<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[_] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER #000-24547
SCIENTIFIC LEARNING CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3234458
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1995 University Avenue, Suite 400
Berkeley, California 94704
(510) 665-6700
(Address of Registrants principal executive offices, including zip code, and
telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ ] No [X]
The number of shares of the Registrant's Common Stock, $.001 par value
per share, outstanding at July 31, 1999 was 10,481,638.
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SCIENTIFIC LEARNING CORPORATION
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements (Unaudited):
Balance Sheets as of June 30, 1999 and December 31, 1998................ 3
Statements of Operations for the Three and Six Months
Ended June 30, 1999 and 1998................................... 4
Statements of Cash Flows for the Six Months
Ended June 30, 1999 and 1998................................... 5
Notes to Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk.............. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................... 14
Item 2. Changes in Securities and Use of Proceeds............................... 14
Item 3. Defaults Upon Senior Securities......................................... 15
Item 4. Submission of Matters to a Vote of Security Holders..................... 15
Item 5. Other Information....................................................... 15
Item 6. Exhibits and Reports on Form 8-K........................................ 16
Signature............................................................... 17
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCIENTIFIC LEARNING CORPORATION
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- ------------
UNAUDITED
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,858 $ 6,362
Accounts receivable 2,242 799
Prepaid expenses and other current assets 996 307
---------- ----------
Total current assets 7,096 7,468
Initial public offering costs 499 --
Restricted cash deposit 280 280
Property and equipment, net 1,579 1,278
Other assets 95 95
---------- ----------
TOTAL ASSETS $ 9,549 $ 9,121
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,243 $ 731
Accrued liabilities 972 1,249
Deferred revenue 4,118 1,649
Current portion of borrowings under bank line of credit 181 278
Current portion of capital lease obligations 7 18
---------- ----------
Total current liabilities 6,521 3,925
Borrowings under bank line of credit 30 121
Other liabilities 221 217
Redeemable convertible preferred stock (Series B, C and D) 23,836 18,940
Stockholders' equity (deficit):
Convertible preferred stock (Series A) 2,355 2,355
Common stock 3,563 2,930
Deferred compensation (1,180) (1,064)
Accumulated deficit (25,797) (18,303)
---------- ----------
Total stockholders' equity (deficit) (21,059) (14,082)
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 9,549 $ 9,121
========== ==========
</TABLE>
See accompanying notes to financial statements.
3
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SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Programs $ 1,673 $ 969 $ 2,749 $ 1,572
Services 378 184 642 228
---------- ---------- ---------- ----------
Total revenues 2,051 1,153 3,391 1,800
Cost of revenues:
Programs 279 166 460 293
Services 426 140 578 174
---------- ---------- ---------- ----------
Total cost of revenues 705 306 1,038 467
---------- ---------- ---------- ----------
Gross profit 1,346 847 2,353 1,333
Operating expenses:
Sales and marketing 3,407 1,686 6,137 2,454
Research and development 710 680 1,472 1,346
General and administrative 1,238 953 2,378 1,773
---------- ---------- ---------- ----------
Total operating expenses 5,355 3,319 9,987 5,573
---------- ---------- ---------- ----------
Operating loss (4,009) (2,472) (7,634) (4,240)
Interest income (expense), net 52 (52) 140 (32)
---------- ---------- ---------- ----------
Net loss $ (3,957) $ (2,524) $ (7,494) $ (4,272)
========== ========== ========== ==========
Basic and diluted net loss per share $ (1.35) $ (0.91) $ (2.61) $ (1.55)
========== ========== ========== ==========
Shares used in computing basic and diluted
net loss per share 2,940,655 2,773,370 2,872,350 2,752,816
========== ========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
4
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SCIENTIFIC LEARNING CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
UNAUDITED
<TABLE>
<CAPTION>
Six months ended June 30,
---------------------------
1999 1998
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (7,494) $ (4,272)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization 367 296
Amortization of deferred compensation 454 415
Changes in operating assets and liabilities:
Accounts receivable (1,443) (274)
Prepaid expenses and other current assets (689) (166)
Accounts payable 512 299
Accrued liabilities (277) 88
Deferred revenue 2,469 1,302
Other liabilities 4 107
---------- ----------
Net cash used in operating activities (6,097) (2,205)
INVESTING ACTIVITIES:
Purchases of property and equipment, net (668) (267)
---------- ----------
Net cash used in investing activities (668) (267)
FINANCING ACTIVITIES:
Proceeds from issuance of common stock 63 39
Proceeds from issuance of preferred stock 4,896 863
Repayments of borrowing under bank line of credit (188) (96)
Repayments of capital lease obligations (11) (14)
Cost of initial public offering of common stock (499) --
---------- ----------
Net cash provided by financing activities 4,261 792
---------- ----------
Decrease in cash and cash equivalents (2,504) (1,680)
Cash and cash equivalents at beginning of period 6,362 2,699
---------- ----------
Cash and cash equivalents at end of period $ 3,858 $ 1,019
========== ==========
</TABLE>
See accompanying notes to financial statements.
5
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NOTES TO FINANCIAL STATEMENTS
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 neuroscience-based programs and other
educational products and services designed to increase human learning and
performance. The Company's revenues have been derived primarily from two
programs, Fast ForWord and Fast ForWord Two, which focus on children aged four
to 13. The Company's programs and 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.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INTERIM FINANCIAL INFORMATION
The interim financial information as of June 30, 1999 and for the six
months ended June 30, 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 six months ended June 30, 1999 are not necessarily indicative of results
that may be expected for any future periods. These financial statements and
notes should be read in conjunction with the Company's audited financial
statements and notes thereto for the year ended December 31, 1998, included in
the Company's prospectus dated July 21, 1999 comprising part of our Registration
Statement on Form S-1, as amended, filed with the Securities and Exchange
Commission, SEC File No. 333-76981.
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". Basic
earnings per share has been computed using 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.
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The calculation of basic and diluted net loss per share, as well as
basic and diluted pro forma net loss per share showing the effect of the
conversion of preferred stock to common upon completion of the initial public
offering, is as follows (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ---------
UNAUDITED UNAUDITED
<S> <C> <C> <C> <C>
Net loss $ (3,957) $ (2,524) $ (7,494) $ (4,272)
========== ========== ========== ==========
Weighted average shares of common stock
outstanding used in computing basic and
diluted net loss per share 2,940,655 2,773,370 2,872,350 2,752,816
========== ========== ========== ==========
Basic and diluted net loss per share $ (1.35) $ (0.91) $ (2.61) $ (1.55)
========== ========== ========== ==========
Pro forma:
Net loss $ (3,957) $ (2,524) $ (7,494) $ (4,272)
========== ========== ========== ==========
Shares used in computing basic and diluted
net loss per share (from above) 2,940,655 2,773,370 2,872,350 2,752,816
Adjustment to reflect the effect of the
assumed conversion of preferred stock from
the date of issuance 5,232,146 3,398,835 5,216,799 3,398,835
---------- ---------- ---------- ----------
Weighted average shares used in computing pro
forma basic and diluted net loss per share 8,172,801 6,172,205 8,089,149 6,151,651
========== ========== ========== ==========
Pro forma basic and diluted net loss per share $ (0.48) $ (0.41) $ (0.93) $ (0.69)
========== ========== ========== ==========
</TABLE>
2. COMPREHENSIVE LOSS
The Company has no items of other comprehensive income, and accordingly
the comprehensive loss is the same as the net loss for all periods reported.
3. 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 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.
7
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4. SUBSEQUENT EVENT
On July 22, 1999, the Company issued 2,300,000 shares of common stock
at an initial public offering price of $16.00 per share. The net proceeds to the
Company from that offering were approximately $34.2 million after deducting the
underwriters' discount. 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
common stock to 40,000,000 and a decrease in the number of authorized shares of
preferred stock to 1,000,000. In addition, upon completion of the initial public
offering, each outstanding share of the Company's convertible preferred stock
was automatically converted into one share of common stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The statements herein that are not purely historical are
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from the results discussed in those discussed
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed herein within this quarterly report on form
10-Q, our Registration Statement on Form S-1, as amended, SEC File No.
333-77133, and other documents filed with the securities and exchange
commission, which factors are incorporated herein by reference. All
forward-looking statements included in this document are based on information
available to us on the date hereof, and we assume no obligation to update any
such forward-looking statements or to update the reasons why actual results
could differ from those projected in the forward-looking statements.
The following should be read in conjunction with the audited financial
statements and the notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations included in our Registration
Statement on Form S-1, as amended, SEC File No. 333-77133.
OVERVIEW
We develop, market and sell proprietary neuroscience-based programs and
other educational products and services designed to increase human learning and
performance. Our programs employ patented, adaptive technologies and are
Internet-enabled. Language and reading skills are the foundation for all
learning, and we have developed programs to help children learn how to read or
become better readers. Our Fast ForWord programs are intensive, computer-based
training programs that focus on improving critical language and reading skills.
Fast ForWord and Fast ForWord Two focus primarily on the learning needs of
children aged four to 13, are based on scientific research and have been field
tested using scientific methods.
8
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We 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. We also offer installation and
technical training to large customers such as schools. Our programs, products
and services 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.
During the second quarter of 1999, we introduced Away We Go!-TM-
skill building software for children of developmental ages four to seven
along with Away We Go! Bookshelf-TM-, a series of storybooks on CD-ROM and
audio CDs. We also launched BrainConnection.com-TM-, which we intend to be a
leading source for information on research on the brain and how that applies
to our daily lives. In addition, we intend to sell our own products and
programs as well as other learning products on BrainConnection.com-TM-. Away
We Go!-TM- and BrainConnection.com-TM- did not contribute significantly to
the quarter.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, various
financial data expressed as a percentage of revenues (unless otherwise noted).
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
------------- ------------ ------------- ----------
<S> <C> <C> <C> <C>
Revenues:
Programs 81.6% 84.0% 81.1% 87.3%
Services 18.4 16.0 18.9 12.7
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
Programs (1) 16.7 17.1 16.7 18.6
Services (2) 112.7 76.1 90.0 76.3
Total cost of 34.4 26.6 30.6 25.9
revenues
Gross margin 65.6% 73.4% 69.4% 74.1%
</TABLE>
(1) Program costs are expressed as a percentage of program revenues.
(2) Service costs are expressed as a percentage of service revenues.
THREE AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1998
REVENUES. Total revenues increased by $898,000 or 77.9% to $2.1 million for
the quarter ended June 30, 1999 and increased by $1.6 million, or 88.4%, to $3.4
million for the six months ended June 30, 1999, compared to the same periods in
1998. Program revenues increased by $704,000 or 72.7% to $1.7 million for the
quarter ended June 30, 1999 and increased by $1.2 million, or 74.9%, to $2.7
million for the six months ended June 30, 1999, compared to the same periods in
1998 because of increased program activations in speech and language
professional
9
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and public school markets. Service revenues increased by $194,000 or 105.4%
to $378,000 for the quarter ended June 30, 1999 and increased by $414,000, or
181.6%, to $642,000 for the six months ended June 30, 1999 compared to the
same periods in 1998 due to increased number of professional development
seminars for both public schools and speech and language professionals in
private practice and software installations in schools.
COST OF REVENUES. Total cost of revenues increased by $399,000 or 130.4% to
$705,000 for the quarter ended June 30, 1999 and increased by $571,000, or
122.3%, to $1.0 million for the six months ended June 30, 1999, compared to the
same periods in 1998. As a percentage of revenues, cost of revenues increased to
34.4% from 26.6% for the quarter ended June 30, 1999, and increased to 30.6%
from 25.9% for the six months ended June 30, 1999. Cost of program revenues
decreased to 16.7% from 17.1% for the quarter ended June 30, 1999 and decreased
to 16.7% from 18.6% for the six months ended June 30, 1999 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 increased to 112.7% from 76.1% for the quarter ended June 30, 1999 and
increased to 90.0% from 76.3% for the six months ended June 30, 1999, due to
costs of training and installations of Fast ForWord programs in public schools.
To encourage schools to adopt Fast ForWord, we have offered discounts on
training and installation services.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased
$1.7 million, or 102.1%, to $3.4 million for the quarter ended June 30, 1999,
and increased $3.7 million, or 150.1%, to $6.1 million for the six months ended
June 30, 1999, compared to the same periods in 1998. This increase was primarily
attributable to increased personnel, marketing and travel costs. We expect
further increases in 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 $30,000 or 4.4%, to $710,000 for the quarter ended June 30, 1999, and
increased $126,000, or 9.4%, to $1.5 million for the six months ended June 30,
1999, compared to the same periods in 1998. 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 our neuroscience expertise.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $285,000 or 29.9%, to $1.2 million for the quarter ended June 30,
1999, and increased $605,000 or 34.1%, to $2.4 million for the six months ended
June 30, 1999, compared to the same periods in 1998. 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 and six months ended June 30, 1999 and June 30, 1998 as we incurred
losses during such periods.
FACTORS THAT MAY AFFECT QUARTERLY RESULTS OF OPERATIONS
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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 those discussed herein with this quarterly
report on Form 10-Q, as contained in our Registration Statement on Form S-1, as
amended, SEC File No. 333-77133, under the heading "Risk Factors", and as
disclosed in other documents filed with the Securities and Exchange Commission.
Significant fluctuations in future quarterly operating results may be caused by
many factors including, among others:
- the demand for technology-based education and training programs
and products;
- the size and timing of product orders and implementation;
- the revenue mix among our programs, 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 and the programs and
services of our competitors;
- seasonality in product purchase and usage;
- competitive conditions;
- our ability to attract and retain experienced personnel;
- the availability of government funding for public schools;
- public school calendars and budget cycles;
- our ability to protect and maintain our intellectual property rights;
- 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.
11
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As a result of all the foregoing factors, and in light of our limited
operating history, 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. It is likely that our future quarterly
operating results from time to time will not meet the expectations of market
analysts or investors, which may have an adverse effect on the price of our
common stock.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities was $6.1 million for the six months
ended June 30, 1999, as compared to $2.2 million in the comparable period of
1998 resulting primarily from operating losses of $7.5 million and increases in
accounts receivable and prepaid expenses of $1.4 million and $0.7 million,
respectively, offset by increases in deferred revenue of $2.5 million. A
substantial portion of the increases in accounts receivable and deferred revenue
relates to increased sales to public schools. The increase in prepaid expenses
is due primarily to increased inventory of marketing, sales and training
materials.
Cash used in investing activities was $668,000 for the six months ended
June 30, 1999, as compared to $267,000 in the comparable period of 1998. The
cash outlays consisted principally of the acquisition of computer equipment,
furniture and fixtures.
These cash needs were primarily financed through the sale of equity
securities in December 1998 and January 1999. As of June 30, 1999, we had cash
and cash equivalents of $3.9 million. We believe that the net proceeds of $34.2
million from our initial public offering, which was completed on July 22, 1999,
will be sufficient to finance our presently anticipated operating losses,
planned capital expenditure requirements and internal growth for at least the
next 18 months.
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. During the next 18 months, we may need to expand
our corporate office facilities which would require us to commit to additional
lease obligations.
YEAR 2000 ISSUES
Our Year 2000 (Y2K) plan is currently being implemented by our Y2K task
force headed by the Director of Information Technology. The Y2K plan applies to
both our internal business systems and products, as well as compliance by our
external customers and providers. There are six phases of the plan:
organizational awareness, inventory, assessment, planning, execution and
validation.
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 September 30,
1999. We expect to be Y2K compliant on all critical systems that rely on the
calendar year, before October 1, 1999. During the second quarter of
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1999, we completed the inventory and assessment phase with respect to
suppliers, service providers and contractors and determined that our
suppliers, service providers and contractors demonstrated Y2K readiness.
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.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET 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 June 30, 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.
We considered the provisions of Financial Reporting Release No. 48,
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." We had no
holdings of derivative financial or commodity instruments at June 30, 1999. Our
revenue, capital expenditures and nearly all of our expenses are transacted in
U.S. dollars. We believe we have minimal exposure to financial market risks
associate with changes in foreign currency exchange rates at this time.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company is involved in legal proceedings in the
ordinary course of business. None of such proceedings are expected to have a
material impact on our business, results of operations or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Between April 1, 1999 and June 30, 1999, an aggregate of 137,036 shares
of common stock were issued to employees upon exercise of options with exercise
prices ranging from $0.26 to $6.00. The consideration received for such shares
was $56,582.00. These sales of common stock made pursuant to the exercise of
stock options were made in reliance on Rule 701 under the Securities Act of
1933, as amended (the "Securities Act") or on Section 4(2) of the Securities
Act. The purchasers in each case represented their intention to acquire the
securities for investment only and not with a view to the distribution thereof.
Appropriate legends were 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.
Our Registration Statement (SEC File No. 333-77133) for our initial
public offering became effective July 21, 1999, covering an aggregate of
2,645,000 shares of common stock, including the underwriters' over-allotment
option. Commencing July 22, 1999, we issued 2,300,000 shares of our common stock
at an initial public offering price of $16.00 per share. Offering proceeds were
approximately $34.2 million. The managing underwriters were Merrill Lynch & Co.,
Thomas Weisel Partners LLC and Pacific Growth Equities, Inc. The aggregate
underwriting fees were approximately $2.6 million.
Upon the closing of the initial public offering in July 1999, all
outstanding shares of our preferred stock were automatically converted, on a
one-for-one basis, into shares of common stock. All warrants to purchase
preferred stock outstanding after the closing of the initial public offering,
when and if exercised, will be converted into the number of shares of common
stock the holder would have received if the warrant had been exercised and the
preferred stock received thereupon had been simultaneously converted immediately
prior to the closing of the initial public offering. Following the closing of
the initial public offering, Scientific Learning filed an amendment to its
Amended and Restated Certificate of Incorporation with the Delaware Secretary of
State which authorizes One Million (1,000,000) shares of undesignated preferred
stock. For additional information about our capital stock, please refer to
"Description of Capital Stock" in our Registration Statement (SEC File No.
333-77133) filed with the Securities and Exchange Commission.
The use of proceeds does not represent a material change in the use of
proceeds as described in our prospectus dated July 21, 1999, comprising part of
our Registration Statement on Form S-1, as amended, filed with the Securities
and Exchange Commission, SEC File No. 333-77133.
14
<PAGE>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In May 1999, prior to our initial public offering, we submitted the
following matters to a vote of our security holders through an Action by Written
Consent. Each of the matters were approved by holders of the required majority
of our outstanding common stock and preferred stock as of May 28, 1999.
1. To approve an amendment and restatement of our Certificate of
Incorporation to effect a two-for-three reverse stock split.
2. To approve an amendment and restatement of our Certificate of
Incorporation and Bylaws to take effect upon the closing of
the initial public offering.
3. To approve an amendment and restatement of our stock option
plan as the 1999 Equity Incentive Plan.
4. To approve the adoption of a 1999 Employee Stock Purchase Plan
and to reserve a total of 350,000 shares of Common Stock
thereunder for issuance to employees.
5. To approve the adoption of a 1999 Non-Employee Director Stock
Option Plan and to reserve a total of 75,000 shares of Common
Stock thereunder for issuance to non-employee directors.
6. To approve a form of indemnity agreement to be entered into
with each of our directors and the officers and agents of
Scientific Learning selected by the Board of Directors.
7. To approve the election of directors until the next annual
meeting of stockholders or until their successors are elected
and qualified, as well as the classification of directors into
three classes as noted below:
<TABLE>
<CAPTION>
Name Class To Serve Until Annual Meeting
---- ----- -----------------------------
<S> <C> <C>
James E. Thomas I 2000 Annual Meeting
Carleton A. Holstrom I 2000 Annual Meeting
Paula A. Tallal I 2000 Annual Meeting
Sheryle J. Bolton II 2001 Annual Meeting
David A. Tanner II 2001 Annual Meeting
Rodman W. Moorhead III 2002 Annual Meeting
Michael M. Merzenich III 2002 Annual Meeting
</TABLE>
ITEM 5: OTHER INFORMATION
Not applicable.
15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
<S> <C>
3.3* Form of Amended and Restated Certificate of Incorporation
3.4* Form of Amended and Restated Bylaws
4.2* Registration Rights Agreement, dated as of October 1, 1996, as amended
on November 14, 1996.
10.1* Form of Indemnity Agreement with each of our directors and executive
officers.
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 1999 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.
27 Financial Data Schedule
</TABLE>
- -------
* Incorporated by reference to the same numbered exhibit previously filed
with the Company's Registration Statement on Form S-1 (SEC File No.
333-77133).
(b) Reports on Form 8-K. The Company did not file any reports on Form 8-K
during the quarter ended June 30, 1999.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCIENTIFIC LEARNING CORPORATION
(Registrant)
- ---------------------------------
FRANK M. MATTSON
Chief Financial Officer, Vice President, Finance and Secretary
(Authorized Officer and Principal Financial and Accounting Officer)
Dated: August 31, 1999
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,858
<SECURITIES> 0
<RECEIVABLES> 2,289
<ALLOWANCES> 47
<INVENTORY> 306
<CURRENT-ASSETS> 7,096
<PP&E> 2,862
<DEPRECIATION> 1,283
<TOTAL-ASSETS> 9,549
<CURRENT-LIABILITIES> 6,521
<BONDS> 0
0
26,191
<COMMON> 3,563
<OTHER-SE> (1,180)
<TOTAL-LIABILITY-AND-EQUITY> 9,549
<SALES> 1,673
<TOTAL-REVENUES> 2,051
<CGS> 279
<TOTAL-COSTS> 705
<OTHER-EXPENSES> 5,355
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,957)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,957)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,957)
<EPS-BASIC> (1.35)
<EPS-DILUTED> (1.35)
</TABLE>
