section 162(m) of the Internal Revenue 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 420,000 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 Section 162(m) limitation set forth above.
Restricted stock purchases may be at any price determined by the board of
directors 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 descent and distribution or a domestic relations order during
the time the stock awarded under a stock bonus or restricted stock bonus
agreement remains subject to the agreement.
In the event of specified 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 these
awards, the vesting provisions of these stock awards will be accelerated and
these stock awards will be terminated upon the change in control if not
previously exercised. In the event of an acquisition under Section 13(d) or
14(d) of the Securities Exchange Act of 1934 of securities representing at least
50% of our combined voting power, the vesting of stock awards will be
accelerated immediately upon the occurrence of this event.
1999 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN. Our 1999 Non-Employee
Directors' Stock Option Plan was adopted by the Board of Directors in April 1999
and was approved by our stockholders in May 1999. The Plan provides for the
automatic grant of options to purchase shares of common stock to non-employee
directors. The board of directors administers the directors' plan, unless the
board of directors 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 75,000 shares.
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<PAGE>
Each non-employee director will automatically be granted an option to
purchase shares of our common stock upon the completion of this offering and
each anniversary thereafter. Any individual who becomes a non-employee director
after this offering will automatically be granted an initial grant upon being
elected to the board of directors and an annual grant on each anniversary of the
date the non-employee director was first elected as a member of the Board during
his or her service as a non-employee director.
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. 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 us or any
affiliate of ours (whether as a non-employee director 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 specified 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 the 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 under Section 13(d) or 14(d) of the
Securities Exchange Act of 1934 of securities representing at least 50% of our
combined voting power, the vesting of options will be accelerated immediately
upon the occurrence of such event.
1999 EMPLOYEE STOCK PURCHASE PLAN. Our 1999 Employee Stock Purchase Plan
was adopted by the Board of Directors in April 1999 and was approved by our
stockholders in May 1999. The plan authorizes the issuance of 350,000 shares of
common stock under purchase rights granted to our employees or to employees of
any affiliate of ours. 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 our
common stock through payroll deductions. The purchase plan is implemented by
offerings of rights to eligible employees. Under the plan, we 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 us or by an affiliate of ours 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 the
employee's rights to purchase our stock to accrue at a rate which exceeds
$25,000 of fair market value of the stock for each calendar year in which the
rights are outstanding. No employee shall be eligible for the grant of any
rights under the purchase plan if immediately after the rights are granted, such
employee has voting power over 5% or more of our 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, we adopted a tax-qualified employee savings
and retirement plan covering all of our employees. Under this 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
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limit ($10,000 in 1998) and have the amount of this 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 us
when made. We may make matching or additional contributions to the 401(k) plan,
in amounts to be determined annually by the board of directors.
CONSULTING AGREEMENTS
In September 1996, we entered into consulting agreements with Dr. Merzenich
and Dr. Tallal. The agreement with Dr. Merzenich enables him to continue to
direct our research and development activities 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 us through
December 31, 2001. The amounts paid to Dr. Merzenich or Dr. Tallal under their
consulting agreements did not exceed $60,000 in 1998. See "Transactions and
Relationships with Related Parties."
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
In June 1998, the board of directors authorized us to enter into indemnity
agreements with each of our directors and executive officers. The form of
indemnity agreement provides that we will indemnify against any and all expenses
of the director or executive officer who incurred expenses because of his or her
status as a director or executive officer, to the fullest extent permitted by
our bylaws.
Our certificate of incorporation and bylaws contain provisions relating to
the limitation of liability and indemnification of directors and officers. The
certificate of incorporation provides that directors will not be personally
liable to us or our stockholders for monetary damages for any breach of
fiduciary duty as a director, except for liability: (1) for any breach of the
directors' duty of loyalty to us or our stockholders; (2) for acts or omissions
not in good faith or which involve intentional misconduct or a knowing violation
of law; (3) 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 (4) for any transaction from which the director
derives any improper personal benefit. The certificate of incorporation also
provides that if the Delaware General Corporation Law is amended after the
approval by our stockholders of the certificate of incorporation to authorize
corporate action further eliminating or limiting the personal liability of
directors, then the liability of the directors will be eliminated or limited to
the fullest extent permitted by the Delaware law. In addition, as permitted by
Section 145 of the Delaware General Corporation Law, our bylaws provide that we
will indemnify our directors and executive officers and may indemnify our 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. We have purchased a directors' and officers' liability
insurance policy providing coverage up to specified amounts for losses incurred
by us, our directors or officers in connection with specified claims against
them, including specified claims under state and federal securities laws.
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TRANSACTIONS AND RELATIONSHIPS WITH RELATED PARTIES
From April to September 1996, we issued an aggregate of 963,101 shares of
our Series A preferred stock, of which 761,951 shares were sold at a price of
$2.55 per share to investors and 61,728 shares were sold at a price of $2.43 per
share to Drs. Merzenich, Holstrom and Jenkins under an employee stock purchase
plan. In October and November 1996, we issued an aggregate of 1,499,999 shares
of Series B preferred stock at a price of $2.70 per share. In connection with
the sale of Series B preferred stock, we also issued warrants to purchase a
total of 952,380 shares of Series C preferred stock with an exercise price of
$4.20 per share (all of which warrants have since been exercised). From December
1998 to January 1999, we issued an aggregate of 1,833,332 shares of Series D
preferred stock at a price of $9.00 per share. In connection with the sale of
Series D preferred stock, we also issued a warrant to purchase 7,222 shares of
Series D preferred stock with an exercise price of $11.25 per share. Listed
below are the directors, executive officers and five percent stockholders who
have made equity investments to purchase shares of our preferred stock or common
stock. See "Principal Stockholders."
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C SERIES D
COMMON PREFERRED PREFERRED PREFERRED PREFERRED AGGREGATE
INVESTOR STOCK STOCK STOCK STOCK STOCK CONSIDERATION
- --------------------------------------- --------- ----------- ---------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Dr. Michael M. Merzenich............... 833,333 20,576 -- -- -- $ 51,000
Dr. Paula A. Tallal.................... 833,333 -- -- -- -- $ 1,000
Dr. William M. Jenkins................. 555,558 20,576 -- -- -- $ 50,667
Dr. Steven L. Miller................... 123,450 -- -- -- -- $ 148
Warburg, Pincus Ventures, L.P. (1)..... -- -- 1,481,481 952,380 1,111,111 $ 17,999,994
Carleton A. Holstrom (2)............... 154,315 40,184 -- -- -- $ 100,186
David A. Tanner (3).................... -- -- -- -- 555,555 $ 4,999,995
</TABLE>
- ------------------------
(1) Messrs. Moorhead and Thomas, our directors, are affiliated with Warburg,
Pincus Ventures. Does not include warrants to purchase 116,666 shares of our
common stock issued to Warburg, Pincus Ventures in June and October 1998 in
connection with Warburg, Pincus Ventures' guarantee of an unsecured line of
credit obtained by the Company.
(2) Includes 19,608 shares of Series A preferred stock held by the Solon Edward
Trust #2, for which Mr. Holstrom serves as trustee.
(3) Includes 555,555 shares held by LF SL Holding LLC. Mr. Tanner is affiliated
with Lazard Capital Partners LLC, the Managing Member of LF SL Holding LLC.
The holders of our Series B, C and D preferred stock are entitled to
registration rights with respect to the common stock issued or issuable upon
conversion of the Series B, C or D preferred stock. 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, we entered into an
agreement that requires us, following the completion of this offering and as
long as Warburg, Pincus Ventures owns at least 10% or 20% of the outstanding
common stock, to nominate and use our best efforts to elect one or two
individuals, respectively, designated by Warburg, Pincus Ventures for election
to the board or directors. See "Risk Factors--Our executive officers and
directors and their affiliates hold a majority of our outstanding capital stock"
and "Description of Capital Stock--Board Representation Rights."
In June 1998, we obtained a $3.0 million unsecured line of credit from
BankBoston, N.A. which was guaranteed by Warburg, Pincus Ventures. This line of
credit has since been paid off in full. In connection with Warburg, Pincus
Ventures providing this guarantee, we issued to Warburg, Pincus Ventures
warrants to purchase 116,666 shares of our common stock at $9.00 per share.
These warrants expire on May 31, 2003. Additionally, in order to enable us to
repay the outstanding balance on lines of
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<PAGE>
credit, Warburg, Pincus Ventures agreed to purchase up to 333,333 shares of our
capital stock at $9.00 per share if requested by us. Our right to require
Warburg, Pincus Ventures to purchase such securities was cancelled in connection
with the closing of our Series D preferred stock financing in December 1998.
Under our license with The Regents of the University of California, we are
obligated to make license-issue fee payments, royalty payments, milestone
payments and other 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, among others, and subsequently assigned
to The Regents. This patent was granted by the USPTO in September 1998. Drs.
Tallal and Merzenich are members of our board of directors, and Drs. Jenkins and
Miller are vice presidents with us. These payments include our obligation to
make minimum royalty payments which commenced the year of our first commercial
sale. In 1999, and for each year thereafter during the term of the license, the
minimum royalty payment will be $150,000. To date, we have paid $200,000 and
issued a net of 114,526 shares of Series A preferred stock, convertible upon the
closing of this offering into 114,526 shares of our common stock, in
satisfaction of all license-issue fees owed under the license and are current on
all royalty payments due under the license. To date, a milestone payment of
$50,000 has become due under the license. However, total aggregate milestone
payments under the license are expected to be $350,000, with individual
milestone payments being dependent upon our achieving specified net sales. We
expensed an aggregate of $415,000 for royalty and milestone payments under the
license for the year ended December 31, 1998. Pursuant to separate patent
policies of The Regents and Rutgers, as well as understandings between inventors
affiliated with each university, each university distributes to those inventors
affiliated with the university, on an annual basis, a portion of the payments
received from us. To date, the amounts distributed to each inventor under 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 these figures are tied to our future performance; however, we
estimate that less than 0.5% of product sales during the term of the license
will be payable by the universities to each inventor. The license was negotiated
by us on an arms-length basis, without involvement by the inventors.
Ms. Bolton's husband, Stephen Shane, is a principal of TouchStar
Communications, which has produced some of our promotional and training videos.
The total compensation paid to TouchStar for production services was
approximately $58,000 in 1998 and approximately $28,000 through April 1999.
We believe that the foregoing transactions were in our best interest. As a
matter of policy these transactions were, and all future transactions between us
and any of our 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 us than could be obtained from unaffiliated third parties
and in connection with bona fide business purposes. See "Management--Consulting
Agreements."
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PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our common stock as of April 30, 1999 (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): (1)
each person (or group of affiliated persons) who is known by us to own
beneficially more than five percent of the common stock; (2) each of the Named
Executive Officers; (3) each of our directors; and (4) all directors and
executive officers 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).............................................. 3,661,638 44.8% 35.0%
466 Lexington Avenue
New York, NY 10017
LF SL Holding LLC (3)........................................................... 555,555 6.8 5.3
30 Rockefeller Plaza, 62(nd) Floor
New York, NY 10020
Sheryle J. Bolton (4)........................................................... 346,667 4.1 3.3
Dr. Michael M. Merzenich (5).................................................... 670,574 8.2 6.4
Dr. Paula A. Tallal (6)......................................................... 803,843 9.8 7.7
Frank M. Mattson (7)............................................................ 73,999 *
Dr. William M. Jenkins.......................................................... 565,022 6.9 5.4
Diane H. Church (8)............................................................. 35,666 * *
James A. Mills (9).............................................................. 30,332 * *
Carleton A. Holstrom (10)....................................................... 194,449 2.4 1.9
Rodman W. Moorhead, III (2)(11)................................................. 3,661,638 44.8 35.0
James E. Thomas (2)(11)......................................................... 3,661,638 44.8 35.0
David A. Tanner (12)............................................................ 555,555 6.8 5.3
All directors and executive officers as a group (11 persons) (13)............... 6,937,745 83.0% 65.1%
</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 8,170,509 shares of common
stock outstanding as of April 30, 1999 and 10,470,509 shares of common stock
outstanding upon completion of this offering.
(2) Includes 116,666 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 Warburg, Pincus Ventures. The
sole general partner of Warburg, Pincus Ventures is Warburg, Pincus & Co., a
New York general partnership. E.M. Warburg, Pincus & Co., LLC, a New York
limited liability company, manages Warburg, Pincus Ventures. The members of
E.M. Warburg, Pincus & Co., LLC are substantially the same as the partners
of Warburg, Pincus & Co. Lionel I. Pincus is the managing partner of
Warburg, Pincus & Co. and the managing member of E.M. Warburg, Pincus & Co.
LLC and may be deemed to control both Warburg, Pincus & Co. and E.M.
Warburg, Pincus & Co. LLC. Warburg, Pincus & Co. has a 15% interest in the
profits of Warburg, Pincus
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Ventures as the general partner and also owns approximately 1.5% of the
limited partnership interests in Warburg, Pincus Ventures. See "Transactions
and Relationships with Related Parties."
(3) Mr. Tanner, a director of the Company, is affiliated with Lazard Capital
Partners LLC, the Managing Member of LF SL Holding LLC. Mr. Tanner is a
Managing Director of Lazard Freres & Co. LLC, the Managing Member of Lazard
Capital Partners LLC.
(4) Includes 283,333 shares subject to immediately exercisable stock options,
150,695 shares of which will be vested as of June 29, 1999 and the remaining
132,638 shares which would be subject to repurchase if purchased prior to
vesting.
(5) Includes 249,999 shares of common stock beneficially owned directly by Dr.
Merzenich, 403,909 shares of common stock held in the Merzenich Family Trust
and 16,666 shares subject to vested stock options.
(6) Includes 670,510 shares of common stock beneficially owned directly by Dr.
Tallal and 133,333 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.
(7) Includes 46,223 shares subject to immediately exercisable stock options,
8,371 of which will be vested as of June 29, 1999 and the remaining 37,852
shares which would be subject to repurchase if purchased prior to vesting.
(8) Includes 24,996 shares subject to immediately exercisable stock options,
1,745 shares of which will be vested as of June 29, 1999 and the remaining
23,251 shares which would be subject to repurchase if purchased prior to
vesting.
(9) Includes 30,332 shares subject to immediately exercisable stock options,
7,562 shares of which will be vested as of June 29, 1999 and the remaining
22,770 shares which would be subject to repurchase if purchased prior to
vesting.
(10) Includes 154,315 shares held by the Holstrom Family Limited Partnership and
19,608 shares held in the Solon Edward Trust #2, for which Mr. Holstrom
serves as trustee. Mr. Holstrom disclaims beneficial ownership of the shares
held in the Solon Edward Trust #2 within the meaning of Rule 13d-3 under the
Securities Act of 1934.
(11) All of the shares indicated as owned by Messrs. Moorhead and Thomas are
owned directly by Warburg, Pincus Ventures, L.P. and are included because of
each individual's affiliation with Warburg, Pincus Ventures, L.P. Messrs.
Moorhead and Thomas are both our directors. Mr. Thomas is a Managing
Director of E.M. Warburg, Pincus & Co., LLC and a general partner of
Warburg, Pincus & Co. Mr. Moorhead is a Senior Managing Director of E.M.
Warburg, Pincus & Co., LLC and a general partner of Warburg, Pincus & Co. 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 Warburg, Pincus Ventures. Each of Messrs. Moorhead and Thomas
disclaim 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.
(12) Includes 555,555 shares held by LF SL Holding LLC. Mr. Tanner is affiliated
with Lazard Capital Partners LLC, the Managing Member of LF SL Holding LLC.
(13) Includes the information in notes (1) through (11), as applicable.
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DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock and provisions of our
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 Registration Statement, of which this
prospectus is a part.
Upon the closing of this offering, our authorized capital stock will consist
of 40,000,000 shares of common stock, $0.001 par value per share, and 1,000,000
shares of preferred stock, $0.001 par value per share.
COMMON STOCK
As of April 30, 1999, there were 8,170,509 shares of common stock
outstanding held by 133 holders of record, which reflects the conversion of all
outstanding shares of preferred stock into common stock. 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 dividends as may be declared by the Board out of
funds legally available therefor. See "Dividend Policy." In the event of a
liquidation, dissolution or winding up of our 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, B,
C and D preferred stock will be converted into 5,232,146 shares of common stock.
See Note 5 to Financial Statements for a description of currently outstanding
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 of these shares of preferred stock,
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 the 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 the
holders will receive dividend payments and payments upon liquidation and could
have the effect of delaying, deferring or preventing a change in control. We
have no present plan to issue any shares of preferred stock.
REGISTRATION RIGHTS
Under a registration rights agreement, some of our stockholders are entitled
to rights with respect to the registration of approximately 4,285,711 shares of
common stock under the Securities Act of 1933. If we propose to register any of
our securities under the Securities Act, these stockholders are entitled to
notice of registration and are entitled to include their shares therein at our
expense, subject to certain limitations. In addition, these stockholders may
require us at our expense to register their shares on Form S-3 when the form
becomes available for use by us. Our stockholders who have registration rights
include Warburg, Pincus Ventures, LF SL Holding LLC, GC&H Investments and HLM/CB
Fund, L.P.
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BOARD REPRESENTATION RIGHTS
Under a purchase agreement with Warburg, Pincus Ventures, among others, we
are required, following the completion of this offering and for so long as
Warburg, Pincus Ventures owns beneficially and of record at least 20% of the
outstanding shares of common stock, to nominate and use our best efforts to have
two individuals designated by Warburg, Pincus Ventures and reasonably acceptable
to us, elected to the board of directors. In addition, we are required,
following the completion of this offering and for so long as Warbug, Pincus
Ventures owns beneficially and of record at least 10% of the outstanding shares
of common stock, to nominate and use our best efforts to have one individual,
designated by Warburg, Pincus Ventures and reasonably acceptable to us, elected
to the board of directors.
DELAWARE ANTI-TAKEOVER LAW AND CHARTER PROVISIONS
We are subject to the provisions of Section 203 of the Delaware General
Corporation 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 of the Delaware General Corporation Law, 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, our certificate of
incorporation and 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 certificate of incorporation and the bylaws will also
require the affirmative vote of the holders of at least 66 2/3% of the voting
power of the outstanding shares to remove a director without cause or amend our
bylaws. In addition, a 66 2/3% vote will be required to amend specified
provisions of the certificate of incorporation, including provisions regarding
managing our 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 certificate of incorporation
authorizes the board of directors to issue up to 1,000,000 shares of preferred
stock and to determine the rights, preferences and privileges of these shares of
preferred stock 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 may be called only by the board of directors, the
chairman of the board of directors 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 our outstanding voting stock, or delay,
prevent or deter a merger, acquisition or tender offer in which our stockholders
could receive a premium for their shares, a proxy contest or other change in our
management. See "Risk Factors--Our charter provisions could have the effect of
delaying or preventing corporate take-overs."
TRANSFER AGENT AND REGISTRAR
BankBoston, N.A. has been appointed as the transfer agent and registrar for
our common stock. The transfer agent's address is 150 Royall Street, Canton,
Massachusetts and its telephone number is (781) 575-2000.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of this offering, we will have outstanding 10,470,509
shares of common stock, based on the number of shares of common stock
outstanding as of April 30, 1999 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 of 1933. The remaining 8,170,509 shares of common stock held by
existing stockholders are restricted securities within the meaning of the
Securities Act. These 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 of 1933. We have granted
holders of 4,285,711 restricted shares rights with respect to the registration
of these shares. See "Description of Capital Stock--Registration Rights."
Holders of 7,992,457 shares of our 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
contractual restrictions and the provisions of Rule 144 and 701, additional
shares will be available for sale in the public market as follows: (i) 106,601
restricted shares will be eligible for immediate sale on the date of this
prospectus; (ii) 681,273 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) 6,148,014
restricted shares will be eligible for sale 180 days after the date of this
prospectus upon expiration of lock-up agreements; and (iv) 123,888 shares of
common stock issuable upon exercise of currently outstanding warrants and
1,844,443 other shares 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 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 ours within
the meaning of Rule 405 under the Securities Act of 1933, of restricted shares
as to which at least one year has elapsed since the date of the holder's
acquisition of such shares from us 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 one percent of the then outstanding shares of common stock
(approximately 104,705 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 Securities and Exchange Commission. Sales under Rule 144 are subject to
various requirements relating to manner of sale, notice and availability of
current public information about us. However, a person (or persons whose shares
are aggregated) who is not deemed to have been an affiliate of ours at any time
during the 90 days immediately preceding the sale and who beneficially owns
restricted shares is entitled to sell 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 us or from an affiliate of ours.
The foregoing is a summary of Rule 144 and is not intended to be a complete
description of that rule.
Subject to various 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 us by our 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 these persons. In addition, the Securities and
Exchange Commission has indicated that Rule 701 will apply to stock options
granted by us 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
65
<PAGE>
provisions of Rule 144 and by affiliates under Rule 144 without compliance with
its one-year minimum holding period requirement.
We intend to file a registration statement on Form S-8 under the Securities
Act covering shares of common stock reserved for issuance under our option
plans. See "Management--Employee Benefit Plans." This 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 ours, be available for sale in the open market, unless such
shares are subject to vesting restrictions or the lock-up agreements described
above. As of April 30, 1999, options to purchase 1,193,474 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 our 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 in the public market after completion of
this offering could materially and adversely affect the prevailing market price
and our ability to raise equity capital in the future.
66
<PAGE>
UNDERWRITING
GENERAL
We intend to offer our common stock through a number of underwriters.
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), Thomas
Weisel Partners LLC and Pacific Growth Equities, Inc. are acting as
representatives of each of the underwriters named below. Subject to the terms
and conditions set forth in a purchase agreement among our company and the
underwriters, we have agreed to sell to the underwriters, and each of the
underwriters severally and not jointly has agreed to purchase from us the number
of shares of common stock indicated below opposite its name, at the public
offering price less the underwriting discount.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...........................................................
Thomas Weisel Partners LLC.......................................................
Pacific Growth Equities, Inc.....................................................
----------
Total........................................................................ 2,300,000
----------
----------
</TABLE>
In the purchase agreement, the several underwriters have agreed, subject to
the terms and conditions set forth in the agreement, to purchase all of the
shares of common stock being sold under the terms of the agreement if any of the
shares are purchased. In the event of a default by an underwriter, the purchase
agreement provides that, under some circumstances, the purchase commitments of
the nondefaulting underwriters may be increased or the purchase agreement may be
terminated.
Generally, we have agreed to indemnify each underwriter against liability
arising out of any untrue statement contained in the registration statement, any
preliminary prospectus or the final prospectus, or the omission of a material
fact required to be stated in the registration statement or such prospectus
necessary to make the statements in the registration statement or such
prospectus not misleading. In addition, we have agreed to indemnify each
underwriter against liablity arising out of violations of laws or regulations of
foreign jurisdictions where reserved shares have been offered. The underwriters
have agreed to indemnify us against liability with respect to untrue statements
or omissions, or alleged untrue statements or omissions, made in the
registration statement, any preliminary prospectus or the final prospectus in
reliance upon and in conformity with written information furnished to us by that
underwriter through Merrill Lynch expressly for use in the registration
statement, such preliminary prospectus or the prospectus. For more detailed
information on the terms of indemnification contained in the purchase agreement,
please see Exhibit 1.1 to the registration statement.
The shares of common stock are being offered by the several underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of various legal matters by counsel for the underwriters and other
conditions. The underwriters reserve the right to withdraw, cancel or modify
this offer and to reject orders in whole or in part.
In this prospectus, references to "underwriters" means any person who
purchases shares of common stock directly from us in connection with the
distribution of shares in this offering. References to "representatives" means
Merrill Lynch, Thomas Weisel Partners LLC and Pacific Growth Equities, Inc. who
have entered into an agreement with us and are acting on behalf of the
underwriters in the
67
<PAGE>
offering. References to "dealers" means any person who acts as an agent, broker
or principal in the business of dealing or trading in securities issued by
another person. In connection with this offering, a "dealer" is an agent, broker
or principal who buys our common stock from the underwriters to sell to others.
Dealers will not buy directly from us. "Selling group members" are the group of
dealers who sell our securities in the public market.
OVER-ALLOTMENT OPTION
We have granted an option to the underwriters, exercisable for 30 days after
the date of this prospectus, to purchase up to an aggregate of 345,000
additional shares of our common stock at the public offering price set forth on
the cover page of this prospectus, less the underwriting discount. The
underwriters may exercise this option solely to cover over-allotments, if any,
made on the sale of the common stock offered hereby. To the extent that the
underwriters exercise this option, each underwriter will be obligated to
purchase a number of additional shares of common stock proportionate to the
underwriter's initial amount reflected in the foregoing table.
COMMISSIONS AND DISCOUNTS
The representatives of the underwriters have advised us that the
underwriters propose initially to offer the shares of common stock to the public
at the initial public offering price set forth on the cover page of this
prospectus, and to certain dealers at that price less a concession not in excess
of $ per share of common stock. The underwriters may allow, and such
dealers may reallow, a discount not in excess of $ per share of common
stock to certain other dealers. After the initial public offering, the public
offering price, concession and discount may change.
The following table shows the per share and total underwriting discount to
be paid by us to the underwriters and the proceeds before expenses to us. This
information is presented assuming either no exercise or full exercise by the
underwriters of their over-allotment option.
<TABLE>
<CAPTION>
WITHOUT WITH
PER SHARE OPTION OPTION
---------- ---------- ---------
<S> <C> <C> <C>
Public offering price..................................................... $ $ $
Underwriting discount..................................................... $ $ $
Proceeds, before expenses, to Scientific Learning......................... $ $ $
</TABLE>
The underwriting fee will be an amount equal to the offering price per share
to the public of the common stock, less the amount paid by the underwriters to
Scientific Learning per share of common stock. The underwriting fee is currently
expected to be approximately 7% of the initial public offering price. The
expenses of the offering, exclusive of the underwriting discount, are estimated
at $900,000 and are payable entirely by us. The expenses consist of the
following:
- a registration fee of $12,788;
- an NASD filing fee of $4,732;
- Nasdaq application fee of $78,875;
- estimated blue sky qualification fees and expenses of $3,000;
- estimated printing and engraving expenses of $150,000;
- estimated legal fees and expenses of $400,000;
- estimated accounting fees and expenses of $200,000;
- estimated transfer agent and registrar fees of $25,000; and
- estimated miscellaneous fees and expenses of $25,605.
68
<PAGE>
RESERVED SHARES
The public offering price, underwriting discount and other terms set forth
in the purchase agreement were approved by the pricing committee of our board of
directors.
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to five percent of the shares offered hereby to be
sold to people associated with us or our directors, officers or employees, such
as vendors, suppliers, existing stockholders and other persons that have
relationships with or are interested in us. No shares have been reserved for our
directors, officers or employees. The number of shares of our common stock
available for sale to the general public will be reduced to the extent that
those persons purchase the reserved shares. Any reserved shares which are not
orally confirmed for purchase within one day of the pricing of this offering
will be offered by the underwriters to the general public on the same terms as
the other shares offered by this prospectus.
NO SALES OF SIMILAR SECURITIES
We and our officers and directors and existing stockholders holding 78.0% of
our capital stock outstanding after this offering have agreed, with certain
exceptions, without the prior written consent of Merrill Lynch on behalf of the
underwriters for a period of 180 days after the date of this prospectus not to,
directly or indirectly:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right
or warrant for the sale of, lend otherwise dispose of or transfer any
shares of our common stock or securities convertible into or exchangeable
or exercisable for or repayable with our common stock, or file a
registration statement under the Securities Act relating to any shares of
our common stock or
- enter into any swap or other agreement that transfers, in whole or in
part, the economic consequence of ownership of our common stock, whether
any such swap or transaction is to be settled by delivery of our common
stock or other securities, in cash or otherwise.
QUOTATION ON THE NASDAQ NATIONAL MARKET
We expect our common stock to be approved for quotation on the Nasdaq
National Market, subject to official notice of issuance, under the symbol
"SCIL." Before this offering, there has been no public market for our common
stock. The initial public offering price will be determined through negotiations
among us and the representatives. The primary factors to be considered in
determining the initial public offering price, in addition to prevailing market
conditions, are the valuation multiples of publicly traded companies that the
representatives believe to be comparable to us, our financial information, the
history of, and the prospects for, our company and the industry in which we
compete, and an assessment of our management, its past and present operations,
the prospects for, and timing of, future revenues of our company, the present
state of our development, and the above factors in relation to market values and
various valuation measures of other companies engaged in activities similar to
ours. We cannot assure you that an active trading market will develop for our
common stock or that our common stock will trade in the public market subsequent
to this offering at or above the initial public offering price.
The underwriters do not expect sales of the common stock to any accounts
over which they exercise discretionary authority to exceed five percent of the
number of shares being offered in this offering.
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of our common stock is completed, the rules of the
Securities and Exchange Commission may limit the ability of the underwriters and
certain selling group members to bid for and
69
<PAGE>
purchase our common stock. As an exception to these rules, the representatives
are permitted to engage in transactions that stabilize the price of our common
stock. These transactions consist of bids or purchases for the purpose of
pegging, fixing or maintaining the price of our common stock.
If the underwriters create a short position in our common stock in
connection with this offering, that is, if they sell more shares of our common
stock than are set forth on the cover page of this prospectus, the
representatives may reduce that short position by purchasing our common stock in
the open market. The representatives may also elect to reduce any short position
by exercising all or part of their over-allotment option.
The representatives may also impose a penalty bid on underwriters and
selling group members if the representatives purchase shares of our common stock
in the open market to reduce the underwriters' short position or to stabilize
the price of our common stock. The representatives may reclaim the amount of the
selling concession from the underwriters and selling group member who sold those
shares.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of these purchases. The imposition of a penalty bid
might also have an effect on the price of our common stock to the extent that it
discourages resales of our common stock.
Neither our company nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of our common stock. In addition, neither
our company nor any of the underwriters makes any representation that the
representatives or the lead managers will engage in these transactions or that
these transactions, once commenced, will not be discontinued without notice.
Thomas Weisel Partners LLC, one of the representatives, was organized and
registered as a broker-dealer in December 1998. Since December 1998, Thomas
Weisel Partners has been named as a lead or co-manager on 39 filed public
offerings of equity securities, of which 17 have been completed, and has acted
as a syndicate member in an additional 16 public offerings of equity securities.
Thomas Weisel Partners does not have any material relationship with us or any of
our officers, directors or other controlling persons, except with respect to its
contractual relationship with us under the purchase agreement entered into in
connection with this offering.
ELECTRONIC PROSPECTUS
A prospectus in electronic format is being made available on an Internet web
site maintained by Wit Capital Corporation. Wit Capital, a member of the
National Association of Securities Dealers, Inc., will participate in the
offering as one of the Underwriters. The National Association of Securities
Dealers, Inc. approved the membership of Wit Capital on September 4, 1997. Since
that time, Wit Capital has acted as an underwriter, e-Manager or selected dealer
in over 100 public offerings. Except for its participation as a manager in this
offering, Wit Capital has no relationship with us or any of our founders or
significant stockholders. The electronic version of this prospectus located on
the web site maintained by Wit Capital includes an additional copy of the table
of contents under the artwork set forth on the inside front cover of the
prospectus. This is the only difference between the printed prospectus and the
electronic prospectus.
70
<PAGE>
LEGAL MATTERS
The validity of the shares of common stock offered hereby is being passed
upon by Cooley Godward LLP, San Francisco, California. 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 18,518 shares of our preferred stock which will convert into 18,518 shares
of our common stock upon the closing of this offering. Additionally, attorneys
at Cooley Godward have requested the opportunity to purchase an aggregate of
2,300 of the shares reserved for sale to people associated with us or our
directors.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 1997 and 1998, and for each of the three
years in the period ended December 31, 1998, as set forth in their report. We
have included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on their
authority as experts in accounting and auditing.
AVAILABLE INFORMATION
We have filed with the Commission a registration statement on Form S-1 under
the Securities Act of 1933 with respect to the common stock offered by this
prospectus. This prospectus does not contain all of the information set forth in
the registration statement and the exhibits and schedules to the registration
statement. For further information about us and the common stock we are
offering, you should refer to the registration statement and the exhibits and
the financial statements, notes and schedules filed as part of the registration
statement. You may read and obtain a copy of the registration statement at the
Commission's Public Reference Room at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. You may obtain information on the
operation of the Public Reference Room by calling the Commission at
1-800-SEC-0330. The Commission maintains a web site that contains reports, proxy
statements and other information regarding registrants, including our reports
and information. The address of the Commission's web site is http://www.sec.gov.
Upon completion of this offering, we will be subject to the informational
requirements of the Securities Exchange Act of 1934. So long as we are subject
to periodic reporting requirements of the Securities Exchange Act of 1934, we
will file with the Commission the reports, proxy statements and other
information required thereby. We intend to furnish our 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.
71
<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, 1997 and 1998, and the related statements of
operations, redeemable convertible preferred stock and stockholders' equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 1998. 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, 1997 and 1998, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
Walnut Creek, California /s/ ERNST & YOUNG LLP
January 15, 1999,
except for Note 8, as to which
the date is May 28, 1999
F-2
<PAGE>
SCIENTIFIC LEARNING CORPORATION
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY
-------------------- MARCH 31, MARCH 31,
1997 1998 1999 1999
--------- --------- ----------- -------------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents........................................ $ 2,699 $ 6,362 $ 7,249
Accounts receivable.............................................. 44 799 1,048
Prepaid expenses and other current assets........................ 157 307 389
--------- --------- -----------
Total current assets............................................... 2,900 7,468 8,686
Restricted cash deposit............................................ 350 280 280
Property and equipment, net........................................ 1,120 1,278 1,359
Other assets....................................................... 86 95 96
--------- --------- -----------
Total assets....................................................... $ 4,456 $ 9,121 $ 10,421
--------- --------- -----------
--------- --------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................................. $ 419 $ 731 $ 630
Accrued liabilities.............................................. 356 1,249 868
Deferred revenue................................................. 342 1,649 1,942
Current portion of borrowings under bank line of credit.......... 193 278 230
Current portion of capital lease obligations..................... 21 18 13
--------- --------- -----------
Total current liabilities.......................................... 1,331 3,925 3,683
Borrowings under bank line of credit............................... 97 121 76
Capital lease obligations.......................................... 19 -- --
Other liabilities.................................................. 71 217 219
--------- --------- -----------
Total liabilities.................................................. 1,518 4,263 3,978
Commitments
Redeemable convertible preferred stock, $0.001 par value, issuable
in series:
Authorized shares-8,046,668 (none pro forma)
Issued and outstanding shares-2,452,379 in 1997, 3,730,156 in
1998, 4,285,711 in 1999, and none pro forma (liquidation
preference-- $19,550).......................................... 8,002 18,940 23,836 $ --
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value:
Authorized shares-10,346,668 (including 8,046,668 shares
designated as redeemable convertible preferred stock)
(1,000,000 pro forma)
Issued and outstanding shares-946,435 in 1997, 1998 and 1999,
and none pro forma (liquidation preference--$2,413).......... 2,355 2,355 2,355 --
Common stock, $0.001 par value:
Authorized shares-37,346,668 (40,000,000 pro forma)
Issued and outstanding shares-2,657,788 in 1997, 2,795,781 in
1998, 2,809,427 in 1999, and 8,041,573 pro forma............. 520 2,930 3,504 29,695
Deferred compensation............................................ (384) (1,064) (1,412) (1,412)
Accumulated deficit.............................................. (7,555) (18,303) (21,840) (21,840)
--------- --------- ----------- -------------
Total stockholders' equity (deficit)............................... (5,064) (14,082) (17,393) $ 6,443
--------- --------- ----------- -------------
-------------
Total liabilities and stockholders' equity (deficit)............... $ 4,456 $ 9,121 $ 10,421
--------- --------- -----------
--------- --------- -----------
</TABLE>
See accompanying notes.
F-3
<PAGE>
SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------- --------------------------
1996 1997 1998 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
Revenues:
Programs................................. $ -- $ 2,249 $ 4,462 $ 603 $ 1,076
Services................................. -- 713 704 44 264
------------ ------------ ------------ ------------ ------------
Total revenues............................. -- 2,962 5,166 647 1,340
Cost of revenues:
Programs................................. -- 481 784 127 181
Services................................. -- 468 614 34 152
------------ ------------ ------------ ------------ ------------
Total cost of revenues..................... -- 949 1,398 161 333
------------ ------------ ------------ ------------ ------------
Gross profit............................... -- 2,013 3,768 486 1,007
Operating expenses:
Sales and marketing...................... 164 2,646 6,057 768 2,730
Research and development................. 1,514 1,965 2,880 666 762
General and administrative............... 933 2,537 4,749 820 1,140
------------ ------------ ------------ ------------ ------------
Total operating expenses................... 2,611 7,148 13,686 2,254 4,632
------------ ------------ ------------ ------------ ------------
Operating loss............................. (2,611) (5,135) (9,918) (1,768) (3,625)
Interest income (expense), net............. 70 162 (832) 20 88
Other income (expense), net................ 44 (85) 2 -- --
------------ ------------ ------------ ------------ ------------
Net loss................................... $ (2,497) $ (5,058) $ (10,748) $ (1,748) $ (3,537)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Basic and diluted net loss per share....... $ (1.02) $ (1.90) $ (3.87) $ (0.64) $ (1.26)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Shares used in computing basic and diluted
net loss per share....................... 2,452,621 2,657,222 2,776,775 2,736,811 2,805,044
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Pro forma basic and diluted net loss per
share (unaudited)........................ $ (1.74) $ (0.44)
------------ ------------
------------ ------------
Shares used in computing pro forma basic
and diluted net loss per share
(unaudited).............................. 6,179,110 8,000,175
------------ ------------
------------ ------------
</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>
STOCKHOLDER'S EQUITY (DEFICIT)
----------------------------------------------
REDEEMABLE
CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
---------------------- ---------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock.................................. -- $ -- -- $ -- 2,656,769 $ 12
Issuance of common stock under stock option plan.......... -- -- -- -- 149 --
Issuance of Series A preferred stock, net of issuance
costs................................................... -- -- 831,909 2,046 -- --
Issuance of Series A preferred stock in connection with
license agreement....................................... -- -- 131,192 354 -- --
Issuance of Series B preferred stock, net of issuance
costs................................................... 1,499,999 4,002 -- -- -- --
Net loss and comprehensive loss........................... -- -- -- -- -- --
--------- ----------- --------- ----------- --------- -----------
Balances at December 31, 1996............................... 1,499,999 4,002 963,101 2,400 2,656,918 12
Issuance of common stock under stock option plan.......... -- -- -- -- 870 --
Issuance of Series C preferred stock upon exercise of
warrant, net of issuance costs.......................... 952,380 4,000 -- -- -- --
Reduction of Series A preferred stock issued in connection
with license agreement.................................. -- -- (16,666) (45) -- --
Deferred compensation related to grant of stock options... -- -- -- -- -- 508
Amortization of deferred compensation..................... -- -- -- -- -- --
Net loss and comprehensive loss........................... -- -- -- -- -- --
--------- ----------- --------- ----------- --------- -----------
Balances at December 31, 1997............................... 2,452,379 8,002 946,435 2,355 2,657,788 520
Issuance of common stock under stock option plan.......... -- -- -- -- 137,993 44
Issuance of Series D preferred stock, net of issuance
costs................................................... 1,277,777 10,938 -- -- -- --
Issuance of common stock warrants to preferred stockholder
in connection with guarantee of line of credit and loan
obtained from stockholder............................... -- -- -- -- -- 780
Deferred compensation related to grant of stock options... -- -- -- -- -- 1,586
Amortization of deferred compensation..................... -- -- -- -- -- --
Net loss and comprehensive loss........................... -- -- -- -- -- --
--------- ----------- --------- ----------- --------- -----------
Balances at December 31, 1998............................... 3,730,156 18,940 946,435 2,355 2,795,781 2,930
Issuance of common stock under stock option plan
(unaudited)............................................. -- -- -- -- 13,646 3
Issuance of Series D preferred stock, net of issuance
costs (unaudited)....................................... 555,555 4,896 -- -- -- --
Deferred compensation related to grant of stock options
(unaudited)............................................. -- -- -- -- -- 571
Amortization of deferred compensation (unaudited)......... -- -- -- -- -- --
Net loss and comprehensive loss (unaudited)............... -- -- -- -- -- --
--------- ----------- --------- ----------- --------- -----------
Balances at March 31, 1999 (unaudited)...................... 4,285,711 $ 23,836 946,435 $ 2,355 2,809,427 $ 3,504
--------- ----------- --------- ----------- --------- -----------
--------- ----------- --------- ----------- --------- -----------
<CAPTION>
TOTAL
STOCKHOLDERS'
DEFERRED ACCUMULATED EQUITY
COMPENSATION DEFICIT (DEFICIT)
--------------- ------------ ---------------
<S> <C> <C> <C>
Issuance of common stock.................................. $ -- $ -- $ 12
Issuance of common stock under stock option plan.......... -- -- --
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 and comprehensive loss........................... -- (2,497) (2,497)
------- ------------ ---------------
Balances at December 31, 1996............................... -- (2,497) (85)
Issuance of common stock under stock option plan.......... -- -- --
Issuance of Series C preferred stock upon exercise of
warrant, net of issuance costs.......................... -- -- --
Reduction of Series A preferred stock issued in connection
with license agreement.................................. -- -- (45)
Deferred compensation related to grant of stock options... (508) -- --
Amortization of deferred compensation..................... 124 -- 124
Net loss and comprehensive loss........................... -- (5,058) (5,058)
------- ------------ ---------------
Balances at December 31, 1997............................... (384) (7,555) (5,064)
Issuance of common stock under stock option plan.......... -- -- 44
Issuance of Series D preferred stock, net of issuance
costs................................................... -- -- --
Issuance of common stock warrants to preferred stockholder
in connection with guarantee of line of credit and loan
obtained from stockholder............................... -- -- 780
Deferred compensation related to grant of stock options... (1,586) -- --
Amortization of deferred compensation..................... 906 -- 906
Net loss and comprehensive loss........................... -- (10,748) (10,748)
------- ------------ ---------------
Balances at December 31, 1998............................... (1,064) (18,303) (14,082)
Issuance of common stock under stock option plan
(unaudited)............................................. -- -- 3
Issuance of Series D preferred stock, net of issuance
costs (unaudited)....................................... -- -- --
Deferred compensation related to grant of stock options
(unaudited)............................................. (571) -- --
Amortization of deferred compensation (unaudited)......... 223 -- 223
Net loss and comprehensive loss (unaudited)............... -- (3,537) (3,537)
------- ------------ ---------------
Balances at March 31, 1999 (unaudited)...................... $ (1,412) $ (21,840) $ (17,393)
------- ------------ ---------------
------- ------------ ---------------
</TABLE>
See accompanying notes.
F-5
<PAGE>
SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------- ----------------------------
1996 1997 1998 1998 1999
--------- --------- --------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................. $ (2,497) $ (5,058) $ (10,748) $ (1,748) $ (3,537)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 77 326 1,328 117 177
Loss on disposal of property and equipment.............. -- 85 -- -- --
Preferred stock issued in connection with license
agreement............................................. 354 (45) -- -- --
Amortization of deferred compensation................... -- 124 906 168 223
Changes in operating assets and liabilities:
Accounts receivable................................... -- (44) (755) (13) (249)
Prepaid expenses and other assets..................... (18) (225) (160) (36) (82)
Accounts payable...................................... 115 304 312 (133) (101)
Accrued liabilities................................... 138 218 894 123 (381)
Deferred revenue...................................... 1 341 1,307 118 293
Other liabilities..................................... 100 (29) 146 55 2
--------- --------- --------- ------------- -------------
Net cash used in operating activities..................... (1,730) (4,003) (6,770) (1,349) (3,655)
INVESTING ACTIVITIES
Restricted cash deposit................................... -- (350) 70 -- --
Purchase of property and equipment, net................... (506) (1,045) (700) (39) (259)
--------- --------- --------- ------------- -------------
Net cash used in investing activities..................... (506) (1,395) (630) (39) (259)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock................. 6,048 4,000 10,938 -- 4,896
Proceeds from issuance of common stock.................... 12 -- 44 27 3
Borrowings under bank line of credit...................... -- 355 6,363 -- --
Repayments of borrowings under bank line of credit........ -- (65) (6,254) (48) (94)
Repayments of capital lease obligations................... (2) (15) (28) (6) (4)
--------- --------- --------- ------------- -------------
Net cash provided by (used in) financing activities....... 6,058 4,275 11,063 (27) 4,801
--------- --------- --------- ------------- -------------
Increase (decrease) in cash and cash equivalents.......... 3,822 (1,123) 3,663 (1,415) 887
Cash and cash equivalents at beginning of period.......... -- 3,822 2,699 2,699 6,362
--------- --------- --------- ------------- -------------
Cash and cash equivalents at end of period................ $ 3,822 $ 2,699 $ 6,362 $ 1,284 $ 7,249
--------- --------- --------- ------------- -------------
--------- --------- --------- ------------- -------------
SUPPLEMENTAL DISCLOSURES:
Interest paid........................................... $ 1 $ 32 $ 142 $ 10 $ 8
--------- --------- --------- ------------- -------------
--------- --------- --------- ------------- -------------
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Capital lease obligations incurred...................... $ 37 $ 20 $ 6 $ 6 $ --
--------- --------- --------- ------------- -------------
--------- --------- --------- ------------- -------------
Issuance of common stock warrants in connection with
guarantee of line of credit and loan obtained from
stockholder........................................... $ -- $ -- $ 780 $ -- $ --
--------- --------- --------- ------------- -------------
--------- --------- --------- ------------- -------------
</TABLE>
See accompanying notes.
F-6
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 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 operates in one business segment, which is the development, marketing
and sales of proprietary software and other educational products and services
designed to increase human learning and performance. The Company's revenues have
been derived primarily from two products, Fast ForWord and Fast ForWord Two,
which focus on children aged four to 13. The Company's products are delivered
through a variety of distribution channels, including sales to public schools,
speech and language professionals in private practice and direct-to-consumer
channels.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INTERIM FINANCIAL INFORMATION
The interim financial information as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999 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 three months ended March 31, 1999 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 December 31, 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)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
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. Service revenues are derived from the Company's Fast ForWord training
seminars for learning facilitators and from services provided to customers.
Revenues on sales of Fast ForWord are recognized over the average duration
of the program. Revenues from seminars are recognized when the seminar is held.
Revenues from services provided to customers are recognized over the average
duration of the program. Cancellations and refunds are allowed in limited
circumstances, and such amounts have not been significant. Provisions are made
for cancellations and refunds as revenue is recorded. Costs of revenues are
recognized as such costs are incurred.
ADVERTISING
Advertising costs are expensed as incurred. Advertising expense was $342,000
and $292,000 for the years ended December 31, 1997 and 1998, respectively (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 using 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.
NET LOSS PER SHARE
Basic and diluted net loss per share information for all periods is
presented under the requirement of FAS No. 128, "Earnings per Share" ("FAS
128"). Basic earnings per share has been computed using
F-8
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the weighted-average number of shares outstanding during the period and excludes
any dilutive effects of stock options, warrants, and convertible securities.
Potentially dilutive securities have been excluded from the computation of
diluted net loss per share as their inclusion would be antidilutive.
Pro forma net loss per share has been computed as described above and also
gives effect, 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 THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------------------- ------------------------
1996 1997 1998 1998 1999
--------- --------- --------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Historical:
Net loss............................... $ (2,497) $ (5,058) $ (10,748) $ (1,748) $ (3,537)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Weighted average shares of common stock
outstanding used in computing basic
and diluted net per loss share....... 2,452,621 2,657,222 2,776,775 2,736,811 2,805,044
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Basic and diluted net loss per share... $ (1.02) $ (1.90) $ (3.87) $ (0.64) $ (1.26)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Pro forma (unaudited):
Net loss............................... $ (2,497) $ (5,058) $ (10,748) $ (1,748) $ (3,537)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Shares used in computing basic and
diluted net loss per share (from
above)............................... 2,452,621 2,657,222 2,776,775 2,736,811 2,805,044
Adjustment to reflect the effect of the
assumed conversion of preferred stock
from the date of issuance............ 3,402,335 5,195,131
--------- -----------
Weighted average shares used in
computing pro forma basic and diluted
net loss per share................... 6,179,110 8,000,175
--------- -----------
--------- -----------
Pro forma basic and diluted net loss
per share............................ $ (1.74) $ (0.44)
--------- -----------
--------- -----------
</TABLE>
If the Company had reported net income, the calculation of diluted earnings
per share would have included approximately an additional 24,000, 906,000,
955,000, 956,000 and 987,000 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, 1997
and 1998 and for the three months ended March 31, 1998 and 1999, respectively.
F-9
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Computer equipment.......................................................... $ 1,168 $ 1,707
Office furniture and equipment.............................................. 300 466
Leasehold improvements...................................................... 21 22
--------- ---------
1,489 2,195
Less accumulated depreciation............................................... 369 917
--------- ---------
$ 1,120 $ 1,278
--------- ---------
--------- ---------
</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. Borrowings under the line of credit
bear interest at the bank's prime rate plus 3% (11.5% at December 31, 1998) and
are secured by substantially all of the Company's assets, excluding intellectual
property. At December 31, 1998, the Company had outstanding borrowings in the
amount of $97,000 which are being repaid in equal monthly installments through
June 1999. The agreement restricts the Company's payment of dividends.
In February 1998, the Company entered into an additional line of credit with
the same bank which provided for borrowings of up to $450,000 to finance
equipment purchases during the year ended December 31, 1998. Borrowings are due
in monthly installments through August 2000 plus interest at the bank's prime
rate plus 3% (11.5% at December 31, 1998) and are secured by substantially all
of the Company's assets, excluding intellectual property. At December 31, 1998,
the Company had outstanding borrowings in the amount of $302,000.
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 was pledged as collateral for
the standby letter of credit, which was subsequently reduced to $280,000 in
September 1998. The standby letter of credit will continue to be 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.
In June 1998, the Company obtained a $3.0 million unsecured line of credit
from another bank. Borrowings under the line of credit bore interest, at the
election of the Company, at the bank's base rate or the adjusted LIBOR plus
1.75%. Borrowings were guaranteed by a significant preferred stockholder of the
Company. In connection with such guarantee, the Company issued to the
stockholder warrants to purchase 66,666 shares of the Company's common stock at
$9.00 per share. Such warrants expire on May 31, 2003. The Company estimated the
fair value of the warrants to be $650,000, which was amortized by charges to
interest expense during the year ended December 31, 1998. Additionally, the
stockholder agreed to purchase up to 333,333 shares of the Company's preferred
F-10
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
3. BANK LINE OF CREDIT (CONTINUED)
stock at $9.00 per share if requested by the Company. The Company's right to
require the stockholder to purchase such securities expired upon the closing of
the Series D preferred stock financing in January 1999. Borrowings under the
line of credit were repaid and the line of credit was terminated in December
1998.
In October 1998, the Company obtained a $3.0 million term loan from a
significant preferred stockholder of the Company. Borrowings under this loan
bore interest at 8% per annum. In connection with such loan, the Company issued
to the stockholder warrants to purchase 50,000 shares of the Company's common
stock at $9.00 per share. Such warrants expire on October 23, 2003. The Company
estimated the fair value of the warrants to be $130,000, which was amortized by
charges to interest expense during the year ended December 31, 1998. The loan
was repaid in December 1998.
4. INCOME TAXES
At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $14,000,000. The net operating loss
carryforward will expire in years 2011 through 2018. 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.
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,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................................... $ 2,668 $ 5,370
Deferred revenue.......................................................... -- 660
Research credit carryforwards............................................. 110 210
Other..................................................................... 254 360
--------- ---------
Total deferred tax assets................................................... 3,032 6,600
Valuation allowance......................................................... (3,032) (6,600)
--------- ---------
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, $2,006,000 and $3,568,000 during the years
ended December 31, 1996, 1997 and 1998, respectively.
F-11
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
5. STOCKHOLDERS' EQUITY
PREFERRED STOCK
Preferred stock is as follows by series:
<TABLE>
<CAPTION>
SHARES ISSUED AND OUTSTANDING
---------------------------------
DECEMBER 31,
DESIGNATED -------------------- MARCH 31,
SERIES SHARES 1997 1998 1999
- -------------------------------------------------- --------- --------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
A Convertible 1,000,000 946,435 946,435 946,435
B Redeemable convertible 1,933,333 1,499,999 1,499,999 1,499,999
C Redeemable convertible 1,200,000 952,380 952,380 952,380
D Redeemable convertible 2,231,112 -- 1,277,777 1,833,332
--------- --------- --------- -----------
6,364,445 3,398,814 4,676,591 5,232,146
--------- --------- --------- -----------
--------- --------- --------- -----------
</TABLE>
Each share of preferred stock is convertible into one share of common stock,
subject to antidilution provisions. Automatic conversion will occur (i) upon
completion of an initial public offering of the Company's common stock with
proceeds of a minimum of $22.5 million at a minimum price of $14.25 per common
share or (ii) upon the consent of the holders of a majority of outstanding
preferred stock. 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, Series C,
and Series D preferred stock are payable in cash in the amount of $0.18, $0.019,
$0.294 and $0.63 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 Board of Directors. No such dividends have been declared as of
December 31, 1998. The Series B, C and D preferred stock have stated redemption
values of $2.70, $4.20 and $9.00 per share, respectively. Series B, C and D
preferred stock are mandatorily redeemable at their stated redemption values in
September 2006, June 2007, and December 2005, respectively.
COMMON STOCK
At December 31, 1998, the Company had reserved shares of common stock for
future issuance as follows:
<TABLE>
<S> <C>
Stock Option Plan:
Options outstanding............................................................ 1,187,956
Options available for future grants............................................ 173,032
Common stock warrants............................................................ 116,666
Convertible preferred stock...................................................... 4,676,591
---------
6,154,245
---------
---------
</TABLE>
F-12
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS
Under the Company's Stock Option Plan, 1,500,000 shares of common stock are
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 can be exercised immediately but, if
so exercised, these unvested shares are subject to repurchase by the Company.
Options and unvested shares granted generally vest over a period of up to five
years. Options under the plan have a maximum term of 10 years. In the event
optionholders cease to be employed by the Company, all unvested options are
forfeited and all vested options may be exercised within a 90-day period after
termination; the Company also has the right to repurchase at the original
purchase price any unvested (but issued) shares if the holder is no longer
employed by the Company. At December 31, 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.
A summary of the Company's stock option activity under the plan is as
follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
------------------------
WEIGHTED-
AVERAGE
EXERCISE
NUMBER OF PRICE
SHARES PER SHARE
--------- -------------
<S> <C> <C>
Granted............................................................ 976,490 $ 0.27
Exercised.......................................................... (149) 0.26
Canceled........................................................... (4,414) 0.26
---------
Outstanding at December 31, 1996..................................... 971,927 0.27
Granted............................................................ 232,632 0.55
Exercised.......................................................... (870) 0.26
Canceled........................................................... (162,305) 0.28
---------
Outstanding at December 31, 1997..................................... 1,041,384 0.33
Granted............................................................ 346,488 4.59
Exercised.......................................................... (137,993) 0.32
Canceled........................................................... (61,923) 0.89
---------
Outstanding at December 31, 1998..................................... 1,187,956 1.54
Granted (unaudited)................................................ 113,533 6.00
Exercised (unaudited).............................................. (13,646) 0.47
Canceled (unaudited)............................................... (11,425) 4.27
---------
Outstanding at March 31, 1999 (unaudited)............................ 1,276,418 $ 1.93
---------
---------
Vested and exercisable at December 31, 1998.......................... 499,613 $ 0.33
--------- -----
--------- -----
Vested and exercisable at March 31, 1999 (unaudited)................. 548,917 $ 0.36
--------- -----
--------- -----
</TABLE>
F-13
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable stock options at December 31, 1998:
<TABLE>
<CAPTION>
OUTSTANDING VESTED AND EXERCISABLE
------------------------------------- ------------------------
WEIGHTED- WEIGHTED- WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING EXERCISE
NUMBER OF PRICE CONTRACTUAL NUMBER OF PRICE
PRICE RANGE SHARES PER SHARE LIFE (YEARS) SHARES PER SHARE
- ------------------------------- --------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
$0.26-$0.30.................... 749,241 $ 0.28 7.52 443,865 $ 0.27
0.60- 0.66.................... 136,637 0.61 8.68 49,328 0.62
0.75.......................... 19,006 0.75 9.04 3,466 0.75
2.25.......................... 45,000 2.25 9.33 2,313 2.25
6.00.......................... 238,072 6.00 9.96 641 6.00
--------- -----------
1,187,956 499,613
--------- -----------
--------- -----------
</TABLE>
The Company recorded deferred compensation of $508,000, $1,586,000 and
$571,000 during the years ended December 31, 1997 and 1998, and the three months
ended March 31, 1999, respectively, representing the difference between the
exercise price and the deemed fair value of certain of the Company's stock
options granted to employees. These amounts are being amortized by charges to
operations over the vesting periods of the individual stock options. Such
amortization amounted to $124,000, $906,000 and $223,000 for the years ended
December 31, 1997 and 1998, and the three months ended March 31, 1999,
respectively. The remaining aggregate deferred compensation of $1,412,000 will
be amortized over the remainder of the vesting periods of the options (generally
five years).
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%, 6.3% and 6.0% for the years
ended December 31, 1996, 1997 and 1998, 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
F-14
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
5. STOCKHOLDERS' EQUITY (CONTINUED)
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>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Pro forma net loss (in thousands)................ $ (2,506) $ (5,092) $ (10,822)
--------- --------- ---------
--------- --------- ---------
Pro forma basic and diluted net loss per share... $ (1.02) $ (1.92) $ (3.90)
--------- --------- ---------
--------- --------- ---------
</TABLE>
The weighted-average fair value of options granted, which is the value
assigned to the options under FAS 123, was $0.03, $1.25 and $6.44 for options
granted during the years ended December 31, 1996, 1997 and 1998, respectively.
The pro forma impact of options on the net loss for the years ended December
31, 1996, 1997 and 1998 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 $57,000 and
$63,000 and the related amortization included is $16,000 and $34,000 at December
31, 1997 and 1998, respectively. Future minimum payments under these leases as
of December 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
----------- -----------
<S> <C> <C>
1999..................................................................... $ 20 $ 949
2000..................................................................... -- 982
2001..................................................................... -- 1,012
2002..................................................................... -- 671
--- -----------
Total minimum lease payments............................................. 20 $ 3,614
-----------
-----------
Less amount representing interest........................................ (2)
---
Present value of minimum lease payments.................................. $ 18
---
---
</TABLE>
Rent expense under all operating leases was $67,000, $418,000 and $974,000
for the years ended December 31, 1996, 1997 and 1998, respectively.
F-15
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
6. COMMITMENTS (CONTINUED)
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 September 1996, the Company entered into a license agreement with a
university for the use of the intellectual property underlying its training
methods. In exchange for the license, the Company issued 131,192 shares of
Series A preferred stock and paid the university a license-issue fee of
$200,000. In March 1997, the number of shares of Series A preferred stock issued
under the agreement was reduced to 114,526.
Under the agreement, additional royalties and milestone payments are payable
to the university based upon revenues from products using the licensed
technology. Royalty and milestone expenses were $202,000 and $415,000 for the
years ended December 31, 1997 and 1998 (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.
8. SUBSEQUENT EVENTS
PROPOSED PUBLIC OFFERING OF COMMON STOCK
On April 22, 1999, 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 March 31, 1999 gives effect to the conversion
of all outstanding shares of convertible preferred stock at that date into
5,232,146 shares of common stock upon the completion of the offering.
STOCK SPLIT
On April 22, 1999, the Board of Directors approved, and on May 28, 1999 the
stockholders approved, a two-for-three reverse stock split of issued and
outstanding common and preferred stock. All common and preferred share prices,
and amounts associated with rights, preferences, dividends and privileges in the
accompanying financial statements have been retroactively adjusted to reflect
the stock split. In connection with the reverse stock split, the Board of
Directors authorized a decrease in the number of authorized shares of common
stock to 35,500,000 and a decrease in the number of authorized shares of
preferred stock to 5,500,000 shares, subject to stockholder approval. Effective
immediately prior to the closing of the initial public offering of its common
stock, the Board of Directors authorized, and the stockholders approved, an
increase in the number of authorized shares of
F-16
<PAGE>
SCIENTIFIC LEARNING CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999, AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
8. SUBSEQUENT EVENTS (CONTINUED)
common stock to 40,000,000 and a decrease in the number of authorized shares of
preferred stock to 1,000,000 shares.
1999 EQUITY INCENTIVE PLAN
On April 22, 1999, the Company's Board of Directors adopted, and on May 28,
1999 the stockholders approved, the 1999 Equity Incentive Plan which amends and
restates the Company's existing stock option plan. There are 2,192,666 shares of
common stock authorized for issuance under the plan. The plan will become
effective upon completion of the Company's initial public offering of its common
stock.
1999 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
On April 22, 1999, the Company's Board of Directors adopted, and on May 28,
1999 the stockholders approved, the 1999 Non-Employee Directors' Stock Option
Plan and reserved an aggregate of 75,000 shares of common stock for grants of
stock options under the plan.
1999 EMPLOYEE STOCK PURCHASE PLAN
On April 22, 1999, the Company's Board of Directors adopted, and on May 28,
1999 the stockholders approved, the 1999 Employee Stock Purchase Plan to be
effective upon the completion of the Company's initial public offering of its
common stock. The Company has reserved a total of 350,000 shares of common stock
for issuance under the plan. Eligible employees may purchase common stock at 85%
of the lesser of the fair market value of the Company's common stock on the
first day of the applicable one year offering period or the date of purchase.
F-17
<PAGE>
[INSIDE BACK COVER]
<TABLE>
<S> <C>
[Picture of a man and a girl sitting [Scientific Learning
together looking at a book] A Neuroscience Company]
[Picture of a woman leaning over a boy
who is sitting at a desk [Language and Reading]
reading a book]
[Background picture of a woman and a girl
reading]
[Reaching Potential]
[Picture of three children sitting
together looking at a book.]
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT, AND THE UNDERWRITERS HAVE NOT, AUTHORIZED ANY OTHER PERSON TO PROVIDE
YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR
INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. WE ARE NOT, AND THE
UNDERWRITERS ARE NOT, MAKING AN OFFER TO SELL THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT
THE INFORMATION APPEARING IN THIS IS ACCURATE AS OF THE DATE ON THE FRONT OF
THIS PROSPECTUS ONLY. OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS
AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 7
How We Intend to Use the Proceeds from this
Offering..................................... 17
Dividend Policy................................ 17
Capitalization................................. 18
Dilution....................................... 19
Selected Financial Data........................ 20
Management's Discussion and Analysis of
Financial Condition and Results of Operations
............................................. 22
Business....................................... 30
Management..................................... 47
Transactions and Relationships with Related
Parties...................................... 59
Principal Stockholders......................... 61
Description of Capital Stock................... 63
Shares Eligible for Future Sale................ 65
Underwriting................................... 67
Legal Matters.................................. 71
Experts........................................ 71
Available Information.......................... 71
Index to Financial Statements.................. F-1
</TABLE>
------------------------
THROUGH AND INCLUDING , 1999 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THESE SECURITIES, WHETHER OR
NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
2,300,000 SHARES
[LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
MERRILL LYNCH & CO.
THOMAS WEISEL PARTNERS LLC
PACIFIC GROWTH EQUITIES, INC.
, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 us 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.................................................. $ 12,788
NASD filing fee................................................... 4,732
Nasdaq application fee............................................ 78,875
Blue sky qualification fee and expenses........................... 3,000
Printing and engraving expenses................................... 150,000
Legal fees and expenses........................................... 400,000
Accounting fees and expenses...................................... 200,000
Transfer agent and registrar fees................................. 25,000
Miscellaneous..................................................... 25,605
Total........................................................... $ 900,000
---------
---------
</TABLE>
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Under Section 145 of the Delaware General Corporation Law, we have broad
powers to indemnify our directors and officers against liabilities they may
incur in such capacities, including liabilities under the Securities Act of
1933. Our bylaws also provide that we will indemnify our directors and executive
officers and may indemnify our other officers, employees and other agents to the
fullest extent not prohibited by Delaware law.
Our 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 us, 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.
We have entered into agreements with our directors and executive officers
that require us 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 our or any of our
affiliated enterprises, provided such person acted in good faith and in a manner
such person reasonably believed to be in or not opposed to our best interests
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 purchase agreement filed as Exhibit 1.1 to this registration statement
provides that the underwriters will indemnify the company and its officers and
directors for specified liabilities arising under the Securities Act of 1933 or
otherwise.
II-1
<PAGE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since our incorporation on November 30, 1995, we have sold and issued the
following unregistered securities:
1. From January 1996 to June 1996, we issued and sold an aggregate of
2,656,769 shares of common stock at prices ranging from $0.0012 to $0.255
per share to seven executive officers and directors, 123,450 of which are
currently held by one individual who is no longer associated with us.
2. In April 1996, we issued and sold an aggregate of 69,958 shares of
Series A preferred stock at $2.43 per share to four executive officers and
directors under our Series A preferred stock Employee Purchase Plan, 8,230
of which are currently held by one individual who is no longer associated
with us.
3. From April 1996 to May 1996, we issued and sold and aggregate of
761,951 shares of Series A preferred stock at $2.55 per share to 68
investors.
4. On September 27, 1996, we issued 131,192 shares of Series A
preferred stock to Rutgers University in partial payment of a license fee.
On March 28, 1997, Rutgers University returned 16,666 shares to us.
5. From October 1996 to November 1996, we issued and sold an aggregate
of 1,499,999 shares of Series B preferred stock at $2.70 per share to two
investors, 1,481,481 of which were sold to Warburg, Pincus Ventures, an
affiliate of ours.
6. On October 1, 1996 we issued a warrant to purchase 952,380 shares of
Series C preferred stock at an exercise price of $4.20 per share to Warburg,
Pincus Ventures, an affiliate of ours. This warrant was subsequently
exercised on June 16, 1997 and the 952,380 shares were issued to the
affiliate.
7. Since inception, we have granted stock options under our stock
option plan covering an aggregate of 1,501,954 shares of our common stock
(net of expirations and cancellations) at exercise prices ranging from
$0.260 to $11.25 per share.
8. Since inception, options to purchase an aggregate of 289,367 shares
of our common stock were exercised for an aggregate purchase price of
$107,759.67 at exercise prices ranging from $0.26 to $6.00 per share.
9. In June and October 1998, we issued to Warburg, Pincus Ventures, an
affiliate of ours, warrants to purchase 116,666 shares of our common stock.
These warrants were issued in connection with Warburg, Pincus Ventures'
guarantee of a $3 million unsecured line of credit obtained by us in June
1998.
10. In December 1998 and January 1999, we issued and sold an aggregate
of 1,833,332 shares of Series D preferred stock at $9.00 per share,
1,111,111 of which were sold to Warburg, Pincus Ventures, an affiliate of
ours.
The sales and issuances of securities in the transactions described in
paragraphs 1 through 6, 9 and 10 above were claimed by the Company to be exempt
from registration under the Securities Act of 1933 by virtue of Section 4(2) of
the Securities Act of 1933. 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 these transactions. Similar legends were imposed in
connection with any subsequent sales of any such securities. All recipients
either received adequate information about us or had access, through employment
or other relationships, to such information.
II-2
<PAGE>
The sales and issuances of securities in the transactions described in
paragraphs 1, 2, 7 and 8 above were claimed by the Company to be exempt from
registration under the Securities Act of 1933 by virtue of Rule 701 promulgated
thereunder in that they were offered and sold either under written compensatory
benefit plans or under a written contract relating to compensation, as provided
by Rule 701.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- --------- -------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Purchase Agreement.
3.1 Amended and Restated Certificate of Incorporation.
3.2 Bylaws.
3.3 Form of Restated Certificate of Incorporation to be filed upon completion of this offering.
3.4 Form of Amended and Restated Bylaws 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, 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 with each of our directors and executive officers, with related schedules.
10.2 1999 Equity Incentive Plan.
10.3 Form of Stock Option Agreement under the Incentive Plan.
10.4 Form of Stock Option Grant Notice under the Incentive Plan.
10.5 1999 Non-Employee Directors' Stock Option Plan.
10.6 Form of Nonstatutory Stock Option Agreement under the Non-Employee Directors' Stock Option Plan
(Initial Grant).
10.7 Form of Nonstatutory Stock Option Agreement under the Non-Employee Directors' Stock Option Plan (Annual
Grant).
10.8 1999 Employee Stock Purchase Plan.
10.9 Form of Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.
10.10 Consulting Agreement, dated as of September 20, 1996, with Dr. Michael M. Merzenich, as modified on
January 19, 1998.
10.11 Consulting Agreement, dated as of September 19, 1996, with Dr. Paula A. Tallal, as modified on January
22, 1998.
10.12 Loan and Security Agreement, dated as of February 13, 1998, with Silicon Valley Bank.
10.13+ Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of
California.
10.14 Lease Agreement, dated as of July 31, 1997, with GBC-University Associates, L.P.
10.15 Securities Purchase Agreement, dated September 24, 1996, with Warburg, Pincus Ventures, L.P.
23.1* Consent of Ernst & Young LLP, Independent Auditors.
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 herewith. All exhibits without asterisks have been previously filed.
+ Certain portions of this exhibit have been omitted based upon our request
for confidential treatment pursuant to Rule 406 for portions of the
referenced exhibit.
II-3
<PAGE>
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.
We hereby undertake 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
of 1933 may be permitted to our directors, officers, and controlling persons
pursuant to the provisions described in Item 14 or otherwise, we have been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefor, unenforceable. In the event that a claim for
indemnification against these liabilities (other than the payment by us of
expenses incurred or paid by a director, officer, or controlling person 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, we will, unless in the opinion of our 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.
We undertake that: (1) for purposes of determining any liability under the
Securities Act of 1933, 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 us pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act of 1933 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 of 1933, 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 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 to the Registration Statement on Form S-1 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, 1999.
<TABLE>
<S> <C> <C>
SCIENTIFIC LEARNING CORPORATION
By: /s/ FRANK M. MATTSON
-----------------------------------------
Frank M. Mattson
CHIEF FINANCIAL OFFICER, VICE PRESIDENT,
FINANCE AND SECRETARY
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ SHERYLE J. BOLTON* President, Chief Executive July 21, 1999
- ------------------------------ Officer and Director
Sheryle J. Bolton (Principal Executive
Officer)
/s/ DR. MICHAEL M. Chief Scientific Officer July 21, 1999
MERZENICH* and Director
- ------------------------------
Dr. Michael M. Merzenich
/s/ DR. PAULA A. TALLAL* Executive Vice President July 21, 1999
- ------------------------------ and Chairman of the
Dr. Paula A. Tallal Board
/s/ FRANK M. MATTSON Chief Financial Officer, July 21, 1999
- ------------------------------ Vice President, Finance
Frank M. Mattson and Secretary (Principal
Financial and Accounting
Officer)
/s/ CARLETON A. HOLSTROM* Director July 21, 1999
- ------------------------------
Carleton A. Holstrom
/s/ RODMAN W. MOORHEAD, III* Director July 21, 1999
- ------------------------------
Rodman W. Moorhead, III
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ JAMES E. THOMAS* Director July 21, 1999
- ------------------------------
James E. Thomas
/s/ DAVID A. TANNER* Director July 21, 1999
- ------------------------------
David A. Tanner
</TABLE>
<TABLE>
<S> <C> <C> <C>
*By: /s/ FRANK M. MATTSON
-------------------------
Frank M. Mattson
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 Purchase Agreement.
3.1 Amended and Restated Certificate of Incorporation.
3.2 Bylaws.
3.3 Form of Restated Certificate of Incorporation to be filed upon completion of this offering.
3.4 Form of Amended and Restated Bylaws 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, 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 with each of our directors and executive officers, with related schedules.
10.2 1999 Equity Incentive Plan.
10.3 Form of Stock Option Agreement under the Incentive Plan.
10.4 Form of Stock Option Grant Notice under the Incentive Plan.
10.5 1999 Non-Employee Directors' Stock Option Plan.
10.6 Form of Nonstatutory Stock Option Agreement under the Non-Employee Directors' Stock Option Plan
(Initial Grant).
10.7 Form of Nonstatutory Stock Option Agreement under the Non-Employee Directors' Stock Option Plan (Annual
Grant).
10.8 1999 Employee Stock Purchase Plan.
10.9 Form of Employee Stock Purchase Plan Offering under the Employee Stock Purchase Plan.
10.10 Consulting Agreement, dated as of September 20, 1996, with Dr. Michael M. Merzenich, as modified on
January 19, 1998.
10.11 Consulting Agreement, dated as of September 19, 1996, with Dr. Paula A. Tallal, as modified on January
22, 1998.
10.12 Loan and Security Agreement, dated as of February 13, 1998, with Silicon Valley Bank.
10.13+ Exclusive License Agreement, dated September 27, 1996, with the Regents of the University of
California.
10.14 Lease Agreement, dated as of July 31, 1997, with GBC-University Associates, L.P.
10.15 Securities Purchase Agreement, dated September 24, 1996, with Warburg,
Pincus Ventures, L.P.
23.1* Consent of Ernst & Young LLP, Independent Auditors.
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 herewith. All exhibits without asterisks have been previously filed.
+ Certain portions of this exhibit have been omitted based upon our request
for confidential treatment pursuant to Rule 406 for portions of the
referenced exhibit.
<PAGE>
[LETTERHEAD]
July 21, 1999
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 2,300,000 shares of the Company's common stock
(collectively, the "Shares").
In connection with this opinion, we have 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.
On the basis of the foregoing, and in reliance thereon, we are of the opinion
that the sale of the Shares by the Company has been duly authorized and 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>
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 January 15,
1999, except for Note 8, as to which the date is May 28, 1999, in the
Registration Statement (Amendment No. 5 to Form S-1, No. 333-77133) and related
Prospectus of Scientific Learning Corporation for the registration of shares of
its Common Stock.
Walnut Creek, California /s/ ERNST & YOUNG LLP
July 21, 1999
