<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 2, 1999
REGISTRATION NO. 333-77133
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
AMENDMENT NO. 3
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. 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.
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
3
<PAGE>
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.
- 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
4
<PAGE>
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
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."
5
<PAGE>
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 COVERING THE BASIC SPEECH AND SOUND
MODIFICATION ALGORITHMS IN OUR PRODUCTS COULD DELAY OUR INTRODUCTION OF NEW
PRODUCTS
We are the exclusive licensee of the technology owned by The Regents of the
University of California ("The Regents") and Rutgers, the State University of
New Jersey ("Rutgers") which is the subject of a patent issued in September
1998, covering the basic speech and sound modification algorithms used in our
programs. We obtained this license under a licensing agreement with The Regents.
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<PAGE>
If we lose or are unable to maintain the license agreement, this could delay
our introduction of new products and would 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.
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 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
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<PAGE>
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.
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
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<PAGE>
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 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.
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<PAGE>
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 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
15
<PAGE>
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.
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.
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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.
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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
22
<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 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. Additionally, 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. 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 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. 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;
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- 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 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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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 $50,000 or 10% of any officer's salary and bonus
disclosed in this table.
(2) In determining compensation packages for our officers, we currently take
into consideration the equity held by the officer. Accordingly, some
officers may receive smaller compensation packages than other officers with
comparable responsibilities.
(3) Represents the costs of membership in an airline club.
(4) Represents the costs of membership in a health club.
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OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options made during the
year ended December 31, 1998 to each of the Named Executive Officers:
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT
ASSUMED ANNUAL RATES
OF STOCK
NUMBER OF INDIVIDUAL GRANTS APPRECIATION FOR
SECURITIES % OF TOTAL OPTIONS ---------------------------- OPTION TERM (4)
UNDERLYING OPTIONS GRANTED IN FISCAL EXERCISE PRICE EXPIRATION ----------------------
NAME GRANTED (1) 1998 (2) ($/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 $15.00 per share, (b) assuming that the aggregate
stock value derived from that calculation compounds at the annual 5% or 10%
rate shown in the table for the entire ten-year term of the option and (c)
subtracting from that result the aggregate option exercise price. The 5% and
10% assumed annual rates of stock price appreciation are mandated by the
rules of the SEC and do not represent our estimate or projection of future
common stock prices.
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AGGREGATED OPTION EXERCISES IN FISCAL 1998
AND YEAR-END OPTION VALUES
The following table sets forth for each of the Named Executive Officers the
number and value of securities underlying unexercised options held by such Named
Executive Officer at December 31, 1998:
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES AT DECEMBER 31, 1998 (1) AT DECEMBER 31, 1998 (2)
ACQUIRED ON VALUE ------------------------------ -----------------------------
NAME EXERCISE (#) REALIZED ($) 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 1,911,398 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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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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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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<PAGE>
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.
57
<PAGE>
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
58
<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."
59
<PAGE>
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
60
<PAGE>
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.
61
<PAGE>
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.
62
<PAGE>
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.
63
<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
64
<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.
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<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
66
<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.
67
<PAGE>
RESERVED SHARES
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 purchase our common stock. As an
exception to these rules, the representatives are permitted to
68
<PAGE>
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.
69
<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.
70
<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
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 (UNAUDITED)
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 (UNAUDITED) (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..................................... 46
Transactions and Relationships with Related
Parties...................................... 58
Principal Stockholders......................... 60
Description of Capital Stock................... 62
Shares Eligible for Future Sale................ 64
Underwriting................................... 66
Legal Matters.................................. 69
Experts........................................ 69
Available Information.......................... 69
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 1,474,742 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 286,670 shares
of our common stock were exercised for an aggregate purchase price of
$101,504.21 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 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 2nd 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 2, 1999
- ------------------------------ Officer and Director
Sheryle J. Bolton (Principal Executive
Officer)
/s/ DR. MICHAEL M. Chief Scientific Officer July 2, 1999
MERZENICH* and Director
- ------------------------------
Dr. Michael M. Merzenich
/s/ DR. PAULA A. TALLAL* Executive Vice President July 2, 1999
- ------------------------------ and Chairman of the
Dr. Paula A. Tallal Board
/s/ FRANK M. MATTSON Chief Financial Officer, July 2, 1999
- ------------------------------ Vice President, Finance
Frank M. Mattson and Secretary (Principal
Financial and Accounting
Officer)
/s/ CARLETON A. HOLSTROM* Director July 2, 1999
- ------------------------------
Carleton A. Holstrom
/s/ RODMAN W. MOORHEAD, III* Director July 2, 1999
- ------------------------------
Rodman W. Moorhead, III
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ JAMES E. THOMAS* Director July 2, 1999
- ------------------------------
James E. Thomas
/s/ DAVID A. TANNER* Director July 2, 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>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SCIENTIFIC LEARNING CORPORATION
(a Delaware corporation)
2,645,000 Shares of Common Stock
PURCHASE AGREEMENT
Dated: July ___, 1999
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SECTION 1. Representations and Warranties. . . . . . . . . . . . . . . . . . . .2
(A) REPRESENTATIONS AND WARRANTIES BY THE COMPANY. . . . . . . . . . . . .2
(i) Compliance with Registration Requirements. . . . . . . . . . .3
(ii) Independent Accountants. . . . . . . . . . . . . . . . . . . .3
(iii) Financial Statements . . . . . . . . . . . . . . . . . . . . .4
(iv) No Material Adverse Change in Business.. . . . . . . . . . . .4
(v) Good Standing of the Company . . . . . . . . . . . . . . . . .4
(vi) Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . .5
(vii) Capitalization . . . . . . . . . . . . . . . . . . . . . . . .5
(viii) Authorization of Agreement . . . . . . . . . . . . . . . . . .5
(ix) Authorization and Description of Securities. . . . . . . . . .5
(x) Absence of Defaults and Conflicts. . . . . . . . . . . . . . .5
(xi) Absence of Labor Dispute . . . . . . . . . . . . . . . . . . .6
(xii) Absence of Proceedings . . . . . . . . . . . . . . . . . . . .6
(xiii) Accuracy of Exhibits . . . . . . . . . . . . . . . . . . . . .6
(xiv) Possession of Intellectual Property. . . . . . . . . . . . . .6
(xv) Absence of Further Requirements. . . . . . . . . . . . . . . .7
(xvi) Possession of Licenses and Permits . . . . . . . . . . . . . .7
(xvii) Title to Property. . . . . . . . . . . . . . . . . . . . . . .7
(xviii) Compliance with Cuba Act . . . . . . . . . . . . . . . . . . .8
(xix) Investment Company Act . . . . . . . . . . . . . . . . . . . .8
(xx) Environmental Laws . . . . . . . . . . . . . . . . . . . . . .8
(xxi) Registration Rights. . . . . . . . . . . . . . . . . . . . . .8
(xxii) Stock Exchange Listing . . . . . . . . . . . . . . . . . . . .8
(xxiii) Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . . .8
(xxiv) Tax Law Compliance . . . . . . . . . . . . . . . . . . . . . .8
(B) OFFICER'S CERTIFICATES . . . . . . . . . . . . . . . . . . . . . . . .9
SECTION 2. Sale and Delivery to Underwriters; Closing. . . . . . . . . . . . . .9
(A) INITIAL SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . .9
(B) OPTION SECURITIES. . . . . . . . . . . . . . . . . . . . . . . . . . .9
(C) PAYMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
(D) DENOMINATIONS; REGISTRATION. . . . . . . . . . . . . . . . . . . . . 10
SECTION 3. Covenants of the Company. . . . . . . . . . . . . . . . . . . . . . 10
(A) COMPLIANCE WITH SECURITIES REGULATIONS AND COMMISSION REQUESTS . . . 10
(B) FILING OF AMENDMENTS . . . . . . . . . . . . . . . . . . . . . . . . 11
(C) DELIVERY OF REGISTRATION STATEMENTS. . . . . . . . . . . . . . . . . 11
(D) DELIVERY OF PROSPECTUSES . . . . . . . . . . . . . . . . . . . . . . 11
(E) CONTINUED COMPLIANCE WITH SECURITIES LAWS. . . . . . . . . . . . . . 11
(F) BLUE SKY QUALIFICATIONS. . . . . . . . . . . . . . . . . . . . . . . 12
(G) RULE 158 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
(H) USE OF PROCEEDS. . . . . . . . . . . . . . . . . . . . . . . . . . . 12
(I) LISTING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
i
<PAGE>
(J) RESTRICTION ON SALE OF SECURITIES. . . . . . . . . . . . . . . . . . 12
(K) REPORTING REQUIREMENTS . . . . . . . . . . . . . . . . . . . . . . . 13
(l) COMPLIANCE WITH NASD RULES . . . . . . . . . . . . . . . . . . . . . 13
SECTION 4. Payment of Expenses.. . . . . . . . . . . . . . . . . . . . . . . . 13
(A) EXPENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
(B) TERMINATION OF AGREEMENT . . . . . . . . . . . . . . . . . . . . . . 14
SECTION 5. Conditions of Underwriters' Obligations . . . . . . . . . . . . . . 14
(A) EFFECTIVENESS OF REGISTRATION STATEMENT. . . . . . . . . . . . . . . 14
(B) OPINION OF COUNSEL FOR COMPANY . . . . . . . . . . . . . . . . . . . 14
(C) OPINION OF COUNSEL FOR UNDERWRITERS. . . . . . . . . . . . . . . . . 14
(D) OFFICERS' CERTIFICATE. . . . . . . . . . . . . . . . . . . . . . . . 15
(E) ACCOUNTANT'S COMFORT LETTER. . . . . . . . . . . . . . . . . . . . . 15
(F) BRING-DOWN COMFORT LETTER. . . . . . . . . . . . . . . . . . . . . . 15
(G) APPROVAL OF LISTING. . . . . . . . . . . . . . . . . . . . . . . . . 15
(h) NO OBJECTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
(i) LOCK-UP AGREEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . 15
(J) CONDITIONS TO PURCHASE OF OPTION SECURITIES. . . . . . . . . . . . . 15
(i) Officers' Certificate. . . . . . . . . . . . . . . . . . . . 16
(ii) Opinion of Counsel for Company . . . . . . . . . . . . . . . 16
(iii) Opinion of Counsel for Underwriters. . . . . . . . . . . . . 16
(iv) Bring-down Comfort Letter. . . . . . . . . . . . . . . . . . 16
(K) ADDITIONAL DOCUMENTS . . . . . . . . . . . . . . . . . . . . . . . . 16
(L) TERMINATION OF AGREEMENT . . . . . . . . . . . . . . . . . . . . . . 16
SECTION 6. Indemnification.. . . . . . . . . . . . . . . . . . . . . . . . . . 17
(A) INDEMNIFICATION OF UNDERWRITERS. . . . . . . . . . . . . . . . . . . 17
(B) INDEMNIFICATION OF COMPANY, DIRECTORS AND OFFICERS . . . . . . . . . 18
(C) ACTIONS AGAINST PARTIES; NOTIFICATION. . . . . . . . . . . . . . . . 18
SECTION 7. Contribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
SECTION 8. Representations, Warranties and Agreements to Survive Delivery. . . 20
SECTION 9. Termination of Agreement. . . . . . . . . . . . . . . . . . . . . . 21
(A) TERMINATION; GENERAL . . . . . . . . . . . . . . . . . . . . . . . . 21
(B) LIABILITIES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
SECTION 10. Default by One or More of the Underwriters . . . . . . . . . . . . 21
SECTION 11. Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
SECTION 12. Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
SECTION 13. Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . . 22
SECTION 14. Effect of Headings.. . . . . . . . . . . . . . . . . . . . . . . . 22
ii
<PAGE>
SCHEDULES
Schedule A - List of Underwriters . . . . . . . . . . . .Sch A-1
Schedule B - Pricing Information. . . . . . . . . . . . .Sch B-1
Schedule C - List of Persons subject to Lock-up . . . . .Sch C-1
EXHIBITS
Exhibit A--Form of Opinion of Company's Counsel . . . . . . .A-1
Exhibit B--Form of Opinion of Underwriters' Counsel . . . . .B-1
Exhibit C--Form of Lock-up Letter . . . . . . . . . . . . . .C-1
Exhibit D--Form of Accountants' Comfort Letter
</TABLE>
iii
<PAGE>
SCIENTIFIC LEARNING CORPORATION
(a Delaware corporation)
2,645,000 Shares of Common Stock
(Par Value $0.001 Per Share)
PURCHASE AGREEMENT
July ___, 1999
Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
Thomas Weisel Partners LLC
Pacific Growth Equities, Inc.
as Representatives of the several Underwriters
c/o Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
North Tower
World Financial Center
New York, New York 10281-1209
Ladies and Gentlemen:
Scientific Learning Corporation, a Delaware corporation (the
"Company"), confirms its agreement with Merrill Lynch & Co., Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") and each of the other
Underwriters named in SCHEDULE A hereto (collectively, the "Underwriters,"
which term shall also include any underwriter substituted as hereinafter
provided in Section 10 hereof), for whom Merrill Lynch, Thomas Weisel
Partners LLC and Pacific Growth Equities, Inc. are acting as representatives
(in such capacity, the "Representatives"), with respect to the issue and sale
by the Company and the purchase by the Underwriters, acting severally and not
jointly, of the respective numbers of shares of Common Stock, par value
$0.001 per share, of the Company ("Common Stock") set forth in said SCHEDULE A,
and with respect to the grant by the Company to the Underwriters, acting
severally and not jointly, of the option described in Section 2(b) hereof to
purchase all or any part of 345,000 additional shares of Common Stock to
cover over-allotments, if any. The aforesaid 2,300,000 shares of Common
Stock (the "Initial Securities") to be purchased by the Underwriters and all
or any part of the 345,000 shares of Common Stock subject to the option
described in Section 2(b) hereof (the "Option Securities") are hereinafter
called, collectively, the "Securities."
The Company understands that the Underwriters propose to make a
public offering of the Securities as soon as the Representatives deem
advisable after this Agreement has been executed and delivered.
The Company and the Underwriters agree that up to five percent (5%)
shares of the Securities to be purchased by the Underwriters (the "Reserved
Securities") shall be reserved for sale by the Underwriters to certain
individuals associated with the Company or the Company's directors, officers
or employees, as part of the distribution of the Securities by the
Underwriters, subject to
<PAGE>
the terms of this Agreement, the applicable rules, regulations and
interpretations of the National Association of Securities Dealers, Inc. (the
"NASD") and all other applicable laws, rules and regulations. To the extent
that such Reserved Securities are not orally confirmed for purchase by such
persons having relationships with the Company by the end of the first
business day after the date of this Agreement, such Reserved Securities may
be offered to the public as part of the public offering contemplated hereby.
The Company has filed with the Securities and Exchange Commission
(the "Commission") a registration statement on Form S-1 (No. 333-77133)
covering the registration of the Securities under the Securities Act of 1933,
as amended (the "1933 Act"), including the related preliminary prospectus or
prospectuses. Promptly after execution and delivery of this Agreement, the
Company will either (i) prepare and file a prospectus in accordance with the
provisions of Rule 430A ("Rule 430A") of the rules and regulations of the
Commission under the 1933 Act (the "1933 Act Regulations") and paragraph (b)
of Rule 424 ("Rule 424(b)") of the 1933 Act Regulations or (ii) if the
Company has elected to rely upon Rule 434 ("Rule 434") of the 1933 Act
Regulations, prepare and file a term sheet (a "Term Sheet") in accordance
with the provisions of Rule 434 and Rule 424(b). The information included in
such prospectus or in such Term Sheet, as the case may be, that was omitted
from such registration statement at the time it became effective but that is
deemed to be part of such registration statement at the time it became
effective (a) pursuant to paragraph (b) of Rule 430A is referred to as "Rule
430A Information" or (b) pursuant to paragraph (d) of Rule 434 is referred to
as "Rule 434 Information." Each prospectus used before such registration
statement became effective, and any prospectus that omitted, as applicable,
the Rule 430A Information or the Rule 434 Information, that was used after
such effectiveness and prior to the execution and delivery of this Agreement,
is herein called a "preliminary prospectus." Such registration statement,
including the exhibits thereto and schedules thereto at the time it became
effective and including the Rule 430A Information and the Rule 434
Information, as applicable, is herein called the "Registration Statement."
Any registration statement filed pursuant to Rule 462(b) of the 1933 Act
Regulations is herein referred to as the "Rule 462(b) Registration
Statement," and after such filing the term "Registration Statement" shall
include the Rule 462(b) Registration Statement. The final prospectus in the
form first furnished to the Underwriters for use in connection with the
offering of the Securities is herein called the "Prospectus." If Rule 434 is
relied on, the term "Prospectus" shall refer to the preliminary prospectus
dated June 22, 1999 together with the Term Sheet and all references in this
Agreement to the date of the Prospectus shall mean the date of the Term
Sheet. For purposes of this Agreement, all references to the Registration
Statement, any preliminary prospectus, the Prospectus or any Term Sheet or
any amendment or supplement to any of the foregoing shall be deemed to
include the copy filed with the Commission pursuant to its Electronic Data
Gathering, Analysis and Retrieval system ("EDGAR").
SECTION 1. Representations and Warranties.
(a) REPRESENTATIONS AND WARRANTIES BY THE COMPANY The Company
represents and warrants to each Underwriter as of the date hereof, as of the
Closing Time referred to in Section 2(c) hereof, and as of each Date of
Delivery (if any) referred to in Section 2(b) hereof, and agrees with each
Underwriter, as follows:
2
<PAGE>
(i) COMPLIANCE WITH REGISTRATION REQUIREMENTS. Each of
the Registration Statement and any Rule 462(b) Registration Statement
has become effective under the 1933 Act and no stop order suspending
the effectiveness of the Registration Statement or any Rule 462(b)
Registration Statement has been issued under the 1933 Act and no
proceedings for that purpose have been instituted or are pending or,
to the knowledge of the Company, are contemplated by the Commission,
and any request on the part of the Commission for additional
information has been complied with.
At the respective times the Registration Statement, any
Rule 462(b) Registration Statement and any post-effective amendments
thereto became effective and at the Closing Time (and, if any Option
Securities are purchased, at the Date of Delivery), the Registration
Statement, the Rule 462(b) Registration Statement and any amendments
and supplements thereto complied and will comply in all material
respects with the requirements of the 1933 Act and the 1933 Act
Regulations and did not and will not contain an untrue statement of a
material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein not misleading,
and the Prospectus, any preliminary prospectus and any supplement
thereto or prospectus wrapper prepared in connection therewith, at
their respective times of issuance and at the Closing Time, complied
and will comply in all material respects with any applicable laws or
regulations of foreign jurisdictions in which the Prospectus and such
preliminary prospectus, as amended or supplemented, if applicable,
are distributed in connection with the offer and sale of Reserved
Securities. Neither the Prospectus nor any amendments or supplements
thereto (including any prospectus wrapper), at the time the
Prospectus or any such amendment or supplement was issued and at the
Closing Time (and, if any Option Securities are purchased, at the
Date of Delivery), included or will include an untrue statement of a
material fact or omitted or will omit to state a material fact
necessary in order to make the statements therein, in the light of
the circumstances under which they were made, not misleading. If
Rule 434 is used, the Company will comply with the requirements of
Rule 434 and the Prospectus shall not be "materially different," as
such term is used in Rule 434, from the prospectus included in the
Registration Statement at the time it became effective. The
representations and warranties in this subsection shall not apply to
statements in or omissions from the Registration Statement or
Prospectus made in reliance upon and in conformity with information
furnished to the Company in writing by any Underwriter through
Merrill Lynch expressly for use in the Registration Statement or
Prospectus.
Each preliminary prospectus and the prospectus filed as part
of the Registration Statement as originally filed or as part of any
amendment thereto, or filed pursuant to Rule 424 under the 1933 Act,
complied when so filed in all material respects with the 1933 Act
Regulations and each preliminary prospectus and the Prospectus
delivered to the Underwriters for use in connection with this
offering was identical to the electronically transmitted copies
thereof filed with the Commission pursuant to EDGAR, except to the
extent permitted by Regulation S-T.
(ii) INDEPENDENT ACCOUNTANTS. The accountants who
certified the financial statements and supporting schedules included
in the Registration Statement are
3
<PAGE>
independent public accountants as required by the 1933 Act and the
1933 Act Regulations.
(iii) FINANCIAL STATEMENTS. The financial statements
included in the Registration Statement and the Prospectus, together
with the related schedules and notes, present fairly the financial
position of the Company at the dates indicated and the statement of
operations, stockholders' equity and cash flows of the Company for
the periods specified; said financial statements and related
schedules and notes have been prepared in conformity with generally
accepted accounting principles ("GAAP") as applied in the United
States, applied on a consistent basis throughout the periods
involved, except as may be expressly stated in the notes thereto.
The supporting schedules included in the Registration Statement
present fairly in accordance with GAAP the information required to be
stated therein. The selected financial data and the summary
financial information included in the Prospectus present fairly the
information shown therein and have been compiled on a basis
consistent with that of the audited financial statements included in
the Registration Statement. No other financial statements or
supporting schedule are required to be included in the Registration
Statement. The financial data set forth in the Prospectus under the
captions "Prospectus Summary--Summary Financial Data," "Selected
Financial Data" and "Capitalization" fairly present the information
set forth therein on a basis consistent with that of the audited
financial statements contained in the Registration Statement.
(iv) NO MATERIAL ADVERSE CHANGE IN BUSINESS. Since the
respective dates as of which information is given in the Registration
Statement and the Prospectus, except as otherwise stated therein, (A)
there has been no material adverse change in the condition, financial
or otherwise, or in the earnings, business affairs or business
prospects of the Company, whether or not arising in the ordinary
course of business (a "Material Adverse Effect") or any development
that could reasonably be expected to have a Material Adverse Effect;
(B) the Company has not incurred any material liability or
obligation, indirect, direct or contingent, not in the ordinary
course of business nor entered into any material transaction or
agreement not in the ordinary course of business; and (C) there has
been no dividend or distribution of any kind declared, paid or made
by the Company on any class of its capital stock.
(v) GOOD STANDING OF THE COMPANY. The Company has been
duly organized and is validly existing as a corporation in good
standing under the laws of the State of Delaware and has corporate
power and authority to own, lease and operate its properties and to
conduct its business as described in the Prospectus and to enter into
and perform its obligations under this Agreement. The Company is
duly qualified as a foreign corporation to transact business and is
in good standing in the State of California and each other
jurisdiction in which such qualification is required, whether by
reason of the ownership or leasing of property or the conduct of
business, except for such jurisdictions (other than California) where
the failure so to qualify or to be in good standing would not,
individually or in the aggregate, result in a Material Adverse Effect.
4
<PAGE>
(vi) SUBSIDIARIES. The Company does not own or control,
directly or indirectly, any corporation, association or other entity.
(vii) CAPITALIZATION. The authorized, issued and
outstanding capital stock of the Company is as set forth in the
Prospectus in the column entitled "Actual" under the caption
"Capitalization" (except for subsequent issuances, if any, pursuant
to this Agreement, pursuant to reservations, agreements or employee
benefit plans referred to in the Prospectus or pursuant to the
exercise of convertible securities or options referred to in the
Prospectus) and conforms to the description thereof set forth in the
Prospectus under the caption "Description of Capital Stock." The
shares of issued and outstanding capital stock of the Company have
been duly authorized and validly issued and are fully paid and
non-assessable; none of the outstanding shares of capital stock of
the Company was issued in violation of the preemptive or other
similar rights of any securityholder of the Company. There are no
authorized or outstanding options, warrants, preemptive rights,
rights of first refusal or other rights to purchase, or equity or
debt securities convertible into or exchangeable or exercisable for,
any capital stock of the Company other than those accurately
described in the Prospectus. The description of the Company's stock
option, stock bonus and other stock plans or arrangements, and the
options or other rights which may be granted thereunder, set forth in
the Prospectus under the caption "Employee Benefit Plans" accurately
and fairly summarize the information required to be shown with respect
to such plans, arrangements, options and rights to the extent
required under the 1933 Act and the 1933 Regulations.
(viii) AUTHORIZATION OF AGREEMENT. This Agreement has been
duly authorized, executed and delivered by the Company.
(ix) AUTHORIZATION AND DESCRIPTION OF SECURITIES. The
Securities have been duly authorized for issuance and sale to the
Underwriters pursuant to this Agreement and, when issued and
delivered by the Company pursuant to this Agreement against payment
of the consideration set forth herein, will be validly issued, fully
paid and non-assessable; the Common Stock conforms to all statements
relating thereto contained in the Prospectus and such description
conforms to the rights set forth in the instruments defining the
same; no holder of the Securities will be subject to personal
liability for debts of the Company solely by reason of being such a
holder; and the issuance of the Securities is not subject to the
preemptive or other similar rights of any securityholder of the
Company.
(x) ABSENCE OF DEFAULTS AND CONFLICTS. The Company is
not in violation of its charter or bylaws or in default (or with the
giving of notice or lapse of time would be in default) in the
performance or observance of any obligation, agreement, covenant or
condition contained in any contract, indenture, mortgage, deed of
trust, loan or credit agreement, note, lease or other agreement or
instrument to which the Company is a party or by which it may be
bound, or to which any of the property or assets of the Company is
subject (collectively, "Agreements and Instruments") except for such
defaults that would not result in a Material Adverse Effect. The
Company's execution, delivery and performance of this Agreement and
the consummation of the transactions contemplated herein and in the
Registration Statement (including the issuance and sale of the
Securities and the use of the proceeds from the sale of the
Securities as described in the Prospectus
5
<PAGE>
under the caption "How We Intend to Use the Proceeds of This
Offering") and compliance by the Company with its obligations
hereunder have been duly authorized by all necessary corporate action
and do not and will not, whether with or without the giving of notice
or passage of time or both, conflict with or constitute a breach of,
default or Repayment Event (as defined below) under, or result in the
creation or imposition of any lien, charge or encumbrance upon any
property or assets of the Company pursuant to, the Agreements and
Instruments (except for such conflicts, breaches, defaults, liens,
charges or encumbrances that would not result in a Material Adverse
Effect), nor will such action result in any violation of the
provisions of the charter or bylaws of the Company or any applicable
law, statute, rule, regulation, judgment, order, writ or decree of
any government, government instrumentality or court, domestic or
foreign, having jurisdiction over the Company or any of its assets,
properties or operations. As used herein, a "Repayment Event" means
any event or condition which gives the holder of any note, debenture
or other evidence of indebtedness (or any person acting on such
holder's behalf) the right to require the repurchase, redemption or
repayment of all or a portion of such indebtedness by the Company.
(xi) ABSENCE OF LABOR DISPUTE. No labor dispute with the
employees of the Company exists or, to the knowledge of the Company,
is imminent, and the Company is not aware of any existing or imminent
labor disturbance by the employees of any of its principal suppliers,
manufacturers, customers or contractors, which, in either case, may
reasonably be expected to result in a Material Adverse Effect.
(xii) ABSENCE OF PROCEEDINGS. There is no action, suit,
proceeding, inquiry or investigation before or brought by any court
or governmental agency or body, domestic or foreign, now pending, or,
to the best of the Company's knowledge, threatened, against or
affecting the Company that is required to be disclosed in the
Registration Statement (other than as disclosed therein), or which
might reasonably be expected to result in a Material Adverse Effect,
or which might reasonably be expected to materially and adversely
affect the properties or assets thereof or the consummation of the
transactions contemplated in this Agreement or the performance by the
Company of its obligations hereunder. The aggregate of all pending
legal or governmental proceedings to which the Company is a party or
of which any of its property or assets is the subject which are not
described in the Registration Statement, including ordinary routine
litigation incidental to the business, could not reasonably be
expected to result in a Material Adverse Effect.
(xiii) ACCURACY OF EXHIBITS. There are no contracts or
documents which are required to be described in the Registration
Statement or the Prospectus or to be filed as exhibits thereto which
have not been so described and filed as required.
(xiv) POSSESSION OF INTELLECTUAL PROPERTY. The Company
owns or possesses, or can acquire on reasonable terms, adequate
patents, patent rights, licenses, inventions, copyrights, know-how
(including trade secrets and other unpatented and/or unpatentable
proprietary or confidential information, systems or procedures),
trademarks, service marks, trade names, trade secrets, approvals or
other intellectual property (collectively, "Intellectual Property")
necessary to carry on its business. The Company has not received any
notice or is not otherwise aware of any infringement of or conflict
with
6
<PAGE>
asserted rights of others with respect to any Intellectual Property
or of any facts or circumstances which would render any Intellectual
Property invalid or inadequate to protect the interest of the Company
therein, and which infringement or conflict (if the subject of any
unfavorable decision, ruling or finding) or invalidity or inadequacy,
singly or in the aggregate, would result in a Material Adverse Effect.
(xv) ABSENCE OF FURTHER REQUIREMENTS. No filing with, or
authorization, approval, consent, license, order, registration,
qualification or decree of, any court or governmental authority or
agency is necessary or required for the performance by the Company of
its obligations hereunder, in connection with the offering, issuance
or sale of the Securities hereunder or the consummation of the
transactions contemplated by this Agreement, except (i) such as have
been already obtained or as may be required under the 1933 Act or the
1933 Act Regulations or state securities laws and (ii) such as have
been obtained under the laws and regulations of jurisdictions outside
the United States in which the Reserved Securities are offered.
(xvi) POSSESSION OF LICENSES AND PERMITS. The Company
possesses such permits, licenses, approvals, consents and other
authorizations (collectively, "Governmental Licenses") issued by the
appropriate federal, state, local or foreign regulatory agencies or
bodies necessary to conduct its business, and the Company is in
compliance with the terms and conditions of all such Governmental
Licenses, except where the failure so to possess or comply would not,
singly or in the aggregate, have a Material Adverse Effect; all of
the Governmental Licenses are valid and in full force and effect,
except when the invalidity of such Governmental Licenses or the
failure of such Governmental Licenses to be in full force and effect
would not have a Material Adverse Effect; and the Company has not
received any written or, to its knowledge, oral notice of proceedings
relating to the revocation or modification of any such Governmental
Licenses which, singly or in the aggregate, if the subject of an
unfavorable decision, ruling or finding, would result in a Material
Adverse Effect.
(xvii) TITLE TO PROPERTY. The Company has good and
marketable title to all real property owned by it and good title to
all other properties owned by it, in each case, free and clear of all
mortgages, pledges, liens, security interests, claims, restrictions
or encumbrances of any kind except such as (a) are described in the
Prospectus or (b) do not, singly or in the aggregate, materially
affect the value of such property and do not interfere with the use
made and proposed to be made of such property by the Company. All of
the leases and subleases material to the business of the Company and
under which the Company holds properties described in the Prospectus,
are in full force and effect (except where the failure to be in full
force and effect would not, singly or in the aggregate, result in a
Material Adverse Effect), and the Company does not have any notice of
any material claim of any sort that has been asserted by anyone
adverse to the Company's rights under any of the leases or subleases
mentioned above, or affecting or questioning the Company's rights to
the continued possession of the leased or subleased premises under
any such lease or sublease, that (if the subject of any unfavorable
decision, ruling or finding) would result in a Material Adverse
Effect).
7
<PAGE>
(xviii) COMPLIANCE WITH CUBA ACT. The Company has complied
with, and is and will be in compliance with, the provisions of that
certain Florida act relating to disclosure of doing business with
Cuba, codified as Section 517.075 of the Florida statutes, and the
rules and regulations thereunder (collectively, the "Cuba Act") or is
exempt therefrom.
(xix) INVESTMENT COMPANY ACT. The Company is not, and upon
the issuance and sale of the Securities as herein contemplated and
the application of the net proceeds therefrom as described in the
Prospectus will not be, an "investment company" as such terms are
defined in the Investment Company Act of 1940, as amended (the "1940
Act").
(xx) ENVIRONMENTAL LAWS. Except as described in the
Registration Statement and except as would not, singly or in the
aggregate, result in a Material Adverse Effect, (A) the Company is
not in violation of any federal, state, local or foreign statute,
law, rule, regulation, ordinance, code, policy or rule of common law
or any judicial or administrative interpretation thereof, including
any judicial or administrative order, consent, decree or judgment,
relating to pollution or protection of human health, the environment
(including, without limitation, ambient air, surface water,
groundwater, land surface or subsurface strata) or wildlife,
including, without limitation, laws and regulations relating to the
release or threatened release of chemicals, pollutants, contaminants,
wastes, toxic substances, hazardous substances, petroleum or
petroleum products (collectively, "Hazardous Materials") or to the
manufacture, processing, distribution, use, treatment, storage,
disposal, transport or handling of Hazardous Materials (collectively,
"Environmental Laws"), (B) the Company has all permits,
authorizations and approvals required under any applicable
Environmental Laws and is in compliance with their requirements, (C)
there are no pending or threatened administrative, regulatory or
judicial actions, suits, demands, demand letters, claims, liens,
notices of noncompliance or violation, investigation or proceedings
relating to any Environmental Law against the Company and (D) there
are no events or circumstances that might reasonably be expected to
form the basis of an order for clean-up or remediation, or an action,
suit or proceeding by any private party or governmental body or
agency, against or affecting the Company relating to Hazardous
Materials or any Environmental Laws.
(xxi) REGISTRATION RIGHTS. There are no persons with
registration rights or other similar rights to have any securities
registered pursuant to the Registration Statement or included in the
Offering that have not been duly waived.
(xxii) STOCK EXCHANGE LISTING. The Securities have been
approved for listing on the Nasdaq National Market, subject only to
official notice of issuance.
(xxiii) USE OF PROCEEDS. The Company currently plans to
apply the net proceeds from the sale of the Securities sold by it in
the manner described under the caption "How We Intend to Use the
Proceeds of this Offering" in the Prospectus.
(xxiv) TAX LAW COMPLIANCE. The Company has filed all
necessary federal, state and foreign income and franchise tax returns
or has properly requested extensions thereof
8
<PAGE>
and has paid all taxes required to be paid by it and, if due and
payable, any related or similar assessment, fine or penalty levied
against it except as may be being contested in good faith and by
appropriate proceedings. The Company has made adequate charges,
accruals and reserves in the applicable financial statements referred
to in Section 1(a)(iii) above in respect of all federal, state and
foreign income and franchise taxes for all periods covered by such
financial statements as to which the tax liability of the Company has
not been finally determined.
(b) OFFICER'S CERTIFICATES. Any certificate signed by any
officer of the Company delivered to the Representatives or to counsel for the
Underwriters pursuant to this Agreement shall be deemed a representation and
warranty by the Company to each Underwriter as to the matters covered thereby.
SECTION 2. SALE AND DELIVERY TO UNDERWRITERS; CLOSING.
(a) INITIAL SECURITIES. On the basis of the representations and
warranties herein contained and subject to the terms and conditions herein
set forth, the Company agrees to sell to each Underwriter, severally and not
jointly, and each Underwriter, severally and not jointly, agrees to purchase
from the Company, at the price per share set forth in SCHEDULE B, the number
of Initial Securities set forth in SCHEDULE A opposite the name of such
Underwriter, plus any additional number of Initial Securities which such
Underwriter may become obligated to purchase pursuant to the provisions of
Section 10 hereof.
(b) OPTION SECURITIES. In addition, on the basis of the
representations and warranties herein contained and subject to the terms and
conditions herein set forth, the Company hereby grants an option to the
Underwriters, severally and not jointly, to purchase up to an additional
345,000 shares of Common Stock at the price per share set forth in SCHEDULE
B, less an amount per share equal to any dividends or distributions declared
by the Company and payable on the Initial Securities but not payable on the
Option Securities. The option hereby granted will expire 30 days after the
date hereof and may be exercised in whole or in part from time to time only
for the purpose of covering over-allotments which may be made in connection
with the offering and distribution of the Initial Securities upon notice by
the Representatives to the Company setting forth the number of Option
Securities as to which the several Underwriters are then exercising the
option and the time and date of payment and delivery for such Option
Securities. Any such time and date of delivery (a "Date of Delivery") shall
be determined by the Representatives, but shall not be later than seven full
business days after the exercise of said option, nor in any event prior to
the Closing Time, as hereinafter defined. If the option is exercised as to
all or any portion of the Option Securities, each of the Underwriters, acting
severally and not jointly, will purchase that proportion of the total number
of Option Securities then being purchased which the number of Initial
Securities set forth in SCHEDULE A opposite the name of such Underwriter
bears to the total number of Initial Securities, subject in each case to such
adjustments as the Representatives in their discretion shall make to
eliminate any sales or purchases of fractional shares.
(c) PAYMENT. Payment of the purchase price for, and delivery of
certificates for, the Initial Securities shall be made at the offices of
Cooley Godward LLP, One Maritime Plaza, 20th Floor, San Francisco, CA 94111,
or at such other place as shall be agreed upon by the
9
<PAGE>
Representatives and the Company, at 7:00 A.M. (California time) on the third
(fourth, if the pricing occurs after 4:30 P.M. (Eastern time) on any given
day) business day after the date hereof (unless postponed in accordance with
the provisions of Section 10), or such other time not later than ten business
days after such date as shall be agreed upon by the Representatives and the
Company (such time and date of payment and delivery being herein called
"Closing Time").
In addition, in the event that any or all of the Option Securities
are purchased by the Underwriters, payment of the purchase price for, and
delivery of certificates for, such Option Securities shall be made at the
above-mentioned offices, or at such other place as shall be agreed upon by
the Representatives and the Company, on each Date of Delivery as specified in
the notice from the Representatives to the Company.
Payment shall be made to the Company by wire transfer of immediately
available funds to a bank account designated by the Company, against delivery
to the Representatives for the respective accounts of the Underwriters of
certificates for the Securities to be purchased by them. It is understood
that each Underwriter has authorized the Representatives, for its account, to
accept delivery of, receipt for, and make payment of the purchase price for,
the Initial Securities and the Option Securities, if any, which it has agreed
to purchase. Merrill Lynch, individually and not as representative of the
Underwriters, may (but shall not be obligated to) make payment of the
purchase price for the Initial Securities or the Option Securities, if any,
to be purchased by any Underwriter whose funds have not been received by the
Closing Time or the relevant Date of Delivery, as the case may be, but such
payment shall not relieve such Underwriter from its obligations hereunder.
(d) DENOMINATIONS; REGISTRATION. Certificates for the Initial
Securities and the Option Securities, if any, shall be in such denominations
and registered in such names as the Representatives may request in writing at
least one full business day before the Closing Time or the relevant Date of
Delivery, as the case may be. The certificates for the Initial Securities
and the Option Securities, if any, will be made available for examination and
packaging by the Representatives in The City of New York not later than 10:00
A.M. (Eastern time) on the business day prior to the Closing Time or the
relevant Date of Delivery, as the case may be.
SECTION 3. COVENANTS OF THE COMPANY. The Company covenants with
each Underwriter as follows:
(a) COMPLIANCE WITH SECURITIES REGULATIONS AND COMMISSION
REQUESTS. The Company, subject to Section 3(b), will comply with the
requirements of Rule 430A or Rule 434, as applicable, and will notify the
Representatives immediately, and confirm the notice in writing, (i) when any
post-effective amendment to the Registration Statement shall become
effective, or any supplement to the Prospectus or any amended Prospectus
shall have been filed, (ii) of the receipt of any comments from the
Commission, (iii) of any request by the Commission for any amendment to the
Registration Statement or any amendment or supplement to the Prospectus or
for additional information, and (iv) of the issuance by the Commission of any
stop order suspending the effectiveness of the Registration Statement or of
any order preventing or suspending the use of any preliminary prospectus, or
of the suspension of the qualification of the Securities for offering or sale
in any jurisdiction, or of the initiation or threatening of any proceedings
for any of such purposes. The Company will promptly effect the filings
necessary
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pursuant to Rule 424(b) and will take such steps as it deems necessary to
ascertain promptly whether the form of prospectus transmitted for filing
under Rule 424(b) was received for filing by the Commission and, in the event
that it was not, it will promptly file such prospectus. The Company will
make every reasonable effort to prevent the issuance of any stop order and,
if any stop order is issued, to obtain the lifting thereof at the earliest
possible moment.
(b) FILING OF AMENDMENTS. The Company will give the
Representatives notice of its intention to file or prepare any amendment to
the Registration Statement (including any filing under Rule 462(b)), any Term
Sheet or any amendment, supplement or revision to either the prospectus
included in the Registration Statement at the time it became effective or to
the Prospectus will furnish the Representatives with copies of any such
documents a reasonable amount of time prior to such proposed filing or use,
as the case may be, and will not file or use any such document to which the
Representatives or counsel for the Underwriters shall reasonably object.
(c) DELIVERY OF REGISTRATION STATEMENTS. The Company has
furnished or will deliver to the Representatives and counsel for the
Underwriters, without charge, signed copies of the Registration Statement as
originally filed and of each amendment thereto (including exhibits filed
therewith or incorporated by reference therein) and signed copies of all
consents and certificates of experts, and will also deliver to the
Representatives, without charge, a conformed copy of the Registration
Statement as originally filed and of each amendment thereto (without
exhibits) for each of the Underwriters. The copies of the Registration
Statement and each amendment thereto furnished to the Underwriters will be
identical to the electronically transmitted copies thereof filed with the
Commission pursuant to EDGAR, except to the extent permitted by Regulation
S-T.
(d) DELIVERY OF PROSPECTUSES. The Company has delivered to each
Underwriter, without charge, as many copies of each preliminary prospectus as
such Underwriter reasonably requested, and the Company hereby consents to the
use of such copies for purposes permitted by the 1933 Act. The Company will
furnish to each Underwriter, without charge, during the period when the
Prospectus is required to be delivered under the 1933 Act or the Securities
Exchange Act of 1934 (the "1934 Act"), such number of copies of the
Prospectus (as amended or supplemented) as such Underwriter may reasonably
request. The Prospectus and any amendments or supplements thereto furnished
to the Underwriters will be identical to the electronically transmitted
copies thereof filed with the Commission pursuant to EDGAR, except to the
extent permitted by Regulation S-T.
(e) CONTINUED COMPLIANCE WITH SECURITIES LAWS The Company will
comply with the 1933 Act and the 1933 Act Regulations so as to permit the
completion of the distribution of the Securities as contemplated in this
Agreement and in the Prospectus. If at any time when a Prospectus is
required by the 1933 Act to be delivered in connection with sales of the
Securities, any event shall occur or condition shall exist as a result of
which it is necessary, in the reasonable opinion of counsel for the
Underwriters or for the Company, to amend the Registration Statement or amend
or supplement the Prospectus in order that the Prospectus will not include
any untrue statements of a material fact or omit to state a material fact
necessary in order to make the statements therein not misleading in the light
of the circumstances existing at the time it is delivered to a purchaser, or
if it shall be necessary, in the reasonable opinion of
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such counsel, at any such time to amend the Registration Statement or amend
or supplement the Prospectus in order to comply with the requirements of the
1933 Act or the 1933 Act Regulations, the Company will promptly prepare and
file with the Commission, subject to Section 3(b), such amendment or
supplement as may be necessary to correct such statement or omission or to
make the Registration Statement or the Prospectus comply with such
requirements, and the Company will furnish to the Underwriters such number of
copies of such amendment or supplement as the Underwriters may reasonably
request.
(f) BLUE SKY QUALIFICATIONS. The Company will use its best
efforts, in cooperation with the Underwriters, to qualify the Securities for
offering and sale under the applicable securities laws of such states and
other jurisdictions (domestic or foreign) as the Representatives may
designate and to maintain such qualifications in effect for a period of not
less than one year from the later of the effective date of the Registration
Statement and any Rule 462(b) Registration Statement; provided, however, that
the Company shall not be obligated to file any general consent to service of
process or to qualify as a foreign corporation or as a dealer in securities
in any jurisdiction in which it is not so qualified or to subject itself to
taxation in respect of doing business in any jurisdiction in which it is not
otherwise so subject. In each jurisdiction in which the Securities have been
so qualified, the Company will file such statements and reports as may be
required by the laws of such jurisdiction to continue such qualification in
effect for a period of not less than one year from the effective date of the
Registration Statement and any Rule 462(b) Registration Statement.
(g) RULE 158. The Company will timely file such reports pursuant
to the 1934 Act as are necessary in order to make generally available to its
securityholders as soon as practicable an earnings statement for the purposes
of, and to provide the benefits contemplated by, the last paragraph of
Section 11(a) of the 1933 Act.
(h) USE OF PROCEEDS. The Company will use the net proceeds
received by it from the sale of the Securities in the manner specified in the
Prospectus under "How We Intend to Use the Proceeds of this Offering."
(i) LISTING. The Company will use its best efforts to effect the
listing of the Common Stock (including the Securities) on the Nasdaq National
Market. The Company will use its best efforts to effect and maintain the
quotation of the Securities on the Nasdaq National Market and will file with
the Nasdaq National Market all documents and notices required by the Nasdaq
National Market of companies that have securities that are traded in the
over-the-counter market and quotations for which are reported by the Nasdaq
National Market.
(j) RESTRICTION ON SALE OF SECURITIES. During a period of 180
days from the date of the Prospectus, the Company will not, without the prior
written consent of Merrill Lynch, (i) 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 to purchase or
otherwise transfer or dispose of any share of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock or file any
registration statement under the 1933 Act with respect to any of the
foregoing or (ii) enter into any swap or any other agreement or any
transaction that transfers, in whole or in part, directly or indirectly, the
economic consequence of ownership of the Common Stock, whether any such swap
or transaction described in clause (i) or
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(ii) above is to be settled by delivery of Common Stock or such other
securities, in cash or otherwise. The foregoing sentence shall not apply to
(A) the Securities to be sold hereunder, (B) any shares of Common Stock
issued by the Company upon the exercise of an option or warrant or the
conversion of a security outstanding on the date hereof and referred to in
the Prospectus, (C) any shares of Common Stock issued or options to purchase
Common Stock granted pursuant to existing employee benefit plans of the
Company referred to in the Prospectus (including the filing of one or more
registration statements on Form S-8 with respect thereto) or (D) any shares
of Common Stock issued pursuant to any non-employee director stock plan or
dividend reinvestment plan.
(k) REPORTING REQUIREMENTS. The Company, during the period when
the Prospectus is required to be delivered under the 1933 Act or the 1934
Act, will file all documents required to be filed with the Commission
pursuant to the 1934 Act within the time periods required by the 1934 Act and
the rules and regulations of the Commission thereunder.
(l) COMPLIANCE WITH NASD RULES. The Company hereby agrees that
it will ensure that the Reserved Securities will be restricted as required by
the NASD or the NASD rules from sale, transfer, assignment, pledge or
hypothecation for a period of three months following the date of this
Agreement. The Underwriters will notify the Company as to which persons will
need to be so restricted. At the request of the Underwriters, the Company
will direct the transfer agent to place a stop transfer restriction upon such
securities for such period of time. Should the Company release, or seek to
release, from such restrictions any of the Reserved Securities, the Company
agrees to reimburse the Underwriters for any reasonable expenses (including,
without limitation, legal expenses) they incur in connection with such
release.
SECTION 4. PAYMENT OF EXPENSES.
(a) EXPENSES. The Company will pay all expenses incident to the
performance of its obligations under this Agreement, including (i) the
preparation, printing and filing of the Registration Statement (including
financial statements and exhibits) as originally filed and of each amendment
thereto, (ii) the preparation, printing and delivery to the Underwriters of
this Agreement, any Agreement among Underwriters and such other documents as
may be required in connection with the offering, purchase, sale, issuance or
delivery of the Securities, (iii) the preparation, issuance and delivery of
the certificates for the Securities to the Underwriters, including any stock
or other transfer taxes and any stamp or other duties payable upon the sale,
issuance or delivery of the Securities to the Underwriters, (iv) the fees and
disbursements of the Company's counsel, accountants and other advisors, (v)
the qualification of the Securities under securities laws in accordance with
the provisions of Section 3(f) hereof, including filing fees and the
reasonable fees and disbursements of counsel for the Underwriters in
connection therewith and in connection with the preparation of the Blue Sky
Survey and any supplement thereto, (vi) the printing and delivery to the
Underwriters of copies of each preliminary prospectus, any Term Sheets and
the Prospectus and any amendments or supplements thereto, (vii) the
preparation, printing and delivery to the Underwriters of copies of the Blue
Sky Survey and any supplement thereto, (viii) the fees and expenses of any
transfer agent or registrar for the Securities and (ix) the filing fees
incident to, and the reasonable fees and disbursements of counsel to the
Underwriters in connection with, the review by the NASD of the terms of the
sale of the Securities, (x) the fees and expenses incurred in connection with
the inclusion of the
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Securities in the Nasdaq National Market and (xi) all costs and expenses of
the Underwriters, including the reasonable fees and disbursements of counsel
for the Underwriters, in connection with matters related to the Reserved
Securities which are designated by the Company for sale to employees and
others having a business relationship with the Company.
(b) TERMINATION OF AGREEMENT. If this Agreement is terminated by
the Representatives in accordance with the provisions of Section 5 or Section
9(a)(i) hereof, the Company shall reimburse the Underwriters for all of their
out-of-pocket expenses, including the reasonable fees and disbursements of
counsel for the Underwriters.
SECTION 5. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations
of the several Underwriters hereunder are subject to the accuracy of the
representations and warranties of the Company contained in Section 1 hereof
or in certificates of any officer of the Company delivered pursuant to the
provisions hereof, to the performance by the Company of its covenants and
other obligations hereunder, and to the following further conditions:
(a) EFFECTIVENESS OF REGISTRATION STATEMENT. The Registration
Statement, including any Rule 462(b) Registration Statement, has become
effective and at Closing Time no stop order suspending the effectiveness of
the Registration Statement shall have been issued under the 1933 Act or
proceedings therefor initiated or threatened by the Commission, and any
request on the part of the Commission for additional information shall have
been complied with to the reasonable satisfaction of counsel to the
Underwriters. A prospectus containing the Rule 430A Information shall have
been filed with the Commission in accordance with Rule 424(b) (or a
post-effective amendment providing such information shall have been filed and
declared effective in accordance with the requirements of Rule 430A) or, if
the Company has elected to rely upon Rule 434, a Term Sheet shall have been
filed with the Commission in accordance with Rule 424(b).
(b) OPINION OF COUNSEL FOR COMPANY At Closing Time, the
Representatives shall have received the favorable opinion, dated as of
Closing Time, of Cooley Godward LLP, counsel for the Company, in form and
substance satisfactory to counsel for the Underwriters, together with signed
or reproduced copies of such letter for each of the other Underwriters to the
effect set forth in EXHIBIT A hereto and to such further effect as counsel to
the Underwriters may reasonably request.
(c) OPINION OF COUNSEL FOR UNDERWRITERS. At Closing Time, the
Representatives shall have received the favorable opinion, dated as of
Closing Time, of Brobeck, Phleger & Harrison LLP, counsel for the
Underwriters, together with signed or reproduced copies of such letter for
each of the other Underwriters to the effect set forth in EXHIBIT B hereto.
In giving such opinion such counsel may rely, as to all matters governed by
the laws of jurisdictions other than the law of the States of California and
New York, the federal law of the United States and the General Corporation
Law of the State of Delaware, upon the opinions of counsel satisfactory to
the Representatives. Such counsel may also state that, insofar as such
opinion involves factual matters, they have relied, to the extent they deem
proper, upon certificates of officers of the Company and certificates of
public officials.
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(d) OFFICERS' CERTIFICATE. At Closing Time, there shall not have
been, since the date hereof or since the respective dates as of which
information is given in the Prospectus, any material adverse change in the
condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Company, whether or not arising in the ordinary
course of business, and the Representatives shall have received a certificate
of the President or a Vice President of the Company and of the Chief
Financial Officer of the Company, dated as of Closing Time, to the effect
that (i) there has been no such material adverse change, (ii) the
representations and warranties in Section 1(a) hereof are true and correct
with the same force and effect as though expressly made at and as of Closing
Time, (iii) the Company has complied with all agreements and satisfied all
conditions on its part to be performed or satisfied at or prior to Closing
Time, and (iv) no stop order suspending the effectiveness of the Registration
Statement has been issued and no proceedings for that purpose have been
instituted or are pending or are contemplated by the Commission.
(e) ACCOUNTANT'S COMFORT LETTER. At the time of the execution of
this Agreement, the Representatives shall have received from Ernst & Young
LLP a letter dated such date, in form and substance satisfactory to the
Representatives, together with signed or reproduced copies of such letter for
each of the other Underwriters containing statements and information of the
type ordinarily included in accountants' "comfort letters" to underwriters
with respect to the financial statements and certain financial information
contained in the Registration Statement and the Prospectus.
(f) BRING-DOWN COMFORT LETTER. At Closing Time, the
Representatives shall have received from Ernst & Young LLP a letter, dated as
of Closing Time, to the effect that they reaffirm the statements made in the
letter furnished pursuant to subsection (e) of this Section, except that the
specified date referred to shall be a date not more than three business days
prior to Closing Time.
(g) APPROVAL OF LISTING. At Closing Time, the Securities shall
have been approved for inclusion in the Nasdaq National Market, subject only
to official notice of issuance.
(h) NO OBJECTION. The NASD shall have confirmed that it has not
raised any objection with respect to the fairness and reasonableness of the
underwriting terms and arrangements.
(i) LOCK-UP AGREEMENTS. At the date of this Agreement, the
Representatives shall have received an agreement substantially in the form of
EXHIBIT C hereto signed by the persons listed on SCHEDULE C hereto.
(j) CONDITIONS TO PURCHASE OF OPTION SECURITIES. In the event
that the Underwriters exercise their option provided in Section 2(b) hereof
to purchase all or any portion of the Option Securities, the representations
and warranties of the Company contained herein and the statements in any
certificates furnished by the Company hereunder shall be true and correct as
of each Date of Delivery and, at the relevant Date of Delivery, the
Representatives shall have received:
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(i) OFFICERS' CERTIFICATE. A certificate, dated such
Date of Delivery, of the President or a Vice President of the Company
and of the chief financial or chief accounting officer of the Company
confirming that the certificate delivered at the Closing Time
pursuant to Section 5(d) hereof remains true and correct as of such
Date of Delivery.
(ii) OPINION OF COUNSEL FOR COMPANY. The favorable
opinion of Cooley Godward LLP, counsel for the Company, in form and
substance satisfactory to counsel for the Underwriters, dated such
Date of Delivery, relating to the Option Securities to be purchased
on such Date of Delivery and otherwise to the same effect as the
opinion required by Section 5(b) hereof.
(iii) OPINION OF COUNSEL FOR UNDERWRITERS. The favorable
opinion of Brobeck, Phleger & Harrison LLP, counsel for the
Underwriters, dated such Date of Delivery, relating to the Option
Securities to be purchased on such Date of Delivery and otherwise to
the same effect as the opinion required by Section 5(c) hereof.
(iv) BRING-DOWN COMFORT LETTER. A letter from Ernst &
Young LLP, in form and substance satisfactory to the Representatives
and dated such Date of Delivery, substantially in the same form and
substance as the letter furnished to the Representatives pursuant to
Section 5(f) hereof, except that the "specified date" in the letter
furnished pursuant to this paragraph shall be a date not more than
five days prior to such Date of Delivery.
(k) ADDITIONAL DOCUMENTS. At Closing Time and at each Date of
Delivery, counsel for the Underwriters shall have been furnished with such
documents and opinions as they may require for the purpose of enabling them
to pass upon the issuance and sale of the Securities as herein contemplated,
or in order to evidence the accuracy of any of the representations or
warranties, or the fulfillment of any of the conditions, herein contained;
and all proceedings taken by the Company in connection with the issuance and
sale of the Securities as herein contemplated shall be satisfactory in form
and substance to the Representatives and counsel for the Underwriters.
(l) TERMINATION OF AGREEMENT. If any condition specified in this
Section shall not have been fulfilled when and as required to be fulfilled,
this Agreement, or, in the case of any condition to the purchase of Option
Securities, on a Date of Delivery which is after the Closing Time, the
obligations of the several Underwriters to purchase the relevant Option
Securities, may be terminated by the Representatives by notice to the Company
at any time at or prior to Closing Time or such Date of Delivery, as the case
may be, and such termination shall be without liability of any party to any
other party except as provided in Section 4 and except that Sections 1, 6, 7
and 8 shall survive any such termination and remain in full force and effect.
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SECTION 6. INDEMNIFICATION.
(a) INDEMNIFICATION OF UNDERWRITERS. The Company agrees to
indemnify and hold harmless each Underwriter and each person, if any, who
controls any Underwriter within the meaning of Section 15 of the 1933 Act or
Section 20 of the 1934 Act as follows:
(i) against any and all loss, liability, claim, damage
and expense whatsoever, as incurred, arising out of any untrue
statement or alleged untrue statement of a material fact contained in
the Registration Statement (or any amendment thereto), including the
Rule 430A Information and the Rule 434 Information, if applicable, or
the omission or alleged omission therefrom of a material fact
required to be stated therein or necessary to make the statements
therein not misleading or arising out of any untrue statement or
alleged untrue statement of a material fact included in any
preliminary prospectus or the Prospectus (or any amendment or
supplement thereto), or the omission or alleged omission therefrom of
a material fact necessary in order to make the statements therein, in
the light of the circumstances under which they were made, not
misleading;
(ii) against any and all loss, liability, claim, damage
and expense whatsoever, as incurred, arising out of (A) the violation
of any applicable laws or regulations of foreign jurisdictions where
Reserved Securities have been offered and (B) any untrue statement or
alleged untrue statement of a material fact included in the
supplement or prospectus wrapper material distributed in Ontario,
Canada in connection with the reservation and sale of the Reserved
Securities to certain individuals associated with the Company or the
Company's directors, officers or employees or the omission or alleged
omission therefrom of a material fact necessary to make the
statements therein, when considered in conjunction with the
Prospectus or preliminary prospectus, not misleading;
(iii) against any and all loss, liability, claim, damage
and expense whatsoever, as incurred, to the extent of the aggregate
amount paid in settlement of any litigation, or any investigation or
proceeding by any governmental agency or body, commenced or
threatened, or of any claim whatsoever based upon any such untrue
statement or omission, or any such alleged untrue statement or
omission or in connection with any violation of the nature referred
to in Section 6(a)(ii)(A) hereof; provided that (subject to Section
6(d) below) any such settlement is effected with the written consent
of the Company; and
(iv) against any and all expense whatsoever, as incurred
(including the fees and disbursements of counsel chosen by Merrill
Lynch), reasonably incurred in investigating, preparing or defending
against any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim
whatsoever based upon any such untrue statement or omission, or any
such alleged untrue statement or omission or in connection with any
violation of the nature referred to in Section 6(a)(ii)(A) hereof, to
the extent that any such expense is not paid under (i), (ii) or (iii)
above;
PROVIDED, HOWEVER, that this indemnity agreement shall not apply to
any loss, liability, claim, damage or expense to the extent arising out of
any untrue statement or omission
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or alleged untrue statement or omission made in reliance upon and in
conformity with written information furnished to the Company by any
Underwriter through Merrill Lynch expressly for use in the Registration
Statement (or any amendment thereto), including the Rule 430A Information and
the Rule 434 Information, if applicable, or any preliminary prospectus or the
Prospectus (or any amendment or supplement thereto) and PROVIDED FURTHER,
that the Company will not be liable to any Underwriter with respect to any
Prospectus to the extent that the Company shall sustain the burden of proving
that any such loss, liability, claim, damage or expense resulted from the
fact that such Underwriter, in contravention of a requirement of this
Agreement or applicable law, sold Securities to a person to whom such
Underwriter failed to send or give, at or prior to the Closing Time, a copy
of the Final Prospectus, as then amended or supplemented if: (i) the Company
has previously furnished copies thereof (sufficiently in advance of the
Closing Time to allow for distribution by the Closing Time) to the
Underwriter and the loss, liability, claim, damage or expense of such
Underwriter resulted from an untrue statement or omission of a material fact
contained in or omitted from the Preliminary Prospectus which was corrected
in the Final Prospectus as, if applicable, amended or supplemented prior to
the Closing Time and such Final Prospectus was required by law to be
delivered at or prior to the written confirmation of sale to such person and
(ii) such failure to give or send such Final Prospectus by the Closing Time
to the party or parties asserting such loss, liability, claim, damage or
expense would have constituted the sole defense to the claim asserted by such
person.
(b) INDEMNIFICATION OF COMPANY, DIRECTORS AND OFFICERS. Each
Underwriter severally agrees to indemnify and hold harmless the Company, its
directors, each of its officers who signed the Registration Statement, and
each person, if any, who controls the Company within the meaning of Section
15 of the 1933 Act or Section 20 of the 1934 Act against any and all loss,
liability, claim, damage and expense described in the indemnity contained in
subsection (a) of this Section, as incurred, but only with respect to untrue
statements or omissions, or alleged untrue statements or omissions, made in
the Registration Statement (or any amendment thereto), including the Rule
430A Information and the Rule 434 Information, if applicable, or any
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto) in reliance upon and in conformity with written information
furnished to the Company by such Underwriter through Merrill Lynch expressly
for use in the Registration Statement (or any amendment thereto) or such
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto).
(c) ACTIONS AGAINST PARTIES; NOTIFICATION. Each indemnified
party shall give notice as promptly as reasonably practicable to each
indemnifying party of any action commenced against it in respect of which
indemnity may be sought hereunder, but failure to so notify an indemnifying
party shall not relieve such indemnifying party from any liability hereunder
to the extent it is not materially prejudiced as a result thereof and in any
event shall not relieve it from any liability which it may have otherwise
than on account of this indemnity agreement. In the case of parties
indemnified pursuant to Section 6(a) above, counsel to the indemnified
parties shall be selected by Merrill Lynch, and, in the case of parties
indemnified pursuant to Section 6(b) above, counsel to the indemnified
parties shall be selected by the Company. An indemnifying party may
participate at its own expense in the defense of any such action; provided,
however, that counsel to the indemnifying party shall not (except with the
consent of the indemnified party) also be counsel to the indemnified party.
In no event shall the
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indemnifying parties be liable for fees and expenses of more than one counsel
(in addition to any local counsel) separate from their own counsel for all
indemnified parties in connection with any one action or separate but similar
or related actions in the same jurisdiction arising out of the same general
allegations or circumstances. No indemnifying party shall, without the prior
written consent of the indemnified parties, settle or compromise or consent
to the entry of any judgment with respect to any litigation, or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever in respect of which indemnification or
contribution could be sought under this Section 6 or Section 7 hereof
(whether or not the indemnified parties are actual or potential parties
thereto), unless such settlement, compromise or consent (i) includes an
unconditional release of each indemnified party from all liability arising
out of suc litigation, investigation, proceeding or claim and (ii) does not
include a statement as to or an admission of fault, culpability or a failure
to act by or on behalf of any indemnified party.
(d) SETTLEMENT WITHOUT CONSENT IF FAILURE TO REIMBURSE. If at
any time an indemnified party shall have requested an indemnifying party to
reimburse the indemnified party for fees and expenses of counsel, such
indemnifying party agrees that it shall be liable for any settlement of the
nature contemplated by Section 6(a)(ii) and Section 6(a)(iii) effected
without its written consent if (i) such settlement is entered into more than
45 days after receipt by such indemnifying party of the aforesaid request,
(ii) such indemnifying party shall have received notice of the terms of such
settlement at least 30 days prior to such settlement being entered into and
(iii) such indemnifying party shall not have reimbursed such indemnified
party in accordance with such request prior to the date of such settlement.
(e) INDEMNIFICATION FOR RESERVED SECURITIES. In connection with
the offer and sale of the Reserved Securities, the Company agrees, promptly
upon a request in writing, to indemnify and hold harmless the Underwriters
from and against any and all losses, liabilities, claims, damages and
expenses incurred by them as a result of the failure of certain individuals
associated with the Company or the Company's directors, officers or employees
to pay for and accept delivery of Reserved Securities which, by the end of
the first business day following the date of this Agreement, were subject to
a properly confirmed agreement to purchase.
SECTION 7. CONTRIBUTION. If the indemnification provided for in
Section 6 hereof is for any reason unavailable to or insufficient to hold
harmless an indemnified party in respect of any losses, liabilities, claims,
damages or expenses referred to therein, then each indemnifying party shall
contribute to the aggregate amount of such losses, liabilities, claims,
damages and expenses incurred by such indemnified party, as incurred, (i) in
such proportion as is appropriate to reflect the relative benefits received
by the Company on the one hand and the Underwriters on the other hand from
the offering of the Securities pursuant to this Agreement or (ii) if the
allocation provided by clause (i) is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits
referred to in clause (i) above but also the relative fault of the Company on
the one hand and of the Underwriters on the other hand in connection with the
statements or omissions, or in connection with any violation of the nature
referred to in Section 6(a)(ii)(A) hereof, which resulted in such losses,
liabilities, claims, damages or expenses, as well as any other relevant
equitable considerations.
19
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The relative benefits received by the Company on the one hand and the
Underwriters on the other hand in connection with the offering of the
Securities pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the offering of the
Securities pursuant to this Agreement (before deducting expenses) received by
the Company and the total underwriting discount received by the Underwriters,
in each case as set forth on the cover of the Prospectus, or, if Rule 434 is
used, the corresponding location on the Term Sheet, bear to the aggregate
initial public offering price of the Securities as set forth on such cover.
The relative fault of the Company on the one hand and the
Underwriters on the other hand shall be determined by reference to, among
other things, whether any such untrue or alleged untrue statement of a
material fact or omission or alleged omission to state a material fact
relates to information supplied by the Company or by the Underwriters and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission or any violation of the nature
referred to in Section 6(a)(ii)(A) hereof.
The Company and the Underwriters agree that it would not be just and
equitable if contribution pursuant to this Section 7 were determined by pro
rata allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take account of
the equitable considerations referred to above in this Section 7. The
aggregate amount of losses, liabilities, claims, damages and expenses
incurred by an indemnified party and referred to above in this Section 7
shall be deemed to include any legal or other expenses reasonably incurred by
such indemnified party in investigating, preparing or defending against any
litigation, or any investigation or proceeding by any governmental agency or
body, commenced or threatened, or any claim whatsoever based upon any such
untrue or alleged untrue statement or omission or alleged omission.
Notwithstanding the provisions of this Section 7, no Underwriter
shall be required to contribute any amount in excess of the amount by which
the total price at which the Securities underwritten by it and distributed to
the public were offered to the public exceeds the amount of any damages which
such Underwriter has otherwise been required to pay by reason of any such
untrue or alleged untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning
of Section 11(f) of the 1933 Act) shall be entitled to contribution from any
person who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 7, each person, if any, who controls an
Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act shall have the same rights to contribution as such Underwriter,
and each director of the Company, each officer of the Company who signed the
Registration Statement, and each person, if any, who controls the Company
within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934
Act shall have the same rights to contribution as the Company. The
Underwriters' respective obligations to contribute pursuant to this Section 7
are several in proportion to the number of Initial Securities set forth
opposite their respective names in SCHEDULE A hereto and not joint.
SECTION 8. REPRESENTATIONS, WARRANTIES AND AGREEMENTS TO SURVIVE
DELIVERY. All representations, warranties and agreements contained in this
Agreement or in certificates of
20
<PAGE>
officers of the Company submitted pursuant hereto shall remain operative and
in full force and effect, regardless of any investigation made by or on
behalf of any Underwriter or controlling person, or by or on behalf of the
Company, and shall survive delivery of the Securities to the Underwriters.
SECTION 9. TERMINATION OF AGREEMENT.
(a) TERMINATION; GENERAL. The Representatives may terminate this
Agreement, by notice to the Company, at any time at or prior to Closing Time
(i) if there has been, since the time of execution of this Agreement or since
the respective dates as of which information is given in the Prospectus, any
material adverse change in the condition, financial or otherwise, or in the
earnings, business affairs or business prospects of the Company, whether or
not arising in the ordinary course of business, or (ii) if there has occurred
any material adverse change in the United States or international financial
markets, any outbreak of hostilities or escalation thereof or other calamity
or crisis or any change or development involving a prospective change in
national or international political, financial or economic conditions, in
each case the effect of which is such as to make it, in the judgment of the
Representatives, impracticable to market the Securities or to enforce
contracts for the sale of the Securities, or (iii) if trading in any
securities of the Company has been suspended or materially limited by the
Commission or the Nasdaq National Market, or if trading generally on the
American Stock Exchange or the New York Stock Exchange or in the Nasdaq
National Market has been suspended or materially limited, or minimum or
maximum prices for trading have been fixed, or maximum ranges for prices have
been required, by any of said exchanges or by such system or by order of the
Commission, the National Association of Securities Dealers, Inc. or any other
governmental authority, or (iv) if a banking moratorium has been declared by
Federal, New York or California authorities.
(b) LIABILITIES. If this Agreement is terminated pursuant to
this Section, such termination shall be without liability of any party to any
other party except as provided in Section 4 hereof, and provided further that
Sections 1, 6, 7 and 8 shall survive such termination and remain in full
force and effect.
SECTION 10. DEFAULT BY ONE OR MORE OF THE UNDERWRITERS. If one or
more of the Underwriters shall fail at Closing Time or a Date of Delivery to
purchase the Securities which it or they are obligated to purchase under this
Agreement (the "Defaulted Securities"), the Representatives shall have the
right, within 24 hours thereafter, to make arrangements for one or more of
the non-defaulting Underwriters, or any other underwriters, to purchase all,
but not less than all, of the Defaulted Securities in such amounts as may be
agreed upon and upon the terms herein set forth; if, however, the
Representatives shall not have completed such arrangements within such
24-hour period, then:
(a) if the number of Defaulted Securities does not exceed
10% of the number of Securities to be purchased on such date, each of
the non-defaulting Underwriters shall be obligated, severally and not
jointly, to purchase the full amount thereof in the proportions that
their respective underwriting obligations hereunder bear to the
underwriting obligations of all non-defaulting Underwriters, or
21
<PAGE>
(b) if the number of Defaulted Securities exceeds 10% of
the number of Securities to be purchased on such date, this Agreement
or, with respect to any Date of Delivery which occurs after the
Closing Time, the obligation of the Underwriters to purchase and of
the Company to sell the Option Securities to be purchased and sold on
such Date of Delivery shall terminate without liability on the part
of any non-defaulting Underwriter.
No action taken pursuant to this Section shall relieve any defaulting
Underwriter from liability in respect of its default.
In the event of any such default which does not result in a
termination of this Agreement or, in the case of a Date of Delivery which is
after the Closing Time, which does not result in a termination of the
obligation of the Underwriters to purchase and the Company to sell the
relevant Option Securities, as the case may be, either the Representatives or
the Company shall have the right to postpone Closing Time or the relevant
Date of Delivery, as the case may be, for a period not exceeding seven days
in order to effect any required changes in the Registration Statement or
Prospectus or in any other documents or arrangements. As used herein, the
term "Underwriter" includes any person substituted for an Underwriter under
this Section 10.
SECTION 11. NOTICES. All notices and other communications hereunder
shall be in writing and shall be deemed to have been duly given if mailed or
transmitted by any standard form of telecommunication. Notices to the
Underwriters shall be directed to the Representatives at 5500 Sears Tower,
Chicago, Illinois 60606, attention of Chief Financial Officer, and notices to
the Company shall be directed to it at 1995 University Avenue, Suite 400,
Berkeley, California 94704, attention of Sheryle J. Bolton, Chief Executive
Officer.
SECTION 12. PARTIES. This Agreement shall each inure to the benefit
of and be binding upon the Underwriters and the Company and their respective
successors. Nothing expressed or mentioned in this Agreement is intended or
shall be construed to give any person, firm or corporation, other than the
Underwriters and the Company and their respective successors and the
controlling persons and officers and directors referred to in Sections 6 and
7 and their heirs and legal representatives, any legal or equitable right,
remedy or claim under or in respect of this Agreement or any provision herein
contained. This Agreement and all conditions and provisions hereof are
intended to be for the sole and exclusive benefit of the Underwriters and the
Company and their respective successors, and said controlling persons and
officers and directors and their heirs and legal representatives, and for the
benefit of no other person, firm or corporation. No purchaser of Securities
from any Underwriter shall be deemed to be a successor by reason merely of
such purchase.
SECTION 13. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York.
SECTION 14. EFFECT OF HEADINGS. The Article and Section headings
herein and the Table of Contents are for convenience only and shall not
affect the construction hereof.
If the foregoing is in accordance with your understanding of our
agreement, please sign and return to the Company a counterpart hereof,
whereupon this instrument, along with all
22
<PAGE>
counterparts, will become a binding agreement between the Underwriters and
the Company in accordance with its terms.
Very truly yours,
SCIENTIFIC LEARNING CORPORATION
By __________________________________
Sheryle J. Bolton, Chief Executive Officer
CONFIRMED AND ACCEPTED,
as of the date first above written:
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
THOMAS WEISEL PARTNERS LLC
PACIFIC GROWTH EQUITIES, INC.
BY: MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By ____________________________
Authorized Signatory
For themselves and as Representatives of the other
Underwriters named in SCHEDULE A hereto.
23
<PAGE>
SCHEDULE A
<TABLE>
<CAPTION>
NUMBER OF
NAME OF UNDERWRITER INITIAL SECURITIES
------------------- ------------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated . . . . . . . . . . . . . . . . . . . . . . .
Thomas Weisel Partners LLC. . . . . . . . . . . . . . . . . .
Pacific Growth Equities, Inc. . . . . . . . . . . . . . . . .
------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300,000
------------------
------------------
</TABLE>
Sch A-1
<PAGE>
SCHEDULE B
SCIENTIFIC LEARNING CORPORATION
2,300,000 Shares of Common Stock
(Par Value $0.001 Per Share)
1. The initial public offering price per share for the
Securities, determined as provided in said Section 2, shall be $[______].
2. The purchase price per share for the Securities to be paid by
the several Underwriters shall be $[______], being an amount equal to the
initial public offering price set forth above less $[_______] per share;
provided that the purchase price per share for any Option Securities
purchased upon the exercise of the over-allotment option described in Section
2(b) shall be reduced by an amount per share equal to any dividends or
distributions declared by the Company and payable on the Initial Securities
but not payable on the Option Securities.
Sch B-1
<PAGE>
SCHEDULE C
LIST OF PERSONS AND ENTITIES SUBJECT TO LOCK-UP
[Company will provide list of persons subject to lock-up]
Sch C-1
<PAGE>
Exhibit A
FORM OF OPINION OF COMPANY'S COUNSEL
TO BE DELIVERED PURSUANT TO
SECTION 5(b)
(i) The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the
State of Delaware.
(ii) The Company has corporate power and authority to own,
lease and operate its properties and to conduct its business as
described in the Prospectus and to enter into and perform its
obligations under the Purchase Agreement.
(iii) The Company is duly qualified as a foreign
corporation to transact business and is in good standing in
California and, to the best of our knowledge, each other jurisdiction
in which such qualification is required, whether by reason of the
ownership or leasing of property or the conduct of business, except
where the failure so to qualify or to be in good standing would not
result in a Material Adverse Effect.
(iv) The authorized, issued and outstanding capital stock
of the Company is as set forth in the Prospectus in the column
entitled "Actual" under the caption "Capitalization" (except for
subsequent issuances, if any, pursuant to the Purchase Agreement or
pursuant to reservations, agreements or employee benefit plans
referred to in the Prospectus or pursuant to the exercise of
convertible securities or options referred to in the Prospectus) and
conforms to the description thereof set forth in the Prospectus under
the caption "Description of Capital Stock." The shares of issued and
outstanding capital stock of the Company have been duly authorized
and validly issued and are fully paid and non-assessable; none of the
outstanding shares of capital stock of the Company was issued in
violation of the preemptive or, to the best of our knowledge, other
similar rights of any securityholder of the Company. To the best of
our knowledge, there are no authorized or outstanding options,
warrants, preemptive rights, rights of first refusal or other rights
to purchase, or equity or debt securities convertible into or
exchangeable or exercisable for, any capital stock of the Company
other than those accurately described in the Prospectus. The
description of the Company's stock option, stock bonus and other
stock plans or arrangements, and the options or other rights which
may be granted thereunder, set forth in the Prospectus under the
caption "Employee Benefit Plans" accurately summarizes the
information required to be shown with respect to such plans,
arrangements, options and rights to the extent required under the
1933 Act and the 1933 Regulations.
(v) The Initial Securities have been duly authorized for
issuance and sale to the Underwriters pursuant to the Purchase
Agreement and, when issued and delivered by the Company pursuant to
the Purchase Agreement against payment of the consideration set forth
in the Purchase Agreement, will be validly issued and fully paid and
non-assessable and no holder of the Securities is or will be subject
to personal liability for the debts of the Company by reason of being
such a holder.
(vi) The issuance of the Securities is not subject to
preemptive or other similar rights of any securityholder of the
Company arising (a) by operation of the charter or bylaws of the
A-1
<PAGE>
Company or the General Corporation Law of the State of Delaware or
(b) to the best of our knowledge, under any agreement to which the
Company is a party.
(vii) To the best of our knowledge, the Company does not
own or control, directly or indirectly, any corporation, association
or other entity.
(viii) The Purchase Agreement has been duly authorized,
executed and delivered by the Company.
(ix) The Registration Statement, including any Rule 462(b)
Registration Statement, has been declared effective under the 1933
Act; any required filing of the Prospectus pursuant to Rule 424(b)
has been made in the manner and within the time period required by
Rule 424(b); and, to the best of our knowledge, no stop order
suspending the effectiveness of the Registration Statement or any
Rule 462(b) Registration Statement has been issued under the 1933 Act
and no proceedings for that purpose have been instituted or are
pending or threatened by the Commission.
(x) The Registration Statement, including any Rule 462(b)
Registration Statement, the Rule 430A Information and the Rule 434
Information, as applicable, the Prospectus and each amendment or
supplement to the Registration Statement and Prospectus as of their
respective effective or issue dates (other than the financial
statements and supporting schedules and other financial information
included therein, as to which we express no opinion) comply as to
form in all material respects with the requirements of the 1933 Act
and the 1933 Act Regulations.
(xi) If Rule 434 has been relied upon, the Prospectus was
not "materially different," as such term is used in Rule 434, from
the prospectus included in the Registration Statement at the time it
became effective.
(xii) The form of certificate used to evidence the Common
Stock, in the form filed as an exhibit to the Registration Statement,
complies in all material respects with all applicable statutory
requirements, and any applicable requirements of the charter and
by-laws of the Company.
(xiii) To the best of our knowledge, there is not pending or
overtly threatened any action, suit, proceeding, inquiry or
investigation, to which the Company is a party, or to which the property
of the Company is subject, before or brought by any court or
governmental agency or body, domestic or foreign, which might reasonably
be expected to result in a Material Adverse Effect, or which might
reasonably be expected to materially and adversely affect the properties
or assets thereof or the consummation of the transactions contemplated
in the Purchase Agreement or the performance by the Company of its
obligations thereunder.
(xiv) The information in the Prospectus under "Risk
Factors--We rely on our intellectual property rights and may be unable
to protect these rights" (except as it relates to matters of patent
law), "Risk Factors--Business--Intellectual Property" (except as it
relates to matters of patent law),
A-2
<PAGE>
"Business--Properties," "Management--Employee Benefit Plans,"
"Management--Consulting Agreements," "Management--Limitation of
Liability and Indemnification Matters," "Transactions and
Relationships with Related Parties" and "Description of Capital
Stock," and in the Registration Statement under Item 14 and Item 15,
to the extent that it constitutes matters of law, summaries of legal
matters, the Company's charter and by-laws or legal proceedings, or
legal conclusions, has been reviewed by us and is correct in all
material respects.
(xv) To the best of our knowledge, there are no statutes or
regulations that are required to be described in the Prospectus that are
not described as required.
(xvi) All descriptions in the Registration Statement of
contracts and other documents to which the Company is a party are
accurate in all material respects; to the best of our knowledge, there
are no franchises, contracts, indentures, mortgages, loan agreements,
notes, leases or other instruments required to be described or referred
to in the Registration Statement or to be filed as exhibits thereto
other than those described or referred to therein or filed as exhibits
thereto, and the descriptions thereof or references thereto are correct
in all material respects.
(xvii) No filing with, or authorization, approval, consent,
license, order, registration, qualification or decree of, any court
or governmental authority or agency, domestic or foreign (other than
under the 1933 Act and the 1933 Act Regulations, which have been
obtained, or as may be required under the securities or blue sky laws
of the various states or by the NASD) is necessary or required in
connection with the due authorization, execution and delivery of the
Purchase Agreement or for the offering, issuance or sale of the
Securities.
(xviii) The execution, delivery and performance of the Purchase
Agreement and the consummation of the transactions contemplated in the
Purchase Agreement and in the Registration Statement (including the
issuance and sale of the Securities and the use of the proceeds from the
sale of the Securities as described in the Prospectus under the caption
"How We Intend to Use the Proceeds of this Offering") and compliance by
the Company with its obligations under the Purchase Agreement do not and
will not, whether with or without the giving of notice or lapse of time
or both, conflict with or constitute a breach of, or default or
Repayment Event (as defined in Section 1(a)(x) of the Purchase
Agreement) under or result in the creation or imposition of any lien,
charge or encumbrance upon any property or assets of the Company
pursuant to any contract, indenture, mortgage, deed of trust, loan or
credit agreement, note, lease or any other agreement or instrument filed
as an exhibit to the Registration Statement (except for such conflicts,
breaches or defaults or liens, charges or encumbrances that would not
have a Material Adverse Effect), nor will such action result in any
violation of the provisions of the charter or bylaws of the Company, or
any applicable law, statute, rule, regulation (other than state
securities or blue sky laws as to which we express no opinion), or any
judgment, order, writ or decree entered against the Company, known to
us, of any government, government
A-3
<PAGE>
instrumentality or court, having jurisdiction over the Company or any
of its properties, assets or operations.
(xix) To the best of our knowledge, other than as set forth in
the Prospectus under the caption "Description of Capital
Stock--Registration Rights," there are no persons with registration
rights or other similar rights to have any securities registered
pursuant to the Registration Statement or otherwise registered by the
Company under the 1933 Act which have not been waived.
(xx) The Company is not an "investment company" as such term
is defined in the 1940 Act.
In rendering such opinions, such counsel may rely as to
matters of fact (but not as to legal conclusions), to the extent they
deem proper, on certificates of responsible officers of the Company
and public officials. Such opinion shall not state that it is to be
governed or qualified by, or that it is otherwise subject to, any
treatise, written policy or other document relating to legal
opinions, including, without limitation, the Legal Opinion Accord of
the ABA Section of Business Law (1991).
Such counsel's opinion letter shall also include
substantially the following statement (which shall not constitute
part of such counsel's legal opinion:
We have participated in conferences with officials of the
Company, the Representatives, counsel for the Underwriters and the
Company's independent accountants, at which conferences the contents
of the Registration Statement and Prospectus and related matters were
discussed, and although we have not verified and are not passing upon
the accuracy or completeness of the statements contained in the
Registration Statement or the Prospectus, on the basis of the
foregoing no facts have come to our attention that would lead us to
believe that the Registration Statement or any amendment thereto,
including the Rule 430A Information and Rule 434 Information (if
applicable), (except for financial statements and schedules and other
financial data included therein or omitted therefrom, as to which we
make no statement), at the time such Registration Statement or any
such amendment became effective, contained an untrue statement of a
material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not
misleading or that the Prospectus or any amendment or supplement
thereto (except for financial statements and other financial data
included therein or omitted therefrom, as to which we make no
statement), at the time this Prospectus was issued, at the time any
such amended or supplemented prospectus was issued or at the Closing
Time, included or includes an untrue statement of a material fact or
omitted or omits to state a material fact necessary in order to make
the statements therein, in light of the circumstances under which
they were made, not misleading.
A-4
<PAGE>
Exhibit B
FORM OF OPINION OF UNDERWRITERS' COUNSEL
<PAGE>
Exhibit C
-, 1999
MERRILL LYNCH & CO.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated,
THOMAS WEISEL PARTNERS
PACIFIC GROWTH EQUITIES, INC.
as Representatives of the several
Underwriters to be named in the
within-mentioned Purchase Agreement
c/o Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
North Tower
World Financial Center
New York, New York 10281-1209
Re: PROPOSED PUBLIC OFFERING BY SCIENTIFIC LEARNING CORPORATION
Dear Sirs:
The undersigned, a stockholder, officer or director of Scientific
Learning Corporation, a Delaware corporation (the "Company"), understands
that Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch"), Thomas Weisel Partners and Pacific Growth Equities, Inc.
propose to enter into a Purchase Agreement (the "Purchase Agreement") with
the Company providing for the public offering of shares (the "Securities") of
the Company's common stock, par value $0.001 per share (the "Common Stock").
In recognition of the benefit that such an offering will confer upon the
undersigned as a stockholder, officer or director of the Company, and for
other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, the undersigned agrees with each underwriter to be
named in the Purchase Agreement that, during a period of 180 days from the
date of the Purchase Agreement, the undersigned will not, without the prior
written consent of Merrill Lynch, directly or indirectly, (i) 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, or otherwise dispose of or transfer any shares of the Company's Common
Stock or any securities convertible into or exchangeable or exercisable for
Common Stock, whether now owned or hereafter acquired by the undersigned or
with respect to which the undersigned has or hereafter acquires the power of
disposition, or file any registration statement under the Securities Act of
1933, as amended, with respect to any of the foregoing or (ii) enter into any
swap or any other agreement or any transaction that transfers, in whole or in
part, directly or indirectly, the economic consequence of ownership of the
Common Stock, whether any such swap or transaction is to be settled by
delivery of Common Stock or other securities, in cash or otherwise.
Very truly yours,
Signature: ________________________
Print Name: _______________________
C-1
<PAGE>
Exhibit D
FORM OF ACCOUNTANTS' COMFORT LETTER PURSUANT TO SECTION 5(e)
We have audited the balance sheets of the Company as of December 31, 1997 and
1998 and the statements of operations, redeemable convertible preferred stock
and stockholders' equity (deficit), and cash flows for three years in the period
ended December 31, 1998, and the related financial statement schedule, all
included in the Registration Statement on Form S-1, filed by the Company under
the Securities Act of 1933, as amended (the "Act"); our reports with respect
thereto also are included in such Registration Statement as amended, including
the information contained in the Prospectus filed pursuant to Rule 424(b) under
the Act, herein referred to as the "Registration Statement".
In connection with the Registration Statement:
1. We are independent auditors with respect to the Company within the meaning
of the Act and the applicable published rules and regulations thereunder
adopted by the Securities and Exchange Commission ("SEC").
2. In our opinion, the financial statements audited by us and included in the
Registration Statement comply as to form in all material respects with the
applicable accounting requirements of the Act and the related published
rules and regulations adopted by the SEC.
3. We have not audited any financial statements of the Company as of any date
or for any period subsequent to December 31, 1998. The purpose (and
therefore the scope) of our audit for the year ended December 31, 1998 was
to enable us to express our opinion on the financial statements at
December 31, 1998 and for the year then ended, but not on the financial
statements for any interim period within such year. Therefore, we are
unable to express and do not express an opinion on: the unaudited
condensed balance sheet at March 31, 1999; the unaudited condensed
statements of operations, redeemable convertible preferred stock and
stockholders' equity (deficit), and cash flows for the three-month periods
ended March 31, 1998 and 1999 included in the Registration Statement; or
the financial position, results of operations, or cash flows as of any
date or for any period subsequent to December 31, 1998.
4. For purposes of this letter, we have read the minutes of meetings of the
stockholders and the Board of Directors and other committees of the Company
as set forth in the minute books from January 1, 1998 through the specified
date not more than five days prior to the date of this Agreement, officials
of the Company having advised us that the minutes of all such meetings
through that date were set forth therein, and have carried out other
procedures to the specified date not more than five days prior to the date
of this Agreement as follows:
a) With respect to the three-month periods ended March 31, 1998 and 1999,
we have:
D-1
<PAGE>
(1) performed the procedures specified by the American Institute of
Certified Public Accountants for a review of interim financial
information as described in SAS 71, INTERIM FINANCIAL INFORMATION,
on the unaudited condensed balance sheet at March 31, 1999 and the
unaudited condensed statements of operations and cash flows for
the three-month periods ended March 31, 1998 and 1999, and the
redeemable convertible preferred stock and stockholders' equity
(deficit) for the three-month period ended March 31, 1999,
included in the Registration Statement; and
(2) inquired of certain officials of the Company who have
responsibility for financial and accounting matters as to whether
the unaudited condensed financial statements referred to under
4.a)(1) above comply as to form in all material respects with the
applicable accounting requirements of the Act and the related
published rules and regulations adopted by the SEC.
b) With respect to the period from April 1, 1999 to May 31, 1999, we have:
(1) read the unaudited financial statements for April and May of both
1998 and 1999 (the financial information for April and May is
incomplete in that it omits the statements of cash flows and other
disclosures) furnished to us by the Company, officials of the
Company having advised us that no such financial statements as of
any date or for any period subsequent to May 31, 1999 were
available; and
(2) inquired of certain officials of the Company who have
responsibility for financial and accounting matters as to whether
the unaudited financial statements referred to under 4.b)(1) are
stated on a basis substantially consistent with that of the
audited financial statements included in the Registration
Statement.
The foregoing procedures do not constitute an audit conducted in accordance
with generally accepted auditing standards. Also, they would not
necessarily reveal matters of significance with respect to the comments in
the following paragraph. Accordingly, we make no representations as to the
sufficiency of the foregoing procedures for your purposes.
5. Nothing came to our attention as a result of the foregoing procedures that
caused us to believe that:
a) any material modifications should be made to the unaudited condensed
financial statements described in 4.a)(1) above, included in the
Registration Statement, for them to be in conformity with generally
accepted accounting principles, except as follows _____________;
D-2
<PAGE>
b) the unaudited condensed financial statements described in 4.a)(1) above
do not comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations adopted by the SEC, except as follows _____________;
c) the unaudited quarterly financial data referred to in 4.b)(1) does not
agree with the amounts set forth in the unaudited condensed financial
statements for those same periods, except as follows _____________;
d) the unaudited amounts referred to in 4.b)(1) were not determined on a
basis consistent with that of the corresponding amounts in the audited
statement of operations, except as follows _____________;
e) (i) at May 31, 1999, there was any change in the capital stock (other
than issuances of common stock upon exercise of options), increase in
long-term debt or decrease in net current assets or stockholders'
equity (deficit) (except as a result of continuing net losses) of the
Company as compared with the amounts shown in the March 31, 1999
unaudited condensed balance sheet included in the Registration
Statement; or (ii) for the period from April 1, 1999 to May 31, 1999,
there was any decrease, as compared with the corresponding period in
the preceding year, in net revenue or increase in the total or
per-share amounts of net loss, except in all instances for changes,
increases, or decreases that the Registration Statement discloses
have occurred or may occur, except as follows ____________ .
6. Company officials have advised us that no financial statements as of any
date or for any period subsequent to May 31, 1999 are available;
accordingly, the procedures carried out by us with respect to changes in
financial statement items after May 31, 1999 have, of necessity, been even
more limited than those with respect to the periods referred to in 4.
above. We have inquired of certain officials of the Company who have
responsibility for financial and accounting matters as to whether there
was any change at the specified date not more than five days prior to the
date of this Agreement in the capital stock (other than issuances of
common stock upon exercise of options), long-term debt or stockholders'
equity (deficit) (except as a result of continuing net losses) of the
Company as compared with the amounts shown on the March 31, 1999 unaudited
condensed balance sheet included in the Registration Statement. On the
basis of these inquiries and our reading of the minutes as described in 4.
above, nothing came to our attention that caused us to believe that there
was any such change, decrease, or increase, except in all instances for
changes, decreases, or increases which the Registration Statement
discloses have occurred or may occur, except as follows _____________.
7. At your request, we have also read the items identified by you on certain
pages of the Registration Statement (prospectus), and have performed the
procedures indicated by reference letter.
D-3
<PAGE>
8. Our audits of the financial statements for the periods referred to in the
introductory paragraph of this letter were comprised of audit tests and
procedures deemed necessary for the purpose of expressing an opinion on
such financial statements taken as a whole. For neither the periods
referred to therein nor any other period did we perform audit tests for
the purpose of expressing an opinion on individual balances of accounts or
summaries of selected transactions such as those enumerated above and,
accordingly, we do not express an opinion thereon.
9. It should be understood that we make no representations as to questions of
legal interpretation or as to the sufficiency for your purposes of the
procedures enumerated in paragraph 7; also, such procedures would not
necessarily reveal any material misstatement of the information identified
in paragraph 7. Further, we have addressed ourselves solely to the
foregoing data as set forth in the Registration Statement and make no
representations as to the adequacy of disclosure or as to whether any
material facts have been omitted.
10. This letter is solely for the information of the addressees and to assist
the underwriters in conducting and documenting their investigation of the
affairs of the Company in connection with the offering of the securities
covered by the Registration Statement, and is not to be used, circulated,
quoted or otherwise referred to within or without the underwriting group
for any other purpose, including, but not limited to, the registration,
purchase, or sale of securities, nor is it to be filed with or referred to
in whole or in part in the Registration Statement or any other document,
except that reference may be made to it in the underwriting agreement or
in any list of closing documents pertaining to the offering of the
securities covered by the Registration Statement.
D-5
<PAGE>
CERTAIN CONFIDENTIAL INFORMATION
CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAD BEEN OMITTED AND FILED
SEPARATELY WITH THE SECURITIES AND
EXCHANGE COMMISSION PURSUANT TO RULE
406 OF THE SECURITIES ACT OF 1933, AS
AMENDED.
EXHIBIT 10.13
EXCLUSIVE LICENSE AGREEMENT
BETWEEN
THE REGENTS OF THE UNIVERSITY OF CALIFORNIA
AND
SCIENTIFIC LEARNING PRINCIPLES CORPORATION
FOR
TRAINING AIDS FOR REMEDIATION OF LEARNING DISABILITIES
UC CASE NO. 94-069-1
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1. DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2. LIFE OF PATENT EXCLUSIVE GRANT . . . . . . . . . . . . . . . . . . . . 3
3. SUBLICENSES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4. PAYMENT TERMS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
5. LICENSE-ISSUE FEE. . . . . . . . . . . . . . . . . . . . . . . . . . . 6
6. MILESTONE PAYMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . 7
7. EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES. . . . . . . . . . . . . 7
8. DUE DILIGENCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
9. PROGRESS AND ROYALTY REPORTS . . . . . . . . . . . . . . . . . . . . . 9
10. BOOKS AND RECORDS. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
11. LIFE OF THE AGREEMENT. . . . . . . . . . . . . . . . . . . . . . . . . 10
12. TERMINATION BY THE REGENTS . . . . . . . . . . . . . . . . . . . . . . 11
13. TERMINATION BY THE LICENSEE. . . . . . . . . . . . . . . . . . . . . . 11
14. DISPOSITION OF LICENSED PRODUCTS ON HAND UPON TERMINATION. . . . . . . 12
15. USE OF NAMES AND TRADEMARKS. . . . . . . . . . . . . . . . . . . . . . 12
16. LIMITED WARRANTY . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
17. PATENT PROSECUTION AND MAINTENANCE . . . . . . . . . . . . . . . . . . 14
18. PATENT MARKING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
19. PATENT INFRINGEMENT. . . . . . . . . . . . . . . . . . . . . . . . . . 16
20. INDEMNIFICATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
21. NOTICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
22. ASSIGNABILITY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
23. NO WAIVER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
24. FAILURE TO PERFORM . . . . . . . . . . . . . . . . . . . . . . . . . . 20
25. GOVERNING LAWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
26. GOVERNMENT APPROVAL OR REGISTRATION. . . . . . . . . . . . . . . . . . 20
27. EXPORT CONTROL LAWS. . . . . . . . . . . . . . . . . . . . . . . . . . 21
28. SECRECY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
29. MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
</TABLE>
i
<PAGE>
EXCLUSIVE LICENSE AGREEMENT
THIS LICENSE AGREEMENT (the "Agreement") is made effective this 27th day of
September, 1996 (the "Effective Date") between THE REGENTS OF THE UNIVERSITY OF
CALIFORNIA, a California corporation having its statewide administrative offices
at 300 Lakeside Drive, 22nd Floor, Oakland, California 94612-3550, ("The
Regents"), and SCIENTIFIC LEARNING PRINCIPLES CORPORATION, a California
corporation having a principal place of business at One Kearney Street, Suite
501, San Francisco, California 94108, (the "Licensee").
BACKGROUND
1. Certain inventions, generally characterized as "Training Aids for the
Remediation of Learning Disabilities" (collectively the "Invention"), were made
in the course of research at the University of California, San Francisco by Drs.
Michael Merzenich, William Jenkins, Christoph Schreiner and by Drs. Paula Tallal
and Steven Miller at Rutgers-the State University of New Jersey ("Rutgers") and
are covered by Regents' Patent Rights as defined below;
2. The Regents and Rutgers have entered into an inter-institutional
agreement whereby The Regents is authorized to enter into this Agreement on
behalf of both The Regents and Rutgers;
3. The Licensee and The Regents have executed a Letter of Intent (U.C.
Control No. 96-30-0452) dated January 9, 1996;
4. The Licensee wishes to obtain rights from The Regents for the
commercial development, use, and sale of products from the Invention, and The
Regents is willing to grant
1.
<PAGE>
those rights so that the invention may be developed to its fullest and the
benefits enjoyed by the general public; and
5. The Licensee is a "small business firm" as defined in 15 U.S.C.
Section 632;
6. Both parties recognize and agree that royalties due under this
Agreement will be paid on both pending patent applications and issued patents:
In view of the foregoing, the parties agree:
1. DEFINITIONS
1.1 "REGENTS' PATENT RIGHTS" means any subject matter claimed in or
covered by any of the following: Pending U.S. Patent Application Serial No.
08/351,803 entitled "Method and Device for Enhancing the Recognition of Speech
Among Speech-Impaired Individuals" filed December 8, 1994 by Drs. Merzenich,
Jenkins, Schreiner, Tallal, and Miller and assigned to The Regents and to
Rutgers; and continuing applications thereof including divisions and
substitutions but excluding continuation-in-part applications except to the
extent that the claims are enabled by the parent case; any patents issuing on
said applications including reissues, reexaminations and extensions; and any
corresponding foreign applications or patents.
1.2 "LICENSED PRODUCT" means any material that is either covered by
Regents' Patent Rights, that is produced by the Licensed Method, or that the use
of which would constitute, but for the license granted to the Licensee under
this Agreement, an infringement of any pending or issued claim within Regents'
Patent Rights.
1.3 "LICENSED METHOD" means any method that is covered by Regents' Patent
Rights, the use of which would constitute, but for the license granted to the
Licensee under this Agreement, an infringement of any pending or issued claim
within Regents' Patent Rights.
2.
<PAGE>
1.4 "NET SALES" means the total of the gross invoice prices of Licensed
Products sold or Licensed Methods performed by the Licensee, an Affiliate or a
sublicensee, less the sum of the following actual and customary deductions where
applicable: cash, trade, or quantity discounts; sales, use, tariff,
import/export duties or other excise taxes imposed on particular sales;
transportation charges and allowances; reserves for bad debts (not to exceed 3
%) or credits to customers because of rejections or returns. For purposes of
calculating Net Sales, transfers to an Affiliate or sublicensee for end use by
the Affiliate or sublicensee will be treated as sales at list price.
1.5 "AFFILIATE" means any corporation or other business entity in which
the Licensee owns or controls, directly or indirectly, at least fifty percent
(50%) of the outstanding stock or other voting rights entitled to elect
directors, or in which the Licensee is owned or controlled directly or
indirectly by at least fifty percent (50%) of the outstanding stock or other
voting rights entitled to elect directors; but in any country where the local
law does not permit foreign equity participation of at least fifty percent
(50%), then an "Affiliate" includes any company in which the Licensee owns or
controls or is owned or controlled by, directly or indirectly, the maximum
percentage of outstanding stock or voting rights permitted by local law.
2. LIFE OF PATENT EXCLUSIVE GRANT.
2.1 Subject to the limitations set forth in this Agreement, The Regents
grants to the Licensee a world-wide license under Regents' Patent Rights to
make, have made, use, sell, offer to sell and import Licensed Products and to
practice Licensed Methods.
2.2 Except as otherwise provided in this Agreement, the license granted in
Paragraph 2.1 is exclusive for the life of the Agreement.
2.3 The Regents and Rutgers reserves the right to use the Invention for
educational and research purposes.
3.
<PAGE>
3. SUBLICENSES.
3.1 The Regents also grants to the Licensee the right to issue sublicenses
to third parties to make, have made, use, sell, offer to sell and import
Licensed Products and to practice Licensed Method, as long as the Licensee has
current exclusive rights thereto under this Agreement. Throughout the term of
each sublicense, the Licensee shall ensure compliance by sublicensee with, to
the extent applicable, all of the rights and obligations due to the Regents and
Rutgers contained in this Agreement.
3.2 The Licensee shall promptly provide The Regents with a copy of each
sublicense issued; collect and guarantee payment of all payments due The Regents
based on sublicensee's sales; and summarize and deliver all reports due The
Regents based on sublicensee's sales.
3.3 Upon termination of this Agreement for any reason, The Regents, at its
sole discretion, shall determine whether the Licensee shall cancel or assign to
The Regents any and all sublicenses.
3.4 Licensee shall pay to The Regents consideration from sublicensing or
transferring the rights licensed to Licensee as follows:
3.4.1 ROYALTIES - the greater of: (i) [ * ] of the royalty income
received by Licensee and/or its Affiliates from any sublicensee in
consideration of the sublicense grant or rights transfer; or (ii) the
royalty based on sublicensee's Net Sales in accordance with the royalty
schedule in Article 7 (EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES).
3.4.2 NON-ROYALTY CONSIDERATION - [ * ] of all non-royalty
consideration, received by Licensee and its Affiliates in consideration of
the sublicense grant or rights transfer, except for the portion thereof
which is designated and demonstrably used by Licensee solely for its
development of Licensed Products and Licensed Methods, excluding equity
payments, bona fide loans and other payments not associated with the
sublicense.
[ * ]Confidential Treatment Requested
4.
<PAGE>
4. PAYMENT TERMS.
4.1 Paragraphs 1.1, 1.2, and 1.3 define Regents' Patent Rights, Licensed
Products and Licensed Methods so that royalties are payable on products and
methods covered by both pending patent applications and issued patents.
Royalties will accrue in each country for the duration of Regents' Patent Rights
in that country and are payable to The Regents when Licensed Products are
invoiced. or if not invoiced, when delivered to a third party.
4.2 Licensee shall pay earned royalties quarterly on or before February
28, May 31, August 31 and November 30 of each calendar year. Each payment will
be for earned royalties accrued within the Licensee's most recently completed
calendar quarter.
4.3 All monies due The Regents are payable in United States dollars. When
Licensed Products are sold for monies other than United States dollars, the
Licensee shall first determine the earned royalty in the currency of the country
in which Licensed Products were sold and then convert the amount into equivalent
United States funds, using the exchange rate quoted in the Wall Street Journal
on the last business day of the reporting period.
4.4 Royalties earned on sales occurring in any country outside the
United States may not be reduced by any taxes, fees, or other charges imposed
by the government of such country on the payment of royalty income. The
Licensee is also responsible for all bank transfer charges. Notwithstanding
this, all payments made by the Licensee in fulfillment of The Regents' tax
liability in any particular country will be credited against earned royalties
or fees due The Regents for that country.
4.5 If at any time legal restrictions prevent the prompt remittance of
royalties by the Licensee from any country where a Licensed Product is sold, the
Licensee shall convert the amount owed to The Regents into United States funds
and shall pay The Regents directly from its U.S. source of funds for as long as
the legal restrictions apply.
4.6 If any patent or patent claim within Regents' Patent Rights is held
invalid in a final decision by a court of competent jurisdiction and last resort
and from which no appeal has or can be taken, all obligation to pay royalties
based on that patent or claim or any claim
5.
<PAGE>
patentably indistinct therefrom will cease as of the date of final decision.
The Licensee will not, however, be relieved from paying any royalties that
accrued before the final decision or that are based on another patent or
claim not involved in the final decision. or that are based on The Regents'
property rights.
4.7 In the event payments, rebillings or fees are not received by The
Regents when due, the Licensee shall pay to The Regents interest charges at a
rate of [ * ] per annum. Interest is calculated from the date payment was due
until actually received by The Regents.
5. LICENSE-ISSUE FEE.
5.1 The Licensee shall pay to The Regents a LICENSE-ISSUE FEE of Two
Hundred Thousand dollars ($200,000) payable as follows: Fifty Thousand
dollars ($50,000) within seven days after the Effective Date; Fifty Thousand
dollars ($50,000) on August 31, 1997 and One Hundred Thousand dollars
($100,000) on February 28, 1998. This fee is non-refundable, non-cancelable,
and is not an advance against royalties.
5.2 The Licensee shall also grant to Rutgers three hundred ninety-three
thousand five hundred seventy-six (393,576) shares of series A preferred stock
within thirty (30) days of execution of this Agreement.
6. MILESTONE PAYMENTS.
6.1 The Licensee shall also pay to The Regents a royalty in the form of
a milestone payments of Fifty Thousand Dollars ($50,000) upon Licensee reaching
[ * ] Dollars [ * ] in cumulative Net Sales of Licensed Products or Licensed
Methods: [ * ] Dollars [ * ] upon Licensee reaching [ * ] Dollars [ * ] in
cumulative Net Sales of Licensed Products or Licensed Methods; and [ * ]
Dollars [ * ] upon Licensee reaching [ * ] Dollars
[ * ]Confidential Treatment Requested
6.
<PAGE>
($[ * ]) in cumulative Net Sales of Licensed Products and Licensed Methods.
Milestone payments are non-refundable and not an advance against earned
Royalties.
7. EARNED ROYALTIES AND MINIMUM ANNUAL ROYALTIES.
7.1 The Licensee shall also pay to The Regents AN EARNED ROYALTY as
follows: [ * ] of the first [ * ] Dollars [ * ] of cumulative Net Sales of
Licensed Products or Licensed Methods; [ * ] thereafter until cumulative Net
Sales reaches [ * ] Dollars [ * ]; and [ * ] of the cumulative Net Sales of
Licensed Products and Licensed Methods in excess of [ * ] Dollars [ * ].
7.2 The Licensee shall pay to The Regents a MINIMUM ANNUAL ROYALTY of
[ * ] Dollars [ * ] beginning with the year of the first commercial sale of
Licensed Product; [ * ] dollar [ * ] in the second year of first commercial
sale and One Hundred Fifty Thousand Dollars ($150,000) per year for the life
of Regents Patent Rights. For the first year of commercial sales, the
Licensee's obligation to pay the minimum annual royalty will be pro-rated for
the number of months remaining in that calendar year when commercial sales
commence and will be due the following February 28, to allow for crediting of
the pro-rated year's earned royalties. For subsequent years, the minimum
annual royalty will be paid to The Regents by February 28 of each year and
will be credited against the earned royalty due for the calendar year in
which the minimum payment was made.
8. DUE DILIGENCE.
8.1 The Licensee, on execution of this Agreement, shall diligently proceed
with the development, manufacture and sale of Licensed Products and shall
earnestly and diligently endeavor to market the same within a reasonable time
after execution of this Agreement and in quantities sufficient to meet market
demands.
[ * ]Confidential Treatment Requested
7.
<PAGE>
8.2 The Licensee shall endeavor to obtain all necessary governmental
approvals for the manufacture, use and sale of Licensed Products.
8.3 The Licensee shall:
8.3.1 complete a second round of financing by April 30, 1997;
8.3.2 commence beta-testing of Licensed Products by December 31,
1996:
8.3.3 make commercially reasonable efforts to market and sell
Licensed Products in the United States by November 30, 1997;
and
8.3.4 act in a commercially reasonable manner to fill the market
demand for Licensed Products following commencement of
marketing at any time during the exclusive period of this
Agreement.
8.4 If the Licensee is unable to perform any of the above provisions, then
The Regents has the right and option to either terminate this Agreement or
reduce the Licensee's exclusive license to a nonexclusive license. This right,
if exercised by The Regents, supersedes the rights granted in Article 2 (GRANT).
8.5 In addition to the obligations set forth above, the Licensee shall
spend an aggregate of not less than [ * ] Dollars [ * ] for the development
of Licensed Products during the first year of this Agreement.
9. PROGRESS AND ROYALTY REPORTS.
9.1 Beginning February 28, 1997 and semi-annually thereafter, the Licensee
shall submit to The Regents a progress report covering the Licensee's (and any
Affiliate or sublicensee's) activities related to the development and testing of
all Licensed Products and the obtaining of the governmental approvals necessary
for marketing. Progress reports are required for each Licensed Product until the
first commercial sale of that Licensed Product occurs in the United States and
shall be again required if commercial sales of such Licensed Product are
suspended or discontinued.
9.2 Progress reports submitted under Paragraph 9.1 shall include, but are
not limited to, the following topics:
[ * ]Confidential Treatment Requested
8.
<PAGE>
* summary of work completed
* key scientific discoveries
* summary of work in progress
* current schedule of anticipated events or milestones
* market plans for introduction of Licensed Products, and
* a summary, of resources (dollar value) spent in the
reporting period.
9.3 The Licensee has a continuing responsibility to keep The Regents
informed of the large/small business entity status (as defined by the United
States Patent and Trademark Office) of itself and its sublicensees and
Affiliates.
9.4 The Licensee shall report to The Regents in its immediately subsequent
progress and royalty report the date of first commercial sale of a Licensed
Product in each country.
9.5 After the first commercial sale of a Licensed Product anywhere in the
world, the Licensee shall make quarterly royalty reports to The Regents on or
before each February 28, May 31, August 31, and November 30 of each year. Each
royalty report will cover the Licensee's most recently completed calendar
quarter and will show (a) the gross sales and Net Sales of Licensed Products
sold during the most recently completed calendar quarter; (b) the number of each
type of Licensed Product sold; (c) the royalties, in U.S. dollars, payable with
respect to sales of Licensed Products; (d) the method used to calculate the
royalty; and (e) the exchange rates used.
9.6 If no sales of Licensed Products have been made during any reporting
period, a statement to this effect is required.
10. BOOKS AND RECORDS.
10.1 The Licensee shall keep accurate books and records showing all
Licensed Products manufactured, used, and/or sold under the terms of this
Agreement. Books and records must be preserved for at least five (5) years from
the date of the royalty payment to which they pertain.
9.
<PAGE>
10.2 Books and records must be open to inspection by representatives or
agents of The Regents at reasonable times. The Regents shall bear the fees and
expenses of examination but if an error in royalties of more than five percent
(5 %) underpayment of the total royalties due for any year is discovered in any
examination then the Licensee shall bear the fees and expenses of that
examination.
11. LIFE OF THE AGREEMENT.
11.1 Unless otherwise terminated by operation of law or by acts of the
parties in accordance with the terms of this Agreement, this Agreement will be
in force from the Effective
Date until the last-to-expire patent licensed under this Agreement; or until the
last patent application licensed under this Agreement is abandoned and no patent
in Regents' Patent Rights ever issues.
11.2 Any termination of this Agreement will not affect the rights and
obligations set forth in the following Articles:
Article 10 Books and Records
Article 14 Disposition of Licensed Products on Hand on
Termination
Article 15 Use of Names and Trademarks
Article 20 Indemnification
Article 24 Failure to Perform
Article 28 Secrecy
12. TERMINATION BY THE REGENTS.
12.1 If the Licensee fails to perform or violates any term of this
Agreement, then The Regents may give written notice of default (Notice of
Default) to the Licensee. If the Licensee fails to repair the default within
sixty (60) days of the effective date of Notice of Default, The Regents may
terminate this Agreement and its licenses by a second written notice (Notice of
Termination). If a Notice of Termination is sent to the Licensee, this Agreement
will automatically terminate on the effective date of that notice. Termination
will not relieve the Licensee of its obligation to pay any fees owing at the
time of termination and will not impair any accrued right of The Regents. These
notices are subject to Article 21 (Notices).
10.
<PAGE>
13. TERMINATION BY THE LICENSEE.
13.1 The Licensee has the right at any time to terminate this Agreement in
whole or as to any portion of Regents' Patent Rights by giving notice in writing
to The Regents. Notice of termination will be subject to Article 21 (Notices)
and termination of this Agreement will be effective sixty (60) days from the
effective date of notice.
13.2 Any termination under the above paragraph does not relieve the
Licensee of any obligation or liability accrued under this Agreement prior to
termination or rescind any payment made to The Regents or anything done by
Licensee prior to the time termination becomes effective. Termination does not
affect in any manner any rights of The Regents arising under this Agreement
prior to termination.
14. DISPOSITION OF LICENSED PRODUCTS ON HAND UPON TERMINATION.
14.1 Upon termination of this Agreement the Licensee is entitled to dispose
of all previously made or partially made Licensed Products, but no more, within
a period of one hundred and twenty (120) days provided that the sale of those
Licensed Products is subject to the terms of this Agreement, including but not
limited to the rendering of reports and payment of royalties required under this
Agreement.
15. USE OF NAMES AND TRADEMARKS.
15.1 Nothing contained in this Agreement confers any right to use in
advertising, publicity, or other promotional activities any name, trade name,
trademark, or other designation of either party hereto (including contraction,
abbreviation or simulation of any of the foregoing). Unless required by law, the
use by the Licensee of the name "The Regents of
11.
<PAGE>
the University of California" or the name of any campus of the University of
California is prohibited.
16. LIMITED WARRANTY.
16.1 The Regents warrants to the Licensee that it has the lawful right to
grant this license.
16.2 This license and the associated Invention are provided WITHOUT
WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR ANY OTHER
WARRANTY, EXPRESS OR IMPLIED. THE REGENTS AND RUTGERS MAKE NO
REPRESENTATION OR WARRANTY THAT THE LICENSED PRODUCTS OR LICENSED METHODS WILL
NOT INFRINGE ANY PATENT OR OTHER PROPRIETARY RIGHT.
16.3 IN NO EVENT MAY THE REGENTS OR RUTGERS BE LIABLE FOR ANY INCIDENTAL,
SPECIAL OR CONSEQUENTIAL DAMAGES RESULTING FROM EXERCISE OF THIS LICENSE OR THE
USE OF THE INVENTION OR LICENSED PRODUCTS.
16.4 This Agreement does not:
16.4.1 express or imply a warranty or representation as to the
validity or scope of any of Regents' Patent Rights;
16.4.2 express or imply a warranty or representation that anything
made, used, sold, offered for sale or imported or otherwise
disposed of under any license granted in this Agreement is
or will be free from infringement of patents of third
parties;
16.4.3 obligate The Regents or Rutgers to' bring or prosecute
actions or suits against third parties for patent
infringement except as provided in Article 19;
12.
<PAGE>
16.4.4 confer by implication, estoppel or otherwise any license or
rights under any patents of The Regents other than Regents'
Patent Rights as defined in this Agreement, regardless of
whether those patents are dominant or subordinate to
Regent's Patent Rights: or
16.4.5 obligate The Regents to furnish any know-how not provided in
Regents' Patent Rights.
17. PATENT PROSECUTION AND MAINTENANCE.
17.1 As long as the Licensee has paid patent costs as provided for in this
Article, The Regents shall diligently endeavor to prosecute and maintain the
United States and foreign patents comprising Regents' Patent Rights using
counsel of its choice, and The Regents shall provide the Licensee with copies of
all relevant documentation so that the Licensee may be informed of the
continuing prosecution and the Licensee agrees to keep this documentation
confidential. The Regent' counsel will take instructions only from The Regents,
and all patents and patent applications under this Agreement will be assigned
solely to The Regents.
17.2 The Regents shall use all reasonable efforts to amend any patent
application to include claims reasonably requested by the Licensee to protect
the products contemplated to be sold under this Agreement.
17.3 The Licensee shall apply for an extension of the term of any patent
included within Regents' Patent Rights if appropriate under the Drug Price
Competition and Patent Term Restoration Act of 1984 and/or European, Japanese
and other foreign counterparts of this Law. The Licensee shall prepare all
documents, and The Regents agrees to execute the documents and to take
additional action as the Licensee reasonably requests in connection therewith.
17.4 If either party receives notice pertaining to infringement or
potential infringement of any issued patent included within Regents' Patent
Rights under the Drug Price Competition and Patent Term Restoration Act of 1984
(and/or foreign counterparts of this Law), that party shall notify the other
party within ten (10) days after receipt of notice of infringement.
13.
<PAGE>
17.5 The Licensee shall bear the costs of preparing, filing, prosecuting
and maintaining all United States and foreign patent applications
contemplated by this Agreement. Costs billed by The Regents' counsel will be
rebilled to the Licensee and are due within thirty (30) days of rebilling by
The Regents. These costs include patent prosecution costs for the Invention
incurred by The Regents prior to the execution of this Agreement and any
patent prosecution costs that may be incurred for patentability opinions,
re-examination, re-issue, interferences, or inventorship determinations.
Prior costs will be due on execution of this Agreement and billing by The
Regents and are at least approximately $7,798.00.
17.6 The Licensee may request The Regents to obtain patent protection on
the Invention in foreign countries if available and if it so desires. The
Licensee shall notify The Regents of its decision to obtain or maintain foreign
patents not less than sixty (60) days prior to the deadline for any payment,
filing, or action to be taken in connection therewith. This notice concerning
foreign filing must be in writing, must identify the countries desired, and must
reaffirm the Licensee's-obligation to underwrite the costs thereof. The absence
of such a notice from the Licensee to The Regents will be considered an election
not to obtain or maintain foreign rights.
17.7 The Licensee's obligation to underwrite and to pay patent prosecution
costs will continue for so long as this Agreement remains in effect, but the
Licensee may terminate its obligations with respect to any given patent
application or patent upon three (3) months written notice to The Regents. The
Regents will use its best efforts to curtail patent costs when a notice of
termination is received from the Licensee. The Regents may prosecute and
maintain such application(s) or patent(s) at its sole discretion and expense,
but the Licensee will have no further right or licenses thereunder. Non-payment
of patent costs may be deemed by The Regents as an election by the Licensee not
to maintain application(s) or patent(s).
17.8 The Regents may file, prosecute or maintain patent applications at
its own expense in any country in which the Licensee has not elected to file,
prosecute, or maintain patent applications in accordance with this Article,
and those applications and resultant patents will not be subject to this
Agreement.
14.
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18. PATENT MARKING.
18.1 The Licensee shall mark all Licensed Products made, used or sold under
the terms of this Agreement, or their containers, in accordance with the
applicable patent marking laws.
19. PATENT INFRINGEMENT.
19.1 If the Licensee or The Regents learns of the substantial infringement
of any patent licensed under this Agreement, that party shall call the other
party's attention thereto in writing and provide them with reasonable evidence
of infringement. Neither party will notify a third party of the infringement of
any of Regents' Patent Rights without first obtaining consent of the other
party, which consent will not be unreasonably denied. Both parties shall use
their best efforts in cooperation with each other to terminate infringement
without litigation.
19.2 The Licensee may request that The Regents take legal action against
the infringement of Regents' Patent Rights. Request must be in writing and must
include reasonable evidence of infringement and damages to the Licensee. If the
infringing activity has not abated within ninety (90) days following the
effective date of request, The Regents then has the right to:
19.2.1 commence suit on its own account; or
19.2.2 refuse to participate in the suit,
and The Regents shall give notice of its election in writing to the Licensee by
the end of the one-hundredth (100th) day after receiving notice of written
request from the Licensee. The Licensee may thereafter bring suit for patent
infringement, at its own expense, if and only if The Regents
15.
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elects not to commence suit and if the infringement occurred during the
period and in a jurisdiction where the Licensee had exclusive rights under
this Agreement. Licensee may join The Regents' suit unless The Regents
determine that there are conflict of interest or other institutional issues
involved in the suit. If, however, the Licensee elects to bring suit in
accordance with this paragraph, The Regents may thereafter join that suit at
its own expense. If Licensee elects to bring suit, it may defer payment of up
to fifty percent (50%) of the earned royalties, due under this Agreement from
Net Sales in the county in which the suit is brought, to fund the suit.
Licensee shall promptly remit payment to The Regents of any such deferred
royalties no later than sixty (60) days after settlement; dismissal; or other
termination of the trial court action.
19.3 Legal action as is decided on will be at the expense of the party
bringing suit and all damages recovered thereby will belong to the party
bringing suit, but legal action brought jointly by The Regents and the Licensee
and fully participated in by both will be at the joint expense of the parties
and all recoveries will be allocated in the following order: (I) to each party
reimbursement in equal amounts of the attorney's costs, fees, and other related
expenses to the extent each party paid for such costs, fees and expenses until
all such costs, fees, and expenses are consumed for each party; and (ii) any
remaining amount will be shared as follows: of any recoveries recovered for
direct damages, twenty-five percent (25%) shall be paid to the Regents and
seventy-five percent (75%) shall be paid to the Licensee; of any recoveries
recovered for enhanced damages, one-half shall be paid to the Regents and
one-half shall be retained by the Licensee.
19.4 Each party shall cooperate with the other in litigation proceedings
instituted hereunder, but at the expense of the party bringing suit except
for suits brought jointly. Litigation will be controlled by the party
bringing the suit except for suits brought jointly, except that The Regents
may be represented by counsel of its choice in any suit brought by the
Licensee.
16.
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20. INDEMNIFICATION.
20.1 The Licensee shall indemnify, hold harmless and defend The Regents and
Rutgers, their respective officers, employees, and agents; the sponsors of the
research that led to the Invention; and the inventors of the patents and patent
applications in Regents' Patent Rights and their employers against any and all
claims, suits, losses, liabilities, damages, costs. fees, and expenses resulting
from or arising out of exercise of this license or any sublicense. This
indemnification includes, but is not limited to, any product liability.
20.2 The Licensee, at its sole cost and expense, shall insure its
activities in connection with the work under this Agreement and obtain, keep in
force and maintain insurance as follows, or an equivalent program of self
insurance:
20.3 Comprehensive or commercial form general liability insurance
(contractual liability included) with limits as follows:
* Each Occurrence $1,000,000
* Products/Completed Operations Aggregate $2,000,000
* Personal and Advertising Injury $1,000,000
* General Aggregate (commercial form only) $3,000,000
Licensee agrees to review whether these limits should be increased in accordance
with the level of sales of Licensed Product; such review to be conducted every,
five (5) years from the effective date of this Agreement in coordination with
The Regents. The coverage and limits referred to under the above do not in any
way limit the liability of the Licensee. The Licensee shall furnish The Regents
with certificates of insurance showing compliance with all requirements.
Certificates must:
* Provide for thirty (30) days' advance written notice to The
Regents and Rutgers of any modification.
* Indicate that The Regents and Rutgers has been endorsed as
an additional Insured under the coverage referred to under
the above.
* Include a provision that the coverage will be primary. and
will not participate with nor will be excess over any valid
and collectable insurance
17.
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or program of self-insurance carried or maintained by The
Regents or by Rutgers.
20.4 The Regents shall notify the Licensee in writing of any claim or suit
brought against The Regents or Rutgers in respect of which The Regents or
Rutgers intends to invoke the provisions of this Article. The Licensee shall
keep The Regents and Rutgers informed on a current basis of its defense of any
claims under this Article. There shall be no settlement of a claim for which
indemnification is sought under this Article 20 without the consent of the
indemnifying party, such consent not to be unreasonably withheld.
21. NOTICES.
21.1 Any notice or payment required to be given to either party is properly
given and effective (a) on the date of delivery if delivered in person or (b)
five (5) days after mailing if mailed by first-class certified mail, postage
paid, to the respective addresses given below, or to another address as is
designated by written notice given to the other party.
In the case of the Licensee: SCIENTIFIC LEARNING PRINCIPLES CORPORATION
One Kearney Street, Suite 501
San Francisco, CA 94108
Attention: Controller
In the case of The Regents: THE REGENTS OF THE UNIVERSITY OF CALIFORNIA
Office of Technology Transfer
1320 Harbor Bay Parkway, Suite 150
Alameda, California 94502
Attention: Executive Director
Research Administration and
Technology Transfer
Referring to: UC Case No. 94-069
18.
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22. ASSIGNABILITY.
22.1 The payments under this Agreement may be assigned by The Regents. This
Agreement is personal to the Licensee and assignable by the Licensee only with
the written consent of The Regents, which consent will not be unreasonably
withheld. This Agreement is assignable by the Licensee to the surviving entity
of a merger.
23. NO WAIVER.
23.1 No waiver by either party of any default of this Agreement may be
deemed a waiver of any subsequent or similar default.
24. FAILURE TO PERFORM.
24.1 If either party finds it necessary to undertake legal action against
the other on account of failure of performance due under this Agreement, then
the prevailing party is entitled to reasonable attorney's fees in addition to
costs and necessary disbursements.
25. GOVERNING LAWS.
25.1 THIS AGREEMENT WILL BE INTERPRETED AND CONSTRUED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF CALIFORNIA, but the scope and validity of any patent or
patent application will be governed by the applicable laws of the country of the
patent or patent application.
26. GOVERNMENT APPROVAL OR REGISTRATION.
26.1 Licensee shall notify The Regents if it becomes aware that this
Agreement is subject to any U.S. or foreign government reporting or approval
requirement. Licensee shall
19.
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make all necessary filings and pay all costs including fees, penalties, and
all other out-of-pocket costs associated with such reporting or approval
process.
27. EXPORT CONTROL LAWS.
27.1 The Licensee shall observe all applicable United States and foreign
laws with respect to the transfer of Licensed Products and related technical
data to foreign countries, including, without limitation, the International
Traffic in Arms Regulations (ITAR) and the Export Administration Regulations.
28. SECRECY.
28.1 With regard to confidential information ("Data"), which can be oral or
written or both, received from The Regents regarding this Invention, the
Licensee agrees:
28.1.1 not to use the Data except for the sole purpose of
performing under the terms of this Agreement;
28.1.2 to safeguard Data against disclosure to others with the same
degree of care as it exercises with its own data of a
similar nature;
28.1.3 not to disclose Data to others (except to its employees,
agents or consultants who are bound to the Licensee by a
like obligation of confidentiality) without the express
written permission of The Regents, except that the Licensee
is not prevented from using or disclosing any of the Data
that:
28.1.3.1 the Licensee can demonstrate by written records
was previously known to it;
28.1.3.2 is now, or becomes in the future, public knowledge
other than through acts or omissions of the
Licensee; or
28.1.3.3 is lawfully obtained by the Licensee from sources
independent of The Regents; and
20.
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28.1.4 that the secrecy obligations of the Licensee with
respect to Data will continue for a period ending
five (5) years from the termination date of this
Agreement.
29. MISCELLANEOUS.
29.1 The headings of the several sections are inserted for convenience of
reference only and are not intended to be a part of or to affect the meaning or
interpretation of this Agreement.
29.2 This Agreement is not binding on the parties until it has been signed
below on behalf of each party. It is then effective as of the Effective Date.
29.3 No amendment or modification of this Agreement is valid or binding on
the parties unless made in writing and signed on behalf of each party.
29.4 This Agreement embodies the entire understanding of the parties and
supersedes all previous Communications, representations or understandings,
either oral or written, between the parties relating to the subject matter
hereof.
29.5 In case any of the provisions contained in this Agreement is held to
be invalid, illegal, or unenforceable in any respect, that invalidity,
illegality or unenforceability will not affect any other provisions of this
Agreement, and this Agreement will be construed as if the invalid, illegal, or
unenforceable provisions had never been contained in it.
29.6 This Agreement will be governed by the laws of the State of California
and the United States of America.
21.
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IN WITNESS WHEREOF, both The Regents and the Licensee have executed this
Agreement, in duplicate originals, by their respective and duly authorized
officers on the day and year written.
SCIENTIFIC LEARNING PRINCIPLES THE REGENTS OF THE UNIVERSITY OF
CORPORATION: CALIFORNIA:
By:/s/ [signature] By:/s/ [signature]
---------------------------- -----------------------------
(Signature) (Signature)
Name:David E. Charron Name: Director, OTM
-------------------------- University of California,
(Please Print) San Francisco
Title:Vice President Date: September 27, 1996
------------------------- ---------------------------
Date:September 27, 1996
---------------------------
22.
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AMENDMENT NO. 1
TO LICENSE AGREEMENT OF SEPTEMBER 27, 1996 BETWEEN THE REGENTS AND
SCIENTIFIC LEARNING CORPORATION COVERING TRAINING AIDS FOR THE
REMEDIATION OF LEARNING DISABILITIES
Effective January 1, 1999, The Regents of the University of California, a
California corporation having its statewide administrative offices at 1111
Franklin Street, Oakland, California 94607-5200 ("The Regents"), and acting
through its Office of Technology Management, 745 Parnassus Avenue, Box 1209,
San Francisco, California 94143-1209, and Scientific Learning Corporation, a
California corporation having a principal place of business at 1995
University Avenue, Suite 400, Berkeley, California 94704-1074 ("SLC"), agree
to this license amendment as follows:
AMENDMENT
1.1 The Regents and SLC agree to amend Article 1.4 of the License as follows:
"1.4 "Net Sales" means the total of the gross invoice prices of Licensed
Products sold or Licensed Methods performed by the Licensee, an Affiliate, or
a sublicensee, less the sum of the following actual and customary deductions
where applicable: cash, trade, or quantity discounts; sales, use, tariff,
import/export duties or other excise taxes imposed on particular sales;
transportation charges and allowances; reserves for bad debts (not to exceed
3%) or credits to customers because of rejections or returns; and reasonable
fees for training and supporting users of Licensed Products. As of the
effective date of this Amendment, [ * ] of the current $850 gross invoice
price of Licensed Product and Licensed Methods is attributed to such
training and support services. Should the proportion of the training and
support services relative to such price increase or decrease, the increased
or decreased proportion shall be promptly reported by licensee to The
Regents. Any decrease shall be immediately applied. However, any increased
proportion shall not be deducted until approved in writing by the Regents,
which approval will not be unreasonably withheld upon receipt by the Regents of
supporting data requested by the Regents. For purposes of calculating Net
Sales, transfers to an Affiliate or sublicensee for end use by the Affiliate
or sublicensee will be treated as sales at list price."
1.2 The Regents and SLC furthermore agree that this Amendment is not
retroactive and applies to the calculation of Net Sales made after January 1,
1999.
IN WITNESS WHEREOF, the parties hereto have executed this agreement in
duplicate originals by their duly authorized officers or representatives.
SCIENTIFIC LEARNING THE REGENTS OF THE
CORPORATION UNIVERSITY OF CALIFORNIA
By: /s/ Frank Mattson By: /s/ Joel B. Kirschbaum
--------------------------- ------------------------------
(Signature) (Signature)
Name: Frank Mattson Name: Joel B. Kirschbaum
------------------------- ---------------------------
(Please Print) (Please Print)
Title: CFO Title: Interim Director
------------------------ ---------------------------
Date: 3/15/99 Date: 3/18/99
------------------------- ----------------------------
[ * ]Confidential Treatment Requested
<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 in the Registration Statement (Amendment No. 3 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
June 29, 1999
