<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-30566
3,600,000 Shares
[LOGO OF SONIC INNOVATIONS]
Common Stock
---------------
This is an initial public offering of shares of common stock of Sonic
Innovations, Inc. All of the 3,600,000 shares of common stock are being sold by
Sonic Innovations.
Prior to this offering, there has been no public market for the common stock.
The common stock has been approved for quotation on The Nasdaq National Market
under the symbol "SNCI."
See "Risk Factors" beginning on page 8 to read about factors you should
consider before buying shares of the common stock.
---------------
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed on the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
---------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial public offering price............................ $14.00 $50,400,000
Underwriting discount.................................... $ 0.98 $ 3,528,000
Proceeds, before expenses, to Sonic Innovations.......... $13.02 $46,872,000
</TABLE>
To the extent that the underwriters sell more than 3,600,000 shares of common
stock, the underwriters have the option to purchase up to an additional 540,000
shares from Sonic Innovations at the initial public offering price less the
underwriting discount.
---------------
The underwriters expect to deliver the shares against payment in New York,
New York on May 5, 2000.
Goldman, Sachs & Co.
Deutsche Banc Alex. Brown
U.S. Bancorp Piper Jaffray
---------------
Prospectus dated May 1, 2000.
<PAGE>
Artwork
Outside front gate
Photo rendition of man with his hands on his knees watching a picnic taking
place in front of him at a distance.
Sonic Innovations logo and name
Headline #1: When you can't hear life the way it really is, it's hard to
be a part of it.
Headline #2: To make a better hearing aid, it took a better understanding
of human hearing.
Inside front foldout
Side of page: ABOUT OUR COMPANY... Sonic Innovations designs, manufactures
and markets advanced digital hearing aids and hearing aid components. We have
developed hearing aids which we believe set a new standard in consumer
satisfaction because they are smaller, more comfortable and more reliable, and
deliver more natural sound than competing hearing aids. Accordingly, our mission
is to be the best hearing aid company in the world.
Left middle of page: TECHNOLOGY never sounded so good. [photo of
integrated circuit on finger] * advanced technology enables individual
personalization; core technology developed by world-renowned experts.
Middle of page: HEALTH never sounded so good. [photo of hearing aid and
dime and brand logos] * NATURA and CONFORMA offer superior sound quality
and improved comfort.
Right of page: COMMUNICATION never sounded so good. [photo of couple at
dinner] * more natural, lifelike listening and communication.
Bottom of page: SONIC innovations Life never sounded so good
Inside back cover
Headline: When someone you love says, "I need you" NATURA lets you say "I
hear you".
[photo rendition of man with his hands on his knees with a child with a
broken truck immediately in front of him and a picnic in the background. Photo
of hearing aid. NATURA logo]
Don't let hearing loss disconnect you from the people who need you. Not
when there's NATURA, a new patented digital hearing technology. NATURA uses a
tiny microchip to give you more natural, lifelike sound.
NATURA is customized and programmed to fit your particular hearing needs.
Ask your hearing care professional about NATURA, and stay connected to your
world.
In the U.S. call 1-888-678-HEAR, and in Europe call +45 38 88 84 00.
www.sonici.com
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary does not contain all of the information that you should consider
before investing in the common stock. You should read the entire prospectus,
including the more detailed information and the financial statements appearing
elsewhere in this prospectus.
Our Business
We design, manufacture and market advanced digital hearing aids and hearing
aid components designed to provide the highest levels of satisfaction for
hearing impaired consumers. Capitalizing on a new understanding of human
hearing, we have developed patented digital signal processing, or DSP,
technologies and embedded them in the smallest single-chip DSP platform ever
installed in a hearing aid. We believe our hearing aids set a new standard for
consumer satisfaction because they are smaller, more comfortable and more
reliable and deliver more natural sound than competing hearing aids.
We introduced our first branded line, NATURA, in the United States in
September 1998 and internationally in 1999. Since the NATURA introduction, we
have achieved five consecutive quarters of increasing revenues, culminating in
net sales of $11.5 million and a net loss of $1.8 million in the fourth quarter
of 1999. We introduced our second brand, CONFORMA, in March 2000. CONFORMA,
using the same proprietary DSP technologies as NATURA, achieves the same
superior sound quality but incorporates new materials technology to deliver
comfortable, instant-fit capability. We sell our branded products directly to
more than 1,000 hearing care professionals in the United States and through a
network of established distributors throughout much of Europe, Japan, Australia
and Canada.
Our Target Market
The market for hearing aids is very large and has substantial unmet needs.
Industry sources estimate that there are approximately 300 million hearing-
impaired people worldwide, including nearly 30 million in North America.
However, existing hearing aids have generally failed to satisfy users, who
typically complain that hearing aids have poor sound quality and are too
visible, uncomfortable, unreliable and expensive. According to MarkeTrack, a
leading industry publication, only approximately 20% of the hearing impaired
have purchased hearing aids, and only half of these hearing aid owners
routinely wear their hearing aids.
Despite this low level of market penetration and high degree of
dissatisfaction, in 1998 worldwide retail sales of hearing aids were
approximately $4.6 billion and wholesale sales were approximately $1.8 billion.
We anticipate that demographic trends, such as the aging of "baby boomers,"
will accelerate the growth in the size of the hearing impaired population.
3
<PAGE>
Our Technology
Our technology strategy is to combine a number of distinct technologies,
supported by over 30 patents and patent applications, to produce premium
digital products. The core of our technology is our proprietary digital signal
processing, or DSP, technologies, which are based on a significant advancement
in the understanding of human hearing. Using state-of-the-art chip design
capabilities, we have embedded our proprietary algorithms into the smallest,
single-chip DSP platform available in a hearing aid today. As a result, our
NATURA products are among the smallest hearing aids available, and our CONFORMA
product is the smallest hearing aid available today. Moreover, our proprietary
EXPRESSfit software automates the process of programming our hearing aids. As a
result, our hearing aids can be individually calibrated to the unique needs of
the wearer so that specific sounds are ampified appropriately in the right
contrast to other sounds, resulting in improved speech recognition and more
natural sound.
Our Products
Our products, built around our proprietary DSP platform, offer superior sound
quality, comfort and reliability with an attractive price/value relationship.
In addition, our products make significant advances in cosmetic appeal and ease
of fitting.
. Our NATURA products are superior programmable hearing aids that provide
wearers more natural, lifelike communication. NATURA products are
available in the three most common custom-molded plastic shell models--
completely-in-the-canal, in-the-canal and in-the-ear--as well as in a
behind-the-ear model.
. Our CONFORMA product is the first product with the potential to address
all of the major limitations of traditional hearing aids and
significantly alter the way hearing aids are made and sold. CONFORMA, a
programmable completely-in-the-canal model, introduces a new, innovative
hearing aid configuration that delivers a fast, comfortable fit in the
smallest hearing aid available. This small size allows it to be placed
deep in the ear canal, virtually eliminating the stigma of wearing a
hearing aid.
CONFORMA physically consists of two parts: a tiny core about the size of
a pencil eraser that contains the product's electronics, and a soft
disposable tip that conforms quickly and precisely to the shape of the
wearer's ear canal. This compressible, foam tip eliminates the need to
custom mold a hard plastic shell to fit the wearer's ear canal, both
increasing comfort for the wearer and enabling a custom fit in a single
visit. We expect CONFORMA to eliminate the need to "remake" a hearing
aid, reduce product returns, improve reliability and save considerable
time for both the wearer and the hearing care professional.
. We are capitalizing on the rapid growth of the digital segment of the
hearing impaired market not only by selling our branded products, but
also by selling hearing aid components consisting of our DSP platform to
established hearing aid companies that lack a satisfactory digital
product line. These companies incorporate our DSP platform into hearing
aids of their own design that they then sell under their own brand
names.
4
<PAGE>
Our Strategy
Our mission is to be the best hearing aid company in the world by delivering
superior products that appeal not only to those consumers who currently use or
have tried hearing aids, but also to the approximately 80% of the hearing
impaired population that historically has chosen not to purchase hearing aids.
Key elements of our strategy include the following:
. Continue to Introduce Innovative Products. We intend to continue to
invest significantly in research and development to introduce new
products and product improvements more rapidly than is typical in our
industry.
. Expand Our Distribution. We are expanding our sales force in the United
States and pursuing additional distribution partners outside the United
States. We believe that the evolution of the current distribution
channel, combined with the characteristics of our branded products, will
create new distribution opportunities such as selling through large
hearing care chains and other chain-based retailers.
. Sell Our DSP Platform. We will continue to sell our DSP platform to
selected established hearing aid companies that have approached us
seeking to benefit from our superior technology. We believe that this
strategy can accelerate market acceptance of our technology and be a
significant source of revenue.
. Increase Brand Awareness. In order to differentiate our products and
reach a greater percentage of potential consumers, we have undertaken a
brand-oriented approach to our marketing and selling efforts.
. Achieve Economies of Scale. As sales volumes increase, per unit
production costs should decline. In addition, CONFORMA offers an
opportunity to standardize the production process and avoid the custom-
molding processes used by other hearing aid manufacturers and in our
NATURA line. We believe that this can enable us to achieve further
economies of scale.
5
<PAGE>
The Offering
<TABLE>
<C> <S>
Shares to be offered by Sonic Innovations..... 3,600,000 shares
Shares outstanding after the offering......... 18,867,481 shares
Proposed Nasdaq National Market Symbol........ SNCI
Use of proceeds............................... For general corporate
purposes, including product
development and
commercialization, research
and development, repayment of
outstanding indebtedness and
working capital and, possibly,
acquisitions and investments.
</TABLE>
Except as otherwise indicated, whenever we present the number of shares of
common stock outstanding, we have given effect to a 1-for-1.9 reverse stock
split effected on April 26, 2000 and to the following issuances at the closing
of this offering of shares of our common stock upon:
. the conversion of all outstanding convertible preferred stock into
12,532,786 shares of our common stock;
. the conversion of $4.5 million of convertible promissory notes (plus
accrued interest) into 329,682 shares of our common stock at a
conversion price equal to 100% of the IPO price;
. the conversion of $4.0 million of convertible promissory notes (plus
accrued interest) into 307,219 shares of our common stock at a
conversion price equal to 93% of the IPO price;
. the conversion of an additional $3.0 million of convertible promissory
notes that were issued on March 31, 2000 into 230,415 shares of our
common stock at a conversion price equal to 93% of the IPO price;
. the conversion of an additional $3.0 million of convertible promissory
notes that will be issued on the closing of this offering into 214,285
shares of our common stock at a conversion price equal to 100% of the
IPO price; and
. the exercise, at an exercise price of $3.80 per share, of outstanding
warrants to purchase 203,727 shares of our common stock (net of 33,126
shares surrendered in lieu of cash payment of the exercise price for
certain warrants)
We calculated the number of shares outstanding after this offering on the
assumption that the underwriters do not exercise their over-allotment option,
and we excluded:
. 2,580,844 shares of our common stock issuable, at a weighted average
exercise price of $2.23 per share, upon exercise of stock options
outstanding on December 31, 1999;
. 17,258 shares of our common stock issuable, at an exercise price of
$3.04 per share, upon exercise of warrants outstanding on December 31,
1999;
. 20,706 shares of our common stock issuable, at an exercise price of
$3.80 per share, upon exercise of warrants outstanding at December 31,
1999; and
. 2,177,621 shares of our common stock that were available for future
grant as of December 31, 1999 under our existing and proposed stock
plans.
Sonic Innovations, Inc. was formed as Sonix Technologies, Inc. in Utah in May
1991. We reincorporated in Delaware and changed our name in 1997. Our principal
executive offices are located at 2795 East Cottonwood Parkway, Suite 660, Salt
Lake City, Utah 84121-7036 and our telephone number is (801) 365-2800. Our
Internet address is www.sonici.com. Information on our web site does not
constitute part of this prospectus.
Our logo, "NATURA," "CONFORMA" and "EXPRESSfit " are trademarks of Sonic
Innovations. Each trademark, trade name or service mark of any other company
appearing in this prospectus belongs to its holder. In this prospectus we cite
industry sources such as The Carnegie Group, MarkeTrak and Hearing Review, but
it has not been our practice to seek consent to identify such industry sources
and you should not consider them to be endorsing our use of their information.
6
<PAGE>
Summary Consolidated Financial Data
The following table summarizes historical and pro forma consolidated
financial data for our business. You should read this data along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes. In the
pro forma share and per share data below, we have assumed the conversion of the
convertible preferred stock and convertible promissory notes and the exercise
of the warrants as described in the first paragraph after the table under
"Summary--The Offering" on page 6 as if they had occurred on January 1, 1999 or
the date of issuance, if later. (See note 13 to consolidated financial
statements.) In the pro forma column in the balance sheet data below, we have
assumed that such conversions and exercises and the repayment after
December 31, 1999 of $1,966,000 of line of credit borrowings and $811,000 of
capital lease obligations occurred on December 31, 1999. In the pro forma as
adjusted column, we have further adjusted the pro forma column to give effect
to this offering at the initial public offering price of $14.00, after
deducting the estimated underwriting discount and the offering expenses payable
by us, and our receipt and application of the net proceeds from this offering.
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- -------- ----------
(In thousands, except share and per share
data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales.................... $ -- $ -- $ -- $ 2,143 $ 28,694
Gross profit................. -- -- -- 87 11,632
Operating loss............... (1,080) (1,545) (5,326) (14,189) (13,751)
Net loss..................... (1,073) (1,584) (5,235) (13,878) (14,906)
Net loss applicable to common
stockholders................ (1,106) (1,732) (5,828) (15,439) (17,337)
Basic and diluted net loss
per common share............ $ (2.26) $ (3.21) $ (8.23) $ (15.61) $ (12.72)
Weighted average number of
common shares outstanding... 487,857 539,364 708,403 988,844 1,363,221
Pro forma basic and diluted
net loss per common share... $ (1.02)
Pro forma weighted average
number of common shares
outstanding................. 14,114,948
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1999
-------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(In thousands)
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents..................... $ 5,939 $ 9,598 $53,532
Working capital (deficit)..................... (5,119) 8,697 53,369
Total assets.................................. 18,462 22,121 66,055
Long-term obligations......................... 2,085 1,400 150
Convertible promissory notes.................. 8,064 -- --
Mandatorily redeemable convertible preferred
stock........................................ 36,130 -- --
Total stockholders' equity (deficit).......... (38,801) 11,829 57,751
</TABLE>
7
<PAGE>
RISK FACTORS
You should carefully consider the risks described below, together with all of
the other information included in this prospectus, before deciding whether to
invest in our common stock. If any of the following risks actually materialize,
our business, financial condition or results of operations could be harmed. In
such case, the trading price of our common stock could decline, and you may
lose all or a part of your investment.
Risks Relating to Our Business
We have a history of losses and negative cash flows from operating activities,
and we expect our operating expenses to continue to increase
We have incurred net losses of $37.0 million for the period from inception
through December 31, 1999, including a net loss of $14.9 million in 1999. We
incurred negative cash flows of $14.0 million from operating activities in
1999. These losses and negative cash flows resulted primarily from expenses we
incurred while developing our initial hearing aid products and establishing an
infrastructure to support our business. We have not achieved profitability. We
may incur net losses and negative cash flows in the future. The size of our
losses and whether or not we achieve profitability will depend in part on the
rate of growth in our net sales.
We intend to increase our operating expenses as we continue to, among other
things:
. improve our current products;
. research and develop new products;
. increase the size of our sales force;
. undertake quality assurance and improvement initiatives;
. improve our manufacturing capability;
. increase our brand recognition; and
. increase our general and administrative functions to support our growing
operations.
With increased expenses, we will need to generate additional revenues to
achieve profitability. Consequently, it is possible that we will not achieve
profitability, and even if we do achieve profitability, we may not sustain or
increase profitability on a quarterly or annual basis in the future.
We expect our financial results to fluctuate significantly, which may cause our
stock price to decline
Our quarterly and annual operating results have fluctuated in the past and
are likely to fluctuate significantly in the future. These fluctuations could
cause our stock price to fluctuate significantly or decline. Factors that have
caused fluctuations in our operating results in the past, and may do so in the
future, include the following:
. demand for and market acceptance of our products;
. manufacturing problems;
. high levels of returns, remakes and repairs; and
. changes in our product or customer mix.
8
<PAGE>
Factors that have not significantly affected our operating results in the
past, but may do so in the future, include the following:
. changes in the timing of product orders, particularly significant orders
from other hearing aid manufacturers for our hearing aid components;
. competitive pressures resulting in lower selling prices or significant
promotional costs;
. unanticipated delays or problems in the introduction of new products;
. inaccurate forecasting of revenues; and
. the announcement or introduction of new products or services by our
competitors.
To respond to these and other factors, we may need to make business decisions
that could adversely affect our operating results. Most of our expenses, such
as employee compensation and lease payment obligations, are relatively fixed in
the short term. Moreover, our expense levels are based, in part, on our
expectations regarding future revenue levels. As a result, if net sales for a
particular period were below our expectations, we may not be able to
proportionately reduce our operating expenses for that period. Therefore, any
revenue shortfall would have a disproportionately negative effect on our
operating results for the period.
Due to these and other factors, we believe that quarter-to-quarter
comparisons of our operating results may not be meaningful. You should not rely
on our results for any one quarter as an indication of our future performance.
In future quarters, our operating results may be below the expectations of
public market analysts or investors. If this occurs, the market price of our
common stock would likely decrease.
The loss of any large customer or any cancellation or delay of a significant
purchase by a large customer could significantly reduce our net sales and harm
our operating results
In addition to selling finished hearing aids to a large number of hearing
care professionals and distributors, we also sell hearing aid components to a
limited number of hearing aid manufacturers. These arrangements have accounted
for a significant portion of our net sales to date. The loss of any of these
large customers, or a significant reduction in sales to these customers, would
significantly reduce our net sales and have a negative effect on our operating
results. For example, sales of components to Starkey Laboratories, Inc.
accounted for approximately $7.3 million, or 26%, of net sales in 1999 and
approximately $4.7 million, or 41%, of net sales in the fourth quarter of 1999.
Although Starkey is contractually committed to purchase a minimum quantity of
components through 2001, if Starkey were to breach its agreement or were to not
buy components after 2001, our net sales would decline substantially, and we
may not be able to recover the lost revenue through other means. See
"Business--Customers" and "Competition." We anticipate that our operating
results in any given period will continue to depend to a significant extent
upon revenues from a small number of large customers.
Other than Starkey, our customers are not generally contractually obligated
to purchase any fixed quantities of products, and they may stop placing orders
with us at any time regardless of any forecast they may have previously
provided. If any of our larger customers were to stop or delay purchases, our
net sales and operating results would be adversely affected, which could cause
our stock price to decline. We may be unable to retain our current customers,
and we may be unable to recruit replacement or additional customers.
9
<PAGE>
We rely on several sole source or limited source suppliers and manufacturers,
and our production will be seriously harmed if these suppliers and
manufacturers are not able to meet our demand and alternative sources are not
available
A number of key components used in our products are currently available only
from a single or limited number of suppliers. For example, our proprietary
digital signal processing, or DSP, chips are manufactured by a single supplier.
Our relationship with this supplier is critical to our business because our
proprietary DSP chip is integral to our products and because only a small
number of suppliers would be able or willing to produce our chip in the
relatively small quantities and with the exacting specifications we require.
Under our agreement with this supplier, we are required to make minimum annual
purchases, which may be higher than our requirements. In addition, the
disposable tip used in our CONFORMA hearing aid is produced by a single
supplier and the receivers and microphones used in our products are available
from only two suppliers. We also rely on contract manufacturers and are
therefore subject to their performance, over which we have little control. We
may be forced to cease producing our products if we experience significant
shortages of critical components from these key suppliers or lose the services
of our contract manufacturers. Finding a substitute part, process, supplier or
manufacturer may be expensive, time-consuming or impossible. In addition, we
may also be required to stock higher levels of inventories to avoid sudden
shortages.
We have new products and a limited selling history, which makes it difficult to
evaluate our business, and our operating results will suffer if our products do
not gain market share as rapidly as we anticipate
We launched NATURA, our first hearing aid product, in September 1998 and
introduced CONFORMA in March 2000. We have been generating revenue from selling
hearing aid components for approximately one year. Accordingly, we have a
limited selling history on which investors can base an evaluation of our
products, business and prospects. Our revenue and income potential are
unproven, and our business model will continue to evolve. For example, we are
developing a new integrated circuit that we intend to introduce in our products
beginning in the second quarter of 2000. If our current and new products do not
gain market share as rapidly as we anticipate, our operating results will
suffer.
We have high levels of product returns, remakes and repairs, and our net sales
and operating results will be lower if these levels remain high or increase
The hearing aid industry experiences high levels of product returns, remakes
and repairs due to factors such as statutorily required liberal return policies
and product performance inconsistent with consumers' expectations. This has
been particularly true for companies like ours that sell premium-priced, high-
end devices. We offer a 90-day return policy in accordance with various state
laws and a minimum of a one-year warranty on our products. To date, we have
experienced high levels of returns, remakes and repairs. We experienced product
quality issues during the first half of 1999, which added to these high levels
of returns, remakes and repairs. Our provision for sales returns was $0.7
million in 1998 and $10.1 million in 1999. Our provision for warranty (remake
and repair) costs was $0.2 million in 1998 and $1.3 million in 1999. Although
we have taken measures to reduce the levels of returns, remakes and repairs on
our products, we may not be able to attain lower levels and these levels may
increase, either of which could reduce our net sales and operating results.
We face aggressive competition in our business, and if we do not compete
effectively our net sales and operating results will suffer
We encounter aggressive competition from over 30 competitors worldwide, many
of which have far greater sales and more extensive financial and business
resources than we have. Our competitors range from some of the world's largest
companies, such as Siemens GmbH, to many
10
<PAGE>
highly specialized firms, such as Starkey Laboratories, Inc. and Oticon A/S, as
well as many smaller hearing aid companies. We may not be able to compete
effectively with these competitors. Consolidation within the industry has
accelerated in the last several years, and further consolidation could produce
stronger competitors. In addition, some of our larger competitors have enhanced
their competitive positions relative to ours by bundling products and services
to hearing care professionals. If we fail to compete effectively, our net sales
and operating results will suffer. For instance, we may have to reduce the
prices of our products to stay competitive.
If we fail to develop new and innovative products, our competitive position may
suffer
In order to be successful, we must develop new products and be a leader in
the commercialization of new technology innovations in the hearing aid market.
Technological innovation is expensive and unpredictable and may require hiring
expert personnel who are difficult to find and attract. Without the timely
introduction of new products, our existing products are likely to become
technologically obsolete over time, which would harm our business. The success
of new product features or product offerings will depend on several factors,
including our ability to:
. identify consumer needs;
. price our products attractively;
. innovate and develop competitive products in a timely manner;
. successfully market and sell new products;
. manufacture and deliver quality products in sufficient quantities to
meet market demand; and
. differentiate our products from our competitors' offerings.
We may not have the technical capabilities or financial resources necessary
to develop technologically innovative products. In addition, any enhancements
to or new generations of our products, even if successfully developed, may not
generate revenue in excess of the costs of development. Our products may be
rendered obsolete by changing consumer preferences or the introduction of
products embodying new technologies or features by our competitors.
Selling hearing aid components to our competitors may increase their
competitive position relative to ours if they design and manufacture more
competitive hearing aids or market their products more effectively than we
market ours
Our business strategy of selling hearing aid components to our competitors
may place us in a vulnerable position. For instance, we may not be able to
compete effectively with these other hearing aid manufacturers if they design
and manufacture a more competitive hearing aid with our components than we do,
or if they market their products more effectively than we do. We may find that
these competitors are able to capture a larger portion of the finished hearing
aid market, limiting our ability to expand our share of the finished hearing
aid market. This could harm our net sales growth and operating results.
We have limited manufacturing experience and may be unable to expand our
manufacturing capabilities sufficiently or to find third parties to manufacture
our products, which would limit our ability to develop and deliver sufficient
quantities of products in a timely manner
To be successful, we must manufacture our products in commercial quantities
in compliance with regulatory requirements at acceptable costs. At the present
time, we have limited manufacturing experience and capabilities. During our
initial phase of selling products in 1998 and early 1999, we were required to
outsource some of our production to keep up with demand, which adversely
impacted our costs and gross margin. During the first half of 1999, we also
experienced problems in
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<PAGE>
product quality, employee training and component production. In the third
quarter of 1999, we relocated our manufacturing facility from Salt Lake City to
the Minneapolis area. We may not be able to expand our manufacturing
capabilities at acceptable costs or enter into agreements with third parties
with respect to these activities. We could incur significant expenses,
particularly if we expand our facilities and hire additional personnel. We may
seek collaborative arrangements with other companies to manufacture current
products or new products. If we rely on third parties to manufacture our
products, our profit margins and our ability to develop and deliver these
products on a timely basis may suffer. Moreover, these third parties may not
perform adequately, and any failures by these parties may impair our ability to
deliver products on a timely basis or otherwise harm our competitive position
and market success.
If we are unable to successfully outsource the production of CONFORMA, we may
be unable to deliver sufficient quantities of CONFORMA in a timely manner
We are currently producing CONFORMA internally. However, we recently selected
a manufacturer experienced in producing high-quality, standardized electronic
devices in volume and anticipate that we will eventually outsource all
production of CONFORMA to this manufacturer. If this manufacturer were unable
to produce commercial quantities of CONFORMA at an acceptable cost and quality
level and meet customer demand for CONFORMA, our net sales and operating
results would be negatively affected.
Our entry into additional distribution channels could harm our relationships
with existing customers and cause them to purchase fewer of our products, which
would reduce our net sales and operating results
We are currently exploring or testing additional distribution channels, such
as selling our hearing aids through alternative or emerging retail channels.
Our current initiatives or any future expansion of these initiatives could
alienate our traditional hearing care professional customers. It is possible
that our hearing care professional channel will react by reducing or
discontinuing their purchases from us. In such a scenario the resulting loss of
revenue may not be offset by our revenue from new distribution channels, and we
may choose not to continue using any of these new channels. Should hearing care
professionals react unfavorably to our strategy, they would likely purchase
fewer of our products, which would reduce our net sales and operating results.
We are dependent on international sales and operations, which exposes us to
foreign and political risks, including the burden of complying with a variety
of quality assurance and other regulatory requirements, that could result in
lower international sales
International sales accounted for $8.0 million, or 28% of our net sales, in
1999. Our European sales operations are administered from our facilities in
Denmark. We anticipate that international sales will continue to account for a
significant portion of our sales. Our reliance on international sales and
operations exposes us to related risks and uncertainties, including:
. maintenance of an appropriate quality system to retain the European
Union's "CE" mark, which we must have to sell hearing aids in the EU;
. differing regulatory requirements;
. trade restrictions and changes in tariffs;
. import and export license requirements and restrictions;
. difficulties in staffing and managing international operations;
12
<PAGE>
. difficulties in collecting receivables and longer collection periods;
and
. fluctuations in currency exchange rates.
If any of these risks materialize, our international sales could decrease and
the operating results of our foreign operations could suffer.
Competition for qualified personnel is intense in technology industries such as
ours, and we may not be able to maintain or expand our business if we are
unable to hire and retain sufficient technical, sales, marketing and
manufacturing personnel
Competition for qualified personnel in technology industries is intense. If
we are unable to hire and retain sufficient technical, sales, marketing and
manufacturing personnel, our business will suffer. Our future success depends
in part on the continued service of our key engineering, sales, marketing,
manufacturing, finance and executive personnel. We do not have long-term
employment contracts with any of our key personnel. We also must attract
qualified research scientists and engineers in order to continue to develop
innovative products. If we fail to retain and hire a sufficient number and type
of personnel, we will not be able to maintain and expand our business. Although
we believe we offer competitive salaries and benefits, we have been and may be
required to increase spending to retain personnel.
We may encounter difficulties in managing our growth, which could adversely
affect our operating results
We have experienced a period of rapid growth that has placed and may continue
to place a strain on our human and capital resources. The number of our
employees increased from 110 at December 31, 1998 to 211 at December 31, 1999.
Our net sales increased from $2.1 million in 1998 to $28.7 million in 1999. If
we are unable to manage this growth effectively, our losses could increase. An
example of the strain arising from growth occurred during the first half of
1999, when we experienced problems in product quality, employee training and
component production. Our ability to manage our operations and growth
effectively requires us to continue to expend funds to improve our operational,
financial and management controls, reporting systems and procedures. If we are
unable to successfully implement improvements to our management information and
control systems in an efficient or timely manner, or if we encounter
deficiencies in existing systems and controls, then management may receive
inadequate information to manage our day-to-day operations properly.
Complications may result from hearing aid use, and we may incur significant
expense if we are sued for product liability
We may be held liable if any product we develop, or any product that uses or
incorporates any of our technologies, causes injury or is found otherwise
unsuitable. Complications that can occur from hearing aid use include allergic
reactions, skin irritation and abrasions, all of which can be caused by the
materials used in the manufacture of the hearing aids or improper use of the
hearing aid by the consumer or dispenser. In addition, hearing aids can emit
distracting or uncomfortable sounds during normal use or failure and may be a
factor in the onset of or change in tinnitus (ringing in the ears). Although we
have not experienced any significant product liability issues to date, product
liability is an inherent risk in the production and sale of hearing aid
products. We intend to continue to maintain product liability insurance, but
this insurance may become prohibitively expensive or may not fully cover our
potential liabilities. Inability to obtain sufficient insurance coverage at an
acceptable cost or otherwise to protect against potential product liability
claims could prevent or inhibit the commercialization of our products. If we
are sued for an injury caused by our products, the resulting liability could
result in significant expense, which would harm our operating results.
13
<PAGE>
Third parties have claimed and may claim in the future that we are infringing
their intellectual property, and we could suffer significant expense or be
prevented from selling products if these claims are successful
Third parties may claim that we are infringing their intellectual property
rights. While we do not believe that any of our products infringe the
proprietary rights of third parties, we may be unaware of intellectual property
rights of others that may cover some of our technology. Whether or not we
actually infringe a third party's rights, any litigation regarding patents or
other intellectual property could be costly and time-consuming and divert our
management and key personnel from our business operations. The complexity of
the technology involved and the uncertainty of intellectual property litigation
increase these risks. Claims of intellectual property infringement might also
require us to enter into costly royalty or license agreements. For example, in
1999, we settled a claim with one of our competitors who claimed that all of
our products infringed patents it held. To avoid litigation, we agreed to pay a
royalty on our sales through September 2001. However, we may not always be able
to obtain royalty or license agreements on terms acceptable to us, or at all.
We also may be subject to significant damages or injunctions against the sale
of our products.
Because our success depends on our proprietary technology, if third parties
infringe our intellectual property, we may be forced to expend significant
resources enforcing our rights or suffer competitive injury
Our success depends in large part on our proprietary technology. We rely on a
combination of patents, copyrights, trademarks, trade secrets, confidentiality
procedures and licensing arrangements
to establish and protect our proprietary technology. If we fail to successfully
enforce our intellectual property rights, our competitive position will suffer.
We may be required to spend significant resources to monitor and police our
intellectual property rights. We may not be able to detect infringement and may
lose our competitive position in the market before we do so. In addition,
competitors may design around our proprietary technology or develop competing
technologies. Intellectual property rights may also be unavailable or limited
in some foreign countries.
Our pending patent and trademark registration applications may not be allowed
or competitors may challenge the validity or scope of these registrations. In
addition, our patents may not provide us with a significant competitive
advantage.
If we fail to comply with a variety of governmental regulations, we may suffer
fines, injunctions or other penalties
Our products are considered to be medical devices and are, accordingly,
subject to extensive regulation in the United States and internationally, which
may hamper the timing of our product introductions or subject us to costly
penalties in the event we fail to comply.
We must comply with facility registration and product listing requirements of
the Food and Drug Administration, or FDA, and adhere to its Quality System
regulations. The FDA enforces the Quality System regulations through periodic
inspections, which we have yet to undergo. If we or any third-party
manufacturers of our products do not conform to the Quality System regulations,
we will be required to find alternative manufacturers that do conform, which
could be a long and costly process.
Generally, medical devices must either receive premarket clearance through
the 510(k) process or be an exempt product. Although we received 510(k)
clearance for our EXPRESSfit fitting and programming system and CONFORMA
hearing aid, we believe our future products and enhancements are exempt from
the 510(k) process. However, if we are required to comply with the FDA
requirements or if we fail to comply, we may be unable to market such products
or enhancements in a timely manner, if at all. Noncompliance with applicable
FDA requirements can
14
<PAGE>
result in fines, injunctions, civil penalties, recall or seizure of products,
total or partial suspension of production or criminal prosecution.
Sales of our products outside the United States are subject to foreign
regulatory requirements that vary widely from country to country. The time
required to obtain approvals required by other countries may be longer than
that required for FDA clearance or approval, and requirements for such
approvals may differ from FDA requirements. In order to market our products in
the 15 member countries of the European Union, we are required to obtain the
EU's CE mark certification, which we accomplished by meeting the requirements
of ISO 9001 in December 1998. Any failure to maintain our ISO 9001
certification or CE mark could significantly reduce our net sales and operating
results.
Risks Related to This Offering and Our Stock
Technology stocks have experienced extreme volatility, and our stock price
could be extremely volatile. Consequently, you may not be able to resell your
shares at or above the price you paid for them
Before this offering, there has not been a public market for our common
stock, and an active public market for our common stock may not develop or be
sustained after this offering. Further, the market price of our common stock
may decline below the price you paid for your shares. The market price of our
common stock could be subject to significant fluctuations after the offering.
Among the factors that could affect our stock price are:
. quarterly variations in our results of operations;
. changes in recommendations by the investment community or in their
estimates of our revenues or operating results;
. speculation in the press or investment community;
. strategic moves by our competitors, such as product announcements or
acquisitions;
. general market conditions; and
. domestic and international macroeconomic factors unrelated to our
performance.
The stock market in general, and technology stocks in particular, have
experienced extreme volatility that has often been unrelated to the operating
performance of particular companies. These broad market fluctuations may
adversely affect the market price of our common stock.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted. If a securities class action suit is filed against us, we would
incur substantial legal fees and our management's attention and resources would
be diverted from operating our business in order to respond to the litigation.
There may be sales of a substantial amount of our common stock 180 days after
this offering, or earlier, by our stockholders, and these sales could cause our
stock price to fall
Sales of substantial amounts of our common stock in the public market after
this offering, or the perception that such sales will occur, could adversely
affect the market price of our common stock and make it difficult for us to
raise funds through equity offerings in the future. A substantial number of
outstanding shares of common stock and shares issuable upon exercise of
outstanding options and warrants will become available for resale in the public
market at prescribed times. Of the 18,867,481 shares to be outstanding after
the offering, 3,600,000 shares offered by this prospectus will be eligible for
immediate sale in the public market without restriction by persons other than
our
15
<PAGE>
affiliates. The remaining 80.9%, or 15,267,481 shares, of our total outstanding
shares will become available for resale in the public market as shown in the
chart below.
<TABLE>
<CAPTION>
Number of Shares Date Available for Resale
---------------- -------------------------
<S> <C>
25,022... Immediately
14,490,540... (180 days after this offering (October 28, 2000), or earlier
in Goldman, Sachs & Co.'s sole discretion)
751,919... Various dates beginning in December 2000
</TABLE>
Beginning 180 days after this offering (October 28, 2000), or earlier in
Goldman, Sachs & Co.'s sole discretion, holders of 12,942,342 shares of the
common stock may require us to register their shares for resale under the
federal securities laws. Registration of such shares would result in these
stockholders being able to immediately resell their shares in the public
market. Any such sales or anticipation thereof could cause the market price of
our common stock to decline.
In addition, after the offering, we also intend to register the 4,758,465
shares of common stock subject to outstanding options or reserved for issuance
under our existing and proposed stock plans. For more information, see "Shares
Eligible for Future Sale."
Insiders will continue to have substantial control over us after this offering,
which could delay or prevent a change in control and may negatively affect your
investment
After this offering, our officers, directors and their affiliated entities
will together control approximately 58.8% of our outstanding common stock. As a
result, these stockholders, if they act together, will be able to exert a
significant degree of influence over our management and affairs and over
matters requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. In addition, this concentration
of ownership may delay or prevent a change in control and might affect the
market price of our common stock, even when a change may be in the best
interests of all stockholders. In addition, the interests of those holding this
concentrated ownership may not always coincide with our interests or the
interests of other stockholders, and, accordingly, they could cause us to enter
into transactions or agreements which we would not otherwise consider.
Provisions in our charter documents and Delaware law may deter takeover efforts
that you feel would be beneficial to stockholder value
Our certificate of incorporation and bylaws and Delaware law contain
provisions which could make it harder for a third party to acquire us without
the consent of our board of directors. These provisions include a classified
board of directors and limitations on actions by our stockholders. In addition,
our board of directors has the right to issue preferred stock without
stockholder approval that could be used to dilute a potential hostile acquiror.
Delaware law also imposes some restrictions on mergers and other business
combinations between us and any holder of 15% or more of our outstanding common
stock. While we believe these provisions provide for an opportunity to receive
a higher bid by requiring potential acquirors to negotiate with our board of
directors, these provisions apply even if the offer may be considered
beneficial by some stockholders and a takeover bid otherwise favored by a
majority of our stockholders might be rejected by our board of directors.
16
<PAGE>
FORWARD-LOOKING STATEMENTS
You should not rely on forward-looking statements in this prospectus. This
prospectus contains forward-looking statements within the meaning of federal
securities laws that relate to future events or our future financial
performance. In many cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"believe," "estimate," "predict," "intend," "potential" or "continue" or the
negative of these terms or other comparable terminology. Examples of these
forward-looking statements include, but are not limited to, statements
regarding the following: the introduction and development of new products and
product improvements, the increasing segmentation of the hearing aid market
between companies that have digital products and those that do not, the
strategy of selling hearing aid components providing additional revenue and
opportunity and accelerating the validation of our technology, the growth in
the hearing impaired population, the implied growth of hearing aid sales
generally and digital hearing aid sales in particular, the success of our
CONFORMA product, our becoming the best hearing aid company in the world,
delivering superior products that appeal to users of hearing aids and the non-
user hearing impaired, expanding our distribution, increasing the penetration
of our branded products, the creation of new distribution opportunities,
obtaining additional distribution partners that increase our geographic reach,
increasing brand awareness, achieving economies of scale, our products'
providing the highest levels of satisfaction for hearing impaired consumers,
deriving benefits in terms of reduced costs and increased quality of
production, estimated warranty costs, increasing sales and improving customer
service, growth in operating expenses, resolving product quality issues,
increased other income, increased capital expenditures, growth in operations,
infrastructure and personnel, the lack of a material adverse effect of Year
2000 problems on our financial condition and results of operations, the lack of
a material impact of the adoption of SFAS No. 133, operating loss carryforwards
expiring as indicated, enhancing our competitive position and having sufficient
manufacturing capacity to satisfy future demand for our products. Factors that
may cause actual results to differ materially from the results expressed or
implied by these forward-looking statements are set forth under "Risk Factors."
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We do not intend to update any of the
forward-looking statements after the date of this prospectus or to conform
these statements to actual results.
17
<PAGE>
USE OF PROCEEDS
Our net proceeds from the sale of 3,600,000 shares of common stock in this
offering at the initial public offering price of $14.00 per share are estimated
to be approximately $45.9 million (approximately $53.0 million if the
underwriters' over-allotment option is exercised in full), after deducting the
estimated underwriting discount and offering expenses payable by us.
We intend to use the net proceeds of this offering for general corporate
purposes, including:
. further development and commercialization of our products;
. research and development;
. repayment of all existing capital lease obligations;
. working capital; and
. possible acquisitions or investments
The amounts and timing of our actual expenditures for each of these purposes
may vary significantly depending upon numerous factors, including the status of
our product development efforts, competition, marketing and sales activities
and market acceptance of our products. Pending use for these or other purposes,
we intend to invest the net proceeds of this offering in short-term,
investment-grade securities.
From time to time, in the ordinary course of business, we evaluate possible
acquisitions of, or investments in, businesses, products and technologies that
are complementary to our business. A portion of the net proceeds may be used to
fund acquisitions or investments. We currently have no arrangements, agreements
or understandings for any such acquisitions or investments.
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We
currently intend to retain all available funds and future earnings, if any, for
use in the operation and expansion of our business and do not anticipate paying
dividends in the future.
18
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization at December 31, 1999:
. On an actual basis;
. On a "pro forma" basis to reflect the conversion of all outstanding
convertible preferred stock and convertible promissory notes and the
exercise of warrants as described in the first paragraph after the table
under "Summary--The Offering" on page 6 and the repayment after December
31, 1999 of $1,966,000 of line of credit borrowings and $811,000 of
capital lease obligations; and
. On a "pro forma as adjusted" basis to reflect the sale of 3,600,000
shares of common stock in this offering at the initial public offering
price of $14.00 per share, after deducting the estimated underwriting
discount and offering expenses payable by us, and the application of a
portion of the net proceeds to repay our debt and capital lease
obligations.
<TABLE>
<CAPTION>
As of December 31, 1999
-------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(In thousands, except share
and per share data)
<S> <C> <C> <C>
Convertible promissory notes, including
accrued interest(1).......................... $ 8,064 $ -- $ --
-------- ------- --------
Line of credit and capital lease obligations,
including current portion.................... 4,765 1,988 --
-------- ------- --------
Other long-term obligations................... 150 150 150
-------- ------- --------
Mandatorily redeemable convertible preferred
stock, Series B, C, and D $.001 par value;
12,178,649 shares designated; 12,083,509
shares outstanding, none pro forma and pro
forma as adjusted............................ 36,130 -- --
-------- ------- --------
Stockholders' equity (deficit):
Preferred stock, Series A convertible, $.001
par value; 13,907,895 shares authorized,
5,000,000 shares pro forma and pro forma as
adjusted; 449,277 shares designated and
outstanding, none pro forma and pro forma
as adjusted................................ 342 -- --
Common stock, $.001 par value; 35,000,000
shares authorized, 70,000,000 shares pro
forma and pro forma as adjusted; 1,449,367
shares issued and outstanding, 15,267,481
pro forma and 18,867,481 pro forma as
adjusted................................... 3 15 19
Additional paid-in capital.................. 6,256 57,216 103,134
Deferred stock-based compensation........... (3,613) (3,613) (3,613)
Accumulated deficit......................... (41,778) (41,778) (41,778)
Accumulated other comprehensive loss........ (11) (11) (11)
-------- ------- --------
Total stockholders' equity (deficit)....... (38,801) 11,829 57,751
-------- ------- --------
Total capitalization....................... $ 10,308 $13,967 $ 57,901
======== ======= ========
</TABLE>
- --------
(1) The face value of the convertible promissory notes is $8.5 million. The
difference between the face value and the amount shown above reflects the
allocation of a portion of the proceeds from the sale of $4.5 million of
such notes to the warrants that were issued in connection with such sale.
See Note 5 of Notes to the Consolidated Financial Statements.
The above table excludes the shares of common stock issuable upon exercise of
outstanding options and warrants described in the second paragraph after the
table under "Summary--The Offering" on page 6.
Subsequent to December 31, 1999 (through May 1, 2000), the Board of Directors
granted options to purchase an additional 175,098 shares of common stock at a
weighted average exercise price of $13.30 per share. See "Management--Incentive
Stock Plans" for a detailed description of our incentive stock plans and
"Description of Capital Stock" for a detailed description of our capital stock.
19
<PAGE>
DILUTION
Our pro forma net tangible book value as of December 31, 1999 was $11.8
million, or $0.77 per share of common stock. Pro forma net tangible book value
per share represents the amount of total tangible assets less total
liabilities, divided by the number of outstanding shares of common stock after
giving effect to the conversion of all outstanding convertible preferred stock
and convertible promissory notes and the exercise of warrants as described in
the first paragraph after the table under "Summary--The Offering" on page 6.
After giving effect to the sale of 3,600,000 shares of common stock offered
by this prospectus at the initial public offering price of $14.00 per share,
less the underwriting discount and offering expenses payable by us, our pro
forma net tangible book value at December 31, 1999 would have been $57.8
million, or $3.06 per share. This represents an immediate increase in the pro
forma net tangible book value to existing stockholders of $2.29 per share and
an immediate dilution to new investors of $10.94 per share. The following table
illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
The initial public offering price per share................... $14.00
Pro forma net tangible book value per share as of
December 31, 1999.......................................... $0.77
Increase per share attributable to public investors......... 2.29
-----
Pro forma net tangible book value per share after the
offering..................................................... 3.06
------
Dilution per share to public investors........................ $10.94
======
</TABLE>
The following table summarizes, on a pro forma basis as of December 31, 1999,
the difference between the number of shares of common stock purchased from us,
the total consideration paid to us and the average price per share paid (i) by
our existing stockholders; and (ii) by the new public investors purchasing
stock in this offering:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ ------------------- Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders (1).. 15,267,481 80.9% $47,090,884 48.3% $ 3.08
New public investors ...... 3,600,000 19.1 50,400,000 51.7 14.00
---------- ----- ----------- -----
Total.................... 18,867,481 100.0% $97,490,884 100.0%
========== ===== =========== =====
</TABLE>
- --------
(1) Including Hoya Healthcare Corporation. See "Certain Transactions--Hoya
Healthcare Corporation."
The above table excludes the outstanding options and warrants described in
the second paragraph after the table under "Summary--The Offering" on page 6.
To the extent that any of these options or warrants are exercised, there will
be further dilution to new investors. Assuming the exercise of all options and
warrants outstanding as of December 31, 1999, the number of shares purchased by
existing stockholders would be 17,886,289, or 83.2%, and the total
consideration paid by existing stockholders would be $52,971,856, or 51.2%, for
an average price per share of $2.96.
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data for the five years ended
December 31, 1999 are derived from our financial statements, which were audited
by Arthur Andersen LLP, independent public accountants.
The selected consolidated financial data set forth below should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this prospectus. In particular, see Note 2 to
consolidated financial statements for an explanation of the calculation of net
loss per share and per share amounts.
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- -------- ---------
(In thousands, except share and per share
data)
<S> <C> <C> <C> <C> <C>
Consolidated Statements of
Operations:
Net sales..................... $ -- $ -- $ -- $ 2,143 $ 28,694
Cost of sales (1)............. -- -- -- 2,056 17,062
------- ------- ------- -------- ---------
Gross profit................ -- -- -- 87 11,632
------- ------- ------- -------- ---------
Operating expenses:
Selling, general and
administrative (1)......... 944 455 1,471 8,444 17,343
Research and development
(1)........................ 136 1,090 3,855 5,832 7,015
Stock-based compensation.... -- -- -- -- 1,025
------- ------- ------- -------- ---------
Total operating expenses.. 1,080 1,545 5,326 14,276 25,383
------- ------- ------- -------- ---------
Operating loss................ (1,080) (1,545) (5,326) (14,189) (13,751)
Other income (expense)........ 7 (39) 91 311 (1,155)
------- ------- ------- -------- ---------
Net loss...................... (1,073) (1,584) (5,235) (13,878) (14,906)
Accretion on mandatorily
redeemable convertible
preferred stock.............. (33) (148) (593) (1,561) (2,431)
------- ------- ------- -------- ---------
Net loss applicable to common
stockholders................. $(1,106) $(1,732) $(5,828) $(15,439) $ (17,337)
======= ======= ======= ======== =========
Basic and diluted net loss per
common share................. $ (2.26) $ (3.21) $ (8.23) $ (15.61) $ (12.72)
======= ======= ======= ======== =========
Weighted average number of
common shares outstanding.... 487,857 539,364 708,403 988,844 1,363,221
======= ======= ======= ======== =========
</TABLE>
- --------
(1) Excludes the following amounts of noncash stock-based compensation
separately reflected: cost of sales--$47; selling, general and
administrative--$840; and research and development--$138.
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet
Data:
Cash and cash equivalents...... $ 1,146 $ 1,264 $ 1,718 $ 11,930 $ 5,939
Working capital (deficit)...... 1,085 1,996 10,521 8,706 (5,119)
Total assets................... 1,250 2,619 13,091 16,872 18,462
Long-term obligations.......... 485 438 625 1,690 2,085
Convertible promissory notes... -- -- -- -- 8,064
Mandatorily redeemable
convertible preferred stock... 1,783 4,636 19,555 33,662 36,130
Total stockholders' deficit.... (1,100) (2,801) (8,549) (23,853) (38,801)
</TABLE>
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in this prospectus contains forward-looking statements that
involve risks and uncertainties. These statements refer to our future plans,
objectives, expectations and intentions. These statements may be identified by
the use of words such as "believes," "expects," "anticipates," "intends,"
"plans" and similar expressions. Our actual results could differ materially and
adversely from those anticipated in such forward-looking statements. Factors
that could contribute to these differences include, but are not limited to, the
risks discussed in the section titled "Risk Factors" in this prospectus.
Overview
We design, manufacture and market advanced digital hearing aids and hearing
aid components designed to provide the highest levels of satisfaction for
hearing impaired consumers. We were primarily engaged in hearing aid research
and development from our inception in 1991 to September 1998, at which time we
shipped our first branded product, NATURA. In 1999, we also began selling
hearing aid components consisting of our proprietary digital signal processing,
or DSP, platform to established hearing aid companies and partially completed
hearing aids, or faceplates, to distributors who market finished hearing aids
under our brand name.
In reporting our financial condition and results of operations, we report two
geographic operating segments. We generally evaluate our operating results on a
company-wide basis because the principal components of all of our products are
sourced from the United States and all research and development and
considerable marketing and administrative support are globally provided from
the United States. However, management reviews the operating results of our
Denmark-based subsidiary, Sonic Innovations A/S, to make decisions about
resource allocation and to assess performance.
Comparison of the Years Ended December 31, 1999 and December 31, 1998
Net Sales. Net sales consist of product sales less provisions for sales
returns, which are made at the time of sale. Sales are recognized when products
are shipped. Net sales were $28.7 million for the year ended December 31, 1999,
an increase of $26.6 million from net sales of $2.1 million for the year ended
December 31, 1998. Because we began selling our products in September 1998, the
1998 amount reflects only one full quarter of sales, all of which consisted of
branded products in the United States. The 1999 amount reflects a full year of
sales and includes $4.2 million of European sales and $11.0 million of hearing
aid component sales. The balance of the net sales increase of $11.4 million
related to growth in our United States customer base. During 1999, we
introduced our behind-the-ear hearing aid model, which accounted for the
majority of our European sales and allowed us to expand our market penetration
in the United States. See "Business--Customers."
We have a 90-day return period for our branded products and do not allow
returns of our hearing aid components. The provisions for sales returns
aggregated $0.7 million and $10.1 million in 1998 and 1999, respectively. This
increase principally related to the increase in net sales from 1998 to 1999. As
of December 31, 1998 and 1999, allowances for sales returns of $0.3 million and
$2.0 million, respectively, were reflected as a reduction in accounts
receivable. We believe that the hearing aid industry in the United States
experiences a high level of product returns due to factors such as statutorily
required liberal return policies and product performance inconsistent with
consumers' expectations. We believe our return levels are within the range
experienced by other high-end hearing aid manufacturers. Due to the need to
provide a return policy competitive with industry practice for our higher-end,
higher-priced products, we expect sales returns of our non-CONFORMA products to
continue at historical levels. We believe that our CONFORMA product has
22
<PAGE>
the potential to experience lower levels of returns in the future. However,
because our experience with CONFORMA at this point is very limited, we are
unable to predict whether our return levels on our CONFORMA product will
achieve lower levels of returns at some future time.
Cost of Sales. Cost of sales consists of manufacturing costs, royalty
expenses, quality assurance costs and costs associated with product returns,
remakes and repairs. Cost of sales was $17.1 million for the year ended
December 31, 1999, an increase of $15.0 million from cost of sales of $2.1
million for the year ended December 31, 1998. The increase is primarily due to
the increase in net sales. As a percentage of net sales, gross profit increased
to 41% for the year ended December 31, 1999 from 4% the previous year as the
fixed costs of our manufacturing operations were spread over a much greater
sales level. During 1998 and 1999, cost of sales was adversely affected by low
production volumes of our hearing aids relative to the fixed costs of
manufacturing capacity and manufacturing overhead at our Salt Lake City and
Minneapolis facilities. In addition, during the initial phase of selling
products in 1998 and early 1999, we were required to outsource some of our
production to keep up with demand, which adversely impacted our costs and gross
margin. We discontinued this outsourcing in April 1999 as we developed the
capability and the capacity to manufacture our requirements internally. During
the first half of 1999, we experienced product quality issues including custom-
molded hearing aid shells that did not match impressions received from the
hearing care professional, completely-in-the-canal hearing aids not being built
small enough, excessive feedback caused by poor electronic componentry
placement, and incorrect venting or wire routing within the hearing aids. Those
issues related directly to an inexperienced hearing aid work force.
In the fall of 1999, we relocated our hearing aid production operation from
Salt Lake City to the Minneapolis area, where the presence of many major
hearing aid and medical device companies has created a skilled labor pool. With
the transition from Salt Lake City to Minneapolis, our production staff hearing
aid experience levels increased from an average of 0.8 years to 9.4 years.
While the duplication of manufacturing operations and costs of relocation
adversely affected our 1999 cost of sales, we expect to derive future benefits
in terms of reduced costs and increased quality of production. During the
fourth quarter of 1999, customer complaints relating to product quality
declined and we believe that we have now resolved all significant product
quality issues that affected us in 1999. In addition, we believe we have
improved our manufacturing processes as we have increased our production
capacity.
At the time of sale, we provide for the cost of remaking and repairing
products under warranty, including hearing aid components. The warranty period
is generally one or two years for branded products and 30 to 120 days for
hearing aid components. Because of the length of the warranty period,
adjustments to the originally recorded provisions may be necessary from time to
time. In 1998 and 1999, the provisions for warranty costs were $0.2 million and
$1.3 million, respectively. As of December 31, 1998 and 1999, the warranty
reserve was $0.1 million and $0.4 million, respectively.
Selling, General and Administrative. Selling, general and administrative
expense primarily consists of wages and benefits for sales and marketing
personnel, sales commissions and advertising, marketing support and
administrative expenses. Selling, general and administrative expense was $17.3
million for the year ended December 31, 1999, an increase of $8.9 million, or
105%, from the $8.4 million recorded for the year ended December 31, 1998. This
increase was largely due to starting up and expanding our European operations
($2.8 million), increased marketing expenditures related to the introduction of
new products ($2.3 million) and increased selling expenses related mainly to
the hiring of additional direct sales and sales support personnel to increase
sales and improve customer service ($2.5 million).
We expect selling, general and administrative expense to increase as we
expand our staff, incur additional costs related to the anticipated growth of
our business and increase direct-to-consumer advertising and promotions. We
intend to continue to pursue an aggressive branding and advertising
23
<PAGE>
campaign and therefore, we expect marketing related expenses to increase.
Marketing expenses may also vary considerably from quarter to quarter as a
result of the timing of our advertising campaigns. To the extent that our sales
volume increases in future periods, we expect sales and marketing expenses to
increase as we expand our customer service distribution and fulfillment
activities. This includes the costs of staffing and further developing our
direct sales force and customer care capabilities.
Research and Development. Research and development expense consists primarily
of wages and benefits for personnel and consulting, software, intellectual
property, clinical study and engineering support costs. Research and
development expense was $7.0 million for the year ended December 31, 1999, an
increase of $1.2 million, or 20%, from the $5.8 million recorded for the year
ended December 31, 1998. Increased research and development expense in 1999
related to development of CONFORMA, which we began test marketing at the end of
1999, and our NATURA behind-the-ear hearing aid model, which we introduced in
the second quarter of 1999, as well as costs incurred in connection with our
ISO 9001 approval and CE mark certification that allowed us to begin sales of
hearing aids in Europe. We are making continual efforts to improve our existing
products as well as to develop new products because we believe that investment
in new product development is critical to attaining our strategic objectives.
As a result, we expect research and development expense to continue to
increase.
Stock-Based Compensation. We have recorded deferred stock-based compensation
expense of $4.6 million, representing the difference between the exercise price
and the deemed fair value of the common stock on the grant date for stock
options granted to employees in 1999. This amount is being amortized over the
vesting periods of the individual stock options. In 1999, $1.0 million of this
amount was amortized, and the remaining amount will be amortized as follows:
$2.1 million, $0.9 million, $0.4 million and $0.2 million in the years ended
December 31, 2000, 2001, 2002 and 2003, respectively.
Other Income (Expense). Other income consists primarily of earnings on our
cash and cash equivalents. Other expense consists principally of interest
associated with convertible promissory notes, short-term borrowings and capital
lease obligations. We incurred other expense of $1.2 million for the year ended
December 31, 1999 compared to other income of $0.3 million for the year ended
December 31, 1998. This shift resulted from decreased cash and cash equivalents
and increased debt necessary to support our operations, capital expenditures
and increased working capital requirements in 1998 and 1999. We expect other
income to increase in the future based on investment of the net proceeds from
this offering.
Income Tax Provision. There has been no provision or benefit for income taxes
for any period since inception due to our operating losses. See "Tax Matters."
Comparison of the Years Ended December 31, 1998 and December 31, 1997
Net Sales. Net sales were $2.14 million for the year ended December 31, 1998
compared to no sales for the year ended December 31, 1997. In September 1998,
we introduced our first branded product line, NATURA, to the United States
market. All sales in 1998 related to the NATURA line.
Cost of Sales. Cost of sales was $2.06 million for the year ended December
31, 1998 compared to no cost of sales for the year ended December 31, 1997. The
gross margin of 4% in 1998 was due to the high costs of establishing and
maintaining manufacturing operations with a low volume of production.
Selling, General and Administrative. Selling, general and administrative
expense was $8.4 million for the year ended December 31, 1998, an increase of
$6.9 million from the $1.5 million
24
<PAGE>
recorded for the year ended December 31, 1997. This increase was primarily due
to marketing-related spending supporting the introduction of the NATURA product
line and the hiring of sales and sales support personnel to increase sales and
commence customer service activities.
Research and Development. Research and development expense was $5.8 million
for the year ended December 31, 1998, an increase of $1.9 million, or 51%, from
the $3.9 million recorded for the year ended December 31, 1997. Much of the
increased spending was due to improvements to our DSP platform. During the
beginning of 1998, changes were made to our DSP platform to move it from a
prototype stage to a manufacturable integrated circuit. We also made
improvements to EXPRESSfit, our system for programming our hearing aids, to
make the process more compatible with hearing care professionals' expectations.
Other Income (Expense). Other income of $0.3 million for the year ended
December 31, 1998 increased by $0.2 million from the $0.1 million of other
income recorded for the year ended December 31, 1997. We received additional
capital funding during 1998 and as a result had increased income from investing
these proceeds.
Quarterly Results
The fourth quarter of 1998 was the first full quarter in which we generated
revenue. The following tables set forth unaudited quarterly consolidated
statements of operations for the five quarters ended December 31, 1999 in
absolute dollars and as a percentage of net sales. This unaudited quarterly
consolidated information, in the opinion of management, includes all
adjustments necessary for a fair presentation of such information in accordance
with generally accepted accounting principles.
<TABLE>
<CAPTION>
For the Quarters Ended
------------------------------------------------
Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1998 1999 1999 1999 1999
-------- --------- -------- --------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Net sales.................... $ 2,081 $ 3,221 $ 5,642 $ 8,370 $11,461
Cost of sales................ 2,016 3,092 3,532 4,536 5,902
------- ------- ------- ------- -------
Gross profit................. 65 129 2,110 3,834 5,559
Selling, general and
administrative expense...... 4,339 3,871 5,238 4,107 4,127
Research and development
expense..................... 1,575 1,465 1,759 1,943 1,848
Stock-based compensation..... -- 12 81 147 785
------- ------- ------- ------- -------
Operating loss............... (5,849) (5,219) (4,968) (2,363) (1,201)
Other income (expense)....... 24 2 (252) (294) (611)
------- ------- ------- ------- -------
Net loss..................... $(5,825) $(5,217) $(5,220) $(2,657) $(1,812)
======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1998 1999 1999 1999 1999
-------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
Net sales................... 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales............... 96.9 96.0 62.6 54.2 51.5
------ ------ ----- ----- -----
Gross profit................ 3.1 4.0 37.4 45.8 48.5
Selling, general and
administrative expense..... 208.5 120.2 92.8 49.0 36.0
Research and development
expense.................... 75.7 45.5 31.2 23.2 16.1
Stock-based compensation.... -- 0.4 1.4 1.8 6.9
------ ------ ----- ----- -----
Operating loss.............. (281.1) (162.1) (88.0) (28.2) (10.5)
Other income (expense)...... 1.2 0.1 (4.5) (3.5) (5.3)
------ ------ ----- ----- -----
Net loss.................... (279.9)% (162.0)% (92.5)% (31.7)% (15.8)%
====== ====== ===== ===== =====
</TABLE>
The trends implied by the above table are not necessarily indicative of
future operating results, growth rates, margins or quarter-to-quarter
comparisons.
25
<PAGE>
Liquidity and Capital Resources
Historically, our principal sources of funds were the sale of common and
preferred stock, the sale of subordinated convertible debt, capital lease
financing arrangements and bank borrowings, totaling approximately $46.4
million.
Net cash used in operating activities totaled $4.6 million, $12.5 million and
$14.0 million in 1997, 1998 and 1999, respectively. For these periods, net cash
used by operating activities was primarily to fund ongoing operations. Net cash
used for operating activities consisted primarily of net operating losses and
increases in accounts receivable and inventories, which were partially offset
by increases in accounts payable and accrued expenses.
To date, our investing activities have consisted mainly of purchases of
property and equipment. Capital expenditures, including those made under
capital leases, totaled $1.0 million, $2.3 million and $2.6 million for 1997,
1998 and 1999, respectively. We financed the acquisition of the majority of our
1998 and 1999 property and equipment through capital leases. We expect to
experience an increase in our capital expenditures consistent with our
anticipated growth in operations, infrastructure and personnel.
Net cash from financing activities was $14.2 million, $12.8 million and
$9.0 million in 1997, 1998 and 1999, respectively. In July 1999, we sold $4.5
million of our 6% convertible promissory notes to our existing investors. The
principal and accrued interest on these notes will convert into shares of our
common stock at the closing of this offering at the IPO price. In addition, in
December 1999, we sold $4.0 million of our 6% convertible promissory notes to
Hoya Healthcare Corporation in connection with our appointment of Hoya as our
exclusive distributor of branded products in Japan. Hoya has agreed to purchase
an additional $3.0 million of our 6% convertible promissory notes on March 31,
2000 and another $3.0 million when we close this offering. All of Hoya's notes
will convert into common stock at the closing of this offering--$7.0 million at
93% of the IPO price and $3.0 million at 100% of the IPO price. See "Certain
Transactions--Hoya Healthcare Corporation."
At December 31, 1999, we had $5.9 million in cash and cash equivalents, $4.8
million of line of credit borrowings and capital lease obligations, $8.1
million of convertible notes ($8.5 million in face value), mandatorily
redeemable convertible preferred stock with a redemption value of $36.1 million
and an accumulated deficit of $41.8 million. We have a $4.0 million bank credit
facility, of which $2.0 million was outstanding at December 31, 1999. This
borrowing and $0.8 million of capital lease obligations were repaid after
December 31, 1999. The line of credit bears interest at a rate of prime plus
2.0% and expires on June 30, 2000. Our credit facility requires us to maintain
a specified level of tangible net worth and includes restrictions on our
incurring additional unsubordinated indebtedness, pledging or encumbering our
assets, paying dividends, and entering into mergers and acquisitions.
All of the convertible debt and preferred stock will convert into common
stock upon the closing of this offering. We intend to repay all of our
remaining debt, which we estimate will not exceed $2.0 million of capital lease
obligations at the time of the offering, with a portion of the net proceeds
from this offering. See "Use of Proceeds" and "Capitalization."
We have issued warrants for the purchase of our common stock in connection
with various financing arrangements based on the requirements of those who
provided us with financing. We issued warrants to purchase 236,853 shares,
exercisable at $3.80 per share, to our existing investors in connection with
their purchase of $4.5 million of our 6% convertible promissory notes in July
and August 1999. We issued warrants to our bank for 17,258 shares, exercisable
at $3.04 per share, in May 1998 in connection with equipment financing and
20,706 shares, exercisable at $3.80 per share, in December 1999 in connection
with establishing a new line of credit.
26
<PAGE>
We have utilized stock options as a means of attracting and retaining
talented managers, and we also grant stock options to all employees upon their
employment with us. Options generally vest over a four-year period. At December
31, 1999, we had 2,580,844 options outstanding at a weighted average exercise
price of $2.23 per share, of which 774,278 were exercisable at a weighted
average exercise price of $0.70 per share.
We expect to experience growth in our operating expenses in order to execute
our business plan, particularly in the areas of research and development and
sales and marketing. As a result, we estimate that these operating expenses, as
well as other expenditures we expect to incur to improve our manufacturing
capability and increase our manufacturing capacity, will constitute a
significant use of our cash resources for at least the next twelve months. In
addition, we may use cash resources to fund acquisitions of complementary
businesses and technologies; however, we currently have no commitments or
agreements and are not involved in any negotiations regarding such
transactions. We believe that the net proceeds we will receive from Hoya and
from this offering, together with our available cash and bank line of credit,
will be sufficient to meet our operating and working capital requirements and
capital expenditures for at least the next twelve months. Thereafter, we may
find it necessary to obtain additional equity or debt financing. In the event
that additional financing is required, we may not be able to raise it on terms
acceptable to us, if at all.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
To date, we have not utilized derivative financial instruments or derivative
commodity instruments. We invest our cash in money market funds, which are
subject to minimal credit and market risk. All of our outstanding debt will be
repaid or converted in connection with this offering. We believe the market
risks associated with these financial instruments are immaterial.
Foreign Currency Risk
We face foreign currency risks primarily as a result of the revenues we
receive from sales made outside the United States. Fluctuations in the exchange
rates between the U.S. dollar and other currencies could increase the sales
price of our products in international markets where the prices of our products
are denominated in U.S. dollars or lead to currency exchange losses where the
prices of our products are denominated in local currencies.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." We are required to adopt SFAS No. 133 for
the year ending December 31, 2000. SFAS No. 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. Because we currently
hold no derivative financial instruments and do not currently engage in hedging
activities, adoption of SFAS No. 133 is expected to have no material impact on
our financial condition or results of operations.
Tax Matters
As of December 31, 1999, we had federal net operating loss carryforwards of
approximately $24.5 million and foreign net operating loss carryforwards of
approximately $1.6 million. Our net operating loss carryforwards will expire at
various dates beginning in 2003 through 2019, if not utilized. Utilization of
the net operating loss carryforwards is subject to a substantial annual
limitation due to the "change of ownership" rules provided by the Internal
Revenue Code and similar state tax provisions. We have evaluated the potential
impact of these provisions on our ability to utilize
27
<PAGE>
the net operating loss carryforwards. See Note 7 of Notes to Consolidated
Financial Statements for a detailed discussion of the limitations. To the
extent that any single-year loss is not utilized to the full amount of the
limitation, such unused loss is carried over to subsequent years until the
earlier of its utilization or the expiration of the relevant carryforward
period.
Deferred tax assets and liabilities are based on differences between
financial reporting and tax reporting bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. We have provided a full valuation
allowance against our net deferred tax assets due to uncertainties surrounding
their realization, primarily due to our lack of an earnings history. See Note 7
of Notes to Consolidated Financial Statements.
28
<PAGE>
BUSINESS
Overview
We design, manufacture and market advanced digital hearing aids and hearing
aid components that are programmable and are designed to provide the highest
levels of satisfaction for hearing impaired consumers. Capitalizing on a new
understanding of human hearing, we have developed patented digital signal
processing, or DSP, technologies and embedded them in the smallest single-chip
DSP platform ever installed in a hearing aid. Our NATURA products incorporate
our DSP technologies, are among the smallest products available today and can
be purchased in the three most common custom-molded plastic shell models. Our
CONFORMA product, a programmable completely-in-the-canal model, also
incorporates our DSP technologies and is an innovative hearing aid that
delivers a fast, comfortable fit in the smallest hearing aid available. We
believe our hearing aids set a new standard for consumer satisfaction because
they are smaller, more comfortable and more reliable and deliver more natural
sound than competing hearing aids.
We introduced our first branded line, NATURA, in the United States in
September 1998 and internationally in 1999. Since the NATURA introduction, we
have achieved five consecutive quarters of increasing revenues, culminating in
net sales of $11.5 million and a net loss of $1.8 million in the fourth
quarter of 1999. We introduced our second brand, CONFORMA, in March 2000.
CONFORMA, using the same proprietary DSP technologies as NATURA, achieves the
same superior sound quality but incorporates new materials technology to
deliver instant-fit capability. CONFORMA also makes advances in
miniaturization, comfort and reliability. We continue to invest in research
and development to introduce new products and product improvements. We sell
our branded products directly to more than 1,000 hearing care professionals in
the United States and through a network of established distributors throughout
much of Europe, Japan, Australia and Canada.
Based on industry data provided by the Hearing Industries Association, we
believe that digital hearing aids represent the fastest growing segment of the
hearing aid market. As digital technology replaces analog technology, we
believe the market will be increasingly segmented into companies that have
digital hearing aids and those that do not. We are capitalizing on this
emerging market trend not only by selling our branded products, but also by
selling hearing aid components consisting of our proprietary DSP platform to
established hearing aid companies that lack a satisfactory digital product
line. This strategy provides significant additional revenue and future
opportunity while accelerating the validation of our technology in the
marketplace.
Background
The Ear and Hearing
The following is a diagram of the ear and its various components:
[Diagram of ear with the following components identified: outer ear, malleus
(hammer), incus (anvil), organ of balance, stopes (stirrup), nerves to the
central auditory system and brain, inner ear (cochlea), eustachian tube,
middle ear, tympanum (eardrum), pinna and ear canal.]
29
<PAGE>
The ear is a sensory organ that can be divided into four sections: the outer
ear, the middle ear, the inner ear and the central auditory system. Sound
processing begins as external sounds enter the outer ear, travel down the ear
canal and strike the eardrum. The sound vibrations are transferred from the
eardrum via the ossicular bone chain in the middle ear to the inner ear. In the
inner ear, the sound waves create fluid vibrations in the cochlea, a fluid-
filled, snail-shaped organ that codes sound vibrations into nerve impulses
using thousands of tiny hair cells. These nerve impulses relay sound
information to the brain via a network of neural transmitters known as the
central auditory system. Various portions of the central auditory system then
process and analyze these impulses, providing the sensory perception of
hearing.
The range of human hearing is measured in both frequency, referred to as
pitch, and intensity, referred to as loudness. Pitch is classically measured in
cycles per second, or Hertz (Hz), while loudness is gauged in decibels (dB).
Sound itself is actually a form of energy that is characterized in Hz and dB.
Speech is one of the most important sounds we hear and process. It provides
information, warning signals, emotion, localization and a sense of three-
dimensional space. Speech sounds contain energy in the frequencies from about
125 to 8,000 Hz and conversational speech levels span from 30 to 70 dB. Vowels
tend to be the louder components and lie in the lower portion of the frequency
range while consonants are softer and lie in the higher frequency range.
Hearing Impairment
The major causes of hearing loss are aging, noise exposure, disease and
injury. Hearing loss is usually gradual and painless, in many cases developing
so slowly that it is barely noticeable. People often do not realize that they
have lost some of their hearing, even though family, business associates and
friends may be quite aware of it. The effects of any hearing loss can be
severe, often dramatically changing the affected person's lifestyle. In adults,
hearing loss creates coping mechanisms, which may include isolation from family
and friends and a reluctance to participate in public events. In children,
hearing loss may negatively affect the ability to learn, the development of
communication skills, and the ability to interact with others.
According to The Carnegie Group, approximately 90% of all permanent hearing
impairments are characterized as sensorineural losses, and the remaining 10%
are characterized as conductive losses. Conductive losses, which are caused by
structural imperfections in the ear, can generally be corrected by surgery.
Sensorineural losses, which stem from deterioration of or damage to the
cochlea, typically cannot be improved by medical or surgical means. Hearing
aids offer the most effective means of improving sensorineural losses.
In the case of sensorineural hearing loss, the various sounds are not
affected equally. Typically, higher frequencies are more difficult to perceive
than lower frequencies. Accordingly, the first sounds to "disappear" are those
that have the highest pitches, such as women's and children's voices and birds'
singing. Furthermore, speech becomes much more difficult to comprehend since it
is the softer, high-pitched consonants that provide essential information to
facilitate discrimination among words. Consider the following word list: cat,
hat, fat, sat. Without the ability to clearly understand the first letter of
each of these words, a person is rendered helpless to make out meaning and
context and to truly comprehend what is being said. This inability to
discriminate among words can make it significantly more difficult to understand
what is said in public gatherings, on television or over the telephone and
impedes conversation within a group of people. As a result, people with hearing
losses often complain that they can hear others talking but do not understand
what is being said.
30
<PAGE>
An example of the impact of high-frequency hearing loss is illustrated by
the following chart:
[Graph of high-frequency hearing loss. Vertical axis measures loudness in
decibels from 0 to 120. Horizontal axis measures frequency in Hertz from 0 to
16,000. The upper comfort is identified across all frequencies at 120
decibels. A line of relatively constant slope, beginning at approximately
125Hz, 20dB and extending through approximately 16,000Hz, 83dB, identifies the
threshold of impaired hearing. A dotted line, beginning at approximately
125Hz, 20dB dipping to approximately 4,000Hz, 10dB and rising to approximately
16,000Hz, 18dB, marks the threshold of normal hearing. An elipse shows that
lawnmower occupies frequencies between approximately 125 and 750Hz and is
between approximately 97 and 105dB. Another elipse shows that vowels in speech
occupy frequencies between approximately 150 and 800Hz and is between
approximately 57 and 65dB. A final elipse shows that consonants in speech
occupy frequencies between approximately 2,500 and 10,000Hz and is between
approximately 38 and 46dB.]
Individual hearing loss does not occur uniformly across the frequency range.
Rather, hearing loss occurs at specific frequencies over the audible range. As
a result, the best solutions are those that provide amplification where it is
needed and not broadly across the frequency range. To improve hearing among
hearing impaired individuals, it is critical that the soft sounds of speech
are raised to the level of audibility while environmental sounds are
concurrently maintained at a comfortable level.
The Hearing Aid Market
The market for hearing aids is very large and has substantial unmet needs.
Industry researchers estimate that there are approximately 300 million people
worldwide, including nearly 30 million in North America, who have hearing
deficits sufficiently severe to interfere with their understanding of normal,
everyday speech. However, according to MarkeTrack, a leading industry
publication, only approximately 20% of these persons have purchased a hearing
aid, and only half of these hearing aid owners routinely wear their hearing
aids. Company-sponsored surveys conducted by a third-party research firm
indicate that more than two-thirds of hearing aid owners are dissatisfied with
the performance of their hearing aids in noisy environments.
The use of hearing aids is particularly low among the mild and moderate
segments of the hearing impaired population, which are generally populated
with younger individuals. These segments of the population are estimated to
comprise over 80% of the hearing impaired population, but often do not
purchase hearing aids due to the stigma associated with wearing a hearing aid
and because existing products are perceived as inadequate, uncomfortable,
unreliable, expensive and unattractive.
31
<PAGE>
The following table shows the percentage of each of the four segments of the
hearing impaired population that have purchased hearing aids:
<TABLE>
<CAPTION>
% of Impaired % of Hearing
Impairment Classification Population Aid Penetration
------------------------- ------------- ---------------
<S> <C> <C>
Mild 31% 4%
Moderate 50 22
Severe 15 50
Profound 4 37
</TABLE>
Despite this low level of market penetration and high degree of
dissatisfaction, in 1998 worldwide retail sales of hearing aids were
approximately $4.6 billion and wholesale sales were approximately $1.8 billion.
The number of hearing aids sold has grown 5% annually during the 1990's. We
anticipate that demographic trends, such as the aging of "baby boomers," will
accelerate the growth in the size of the hearing impaired population.
The hearing aid market can be categorized into two segments: analog and
digital. Digital hearing aids were first introduced in 1996 and currently
represent 10% of global hearing aid sales. Despite their premium pricing,
digital hearing aids represent the fastest growing segment of the market. We
believe that as companies exploit the full potential of the digital platform
over the next several years, the percentage of sales from digital hearing aids
will increase significantly.
According to MarkeTrak, nearly 40% of all hearing aids are sold in the United
States and about one-third are sold in Europe. The Pacific Rim represents
nearly 15% of global volume and the rest of the world accounts for the balance.
Hearing Aids and Hearing Aid Technology
Types of Hearing Aids
A hearing aid generally consists of an external shell surrounding a
microphone that detects incoming sound and an amplifier that increases the
intensity of the sound either across the frequency spectrum or, for newer,
programmable hearing aids, a limited part of the spectrum. The hearing aid also
contains a miniature speaker (receiver) to transmit the modified sound to the
eardrum. A tiny battery with a life of one to four weeks supplies power.
Hearing aids are generally available in several models and sizes. The four
most common configurations are, ranging from smallest to largest:
. completely-in-the-canal;
. in-the-canal;
. in-the-ear; and
. behind-the-ear.
The smaller devices are usually inconspicuous, address less severe hearing
losses and are more expensive than larger devices. The larger devices generally
address more severe hearing losses and also appeal to individuals with limited
manual dexterity, who may find the smaller devices harder to manipulate.
The Evolution of Hearing Aid Technology
Early hearing aids simply amplified previously inaudible sounds to an audible
level, which caused sounds that were comfortable or fairly loud to become
uncomfortably loud. Hence, the wearer was often forced to adjust the hearing
aid volume control in order to avoid distortion and find the acceptable balance
between sounds of differing intensities. This problem severely limited
improvements in speech intelligibility, so hearing was, in reality, only
partially improved.
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<PAGE>
In the 1980's, hearing aids emerged that amplified sounds at different
frequencies by predetermined amounts. These hearing aids were also able to
limit sound amplification beyond a specified level to avoid discomfort
associated with overamplification. Although hearing aids employing this
technology helped somewhat and are still sold today, these hearing aids did not
improve speech recognition to a level that satisfied users.
In the early 1990's, multiband compression was introduced into hearing aids.
This technology enabled differential amplification, which varies according to
input intensity level, of two or more separate parts of the frequency spectrum.
Many hearing aid companies have now developed analog multiband compression
circuits that improve speech intelligibility from its previously low levels.
By 1996, technological advances based on digital signal processing led to the
first digital hearing aids. Digital technology allows more channels, or
"bands," to segregate the frequency range and provides better compression and
more effective sound processing algorithms to be built into smaller integrated
circuits that consume less power. As a result, battery life is longer. Analog
circuits can provide very similar sound processing benefits, but not in the
small size, low-power integrated circuits required for small hearing aids.
Nearly 20% of today's hearing aids are classified as "premium" hearing aids.
Premium hearing aids are often called "programmables" because a prescriptive
correction adapted to an individual's hearing loss is loaded into each hearing
aid. Sophisticated multiband compression circuits enable these hearing aids to
deliver differential amplification in the frequency bands where it is most
needed. Some of these hearing aids have analog signal processing and digital
programming, while some have digital signal processing and digital programming.
The Process of Getting a Hearing Aid
Hearing aids are sold as a part of a bundled package that typically includes
the devices themselves, the audiological exam and related services. In the
United States, the bundle is usually paid for entirely by the consumer, since
Medicare, Medicaid and private insurance historically have not provided
coverage. The hearing care professional devotes significant time to the
consumer, and it is the hearing care professional who determines the price of
the package.
We believe that premium hearing aids, either 100% digital or digitally
programmable, typically cost the consumer $2,000 to $3,500 each (or $4,000 to
$7,000 per pair), with $1,000 to $1,400 of this going to the manufacturer.
Conventional analog hearing devices, comprising 80% of sales in the market,
typically cost the consumer $750 to $1,200 each, with one-third to one-half of
the price going to the manufacturer.
An individual who seeks help for a sensorineural hearing loss is often
referred by an ear-nose-throat physician to a hearing care professional--an
audiologist or a hearing aid dispenser. The hearing care professional performs
an audiologic test and extensive fitting procedures prior to selling the
hearing device.
Most hearing aids, particularly in the United States, are custom-made to each
individual's ear canal, particularly for users in the mild to moderate loss
category. The hearing care professional first takes an impression of the
person's ear canal with a liquid silicone material that hardens to the
approximate shape of the canal. This impression is sent to the manufacturer who
then builds an aid within a custom shell that matches the impression. This
process usually requires about one week.
There is considerable art and craftsmanship associated with creating custom
hearing aids that fit comfortably. A great deal of judgment is involved in
shaping the final shell, and the impressions themselves are often imperfect
replicas of the consumer's canal anatomy. The hearing care professional either
makes small modifications to the shell by sanding different surfaces or sends
the hearing aid back to the manufacturer for a remake due to discomfort. It is
quite common for a new hearing aid to require remaking, which often requires an
additional week.
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Limitations of Traditional Hearing Aids
Traditional hearing aids have generally failed to satisfy the needs of the
hearing impaired due to several limitations in the performance of the hearing
aids themselves as well as in the process required to purchase hearing aids.
Although some manufacturers have made advances in one or two of the areas
listed below, to date, no hearing aid manufacturer has successfully addressed
all of the following limitations with a single hearing aid:
. Lack of Acceptable Sound Quality. A large measure of user
dissatisfaction stems from the lack of adequate or acceptable sound
processing. Of the hearing aids sold today, we estimate that 80% are
manufactured using older analog technology. These low-price hearing aids
were designed to make everything louder by amplifying all sounds by a
predetermined amount regardless of the frequency or intensity of the
incoming sounds. Despite technological advances over the last 30 years,
many newer premium hearing aids simply use digital technology to
implement an older understanding of human hearing and are thus unable to
restore natural sound quality.
. Cosmetically Unappealing. Traditional hearing aids are large,
unattractive devices. Many hearing impaired individuals feel there is a
stigma attached to wearing a noticeable hearing aid.
. Uncomfortable. Virtually all hearing aids, despite being custom-molded,
are made of hard plastic that can irritate the wearer after prolonged
use.
. Lengthy Process of Obtaining a Hearing Aid. The time from an initial
appointment until the delivery of a final hearing aid can take from one
to four weeks and involves multiple appointments with a hearing care
professional. In addition, a consumer returning a hearing aid for a
remake or repair must wait a week or more for a refurbished hearing aid,
during which time the consumer is without the benefit of a custom
hearing aid.
. Unreliable. Hearing aids have historically been viewed by many owners as
unreliable and, in fact, often require repair more than once a year. The
majority of these repairs are caused by an accumulation of earwax as
opposed to a component malfunction. Wearers typically do not clean their
aids and many hearing care professionals are ineffective in this
endeavor so the manufacturer is often left to perform this service.
. Expensive. Hearing aids can cost up to $3,500 each, which represents a
significant investment for the hearing impaired individual.
The limitations of current hearing aid products, the inefficiencies of the
dispensing process and the custom nature of fitting a hearing aid have led to
high levels of returns, remakes and repairs, which are commonly referred to in
the industry as the "three R's." Returns, remakes and repairs have affected
manufacturers, dispensers and wearers for decades and significantly increase
costs for all three groups.
According to the Hearing Review, an industry publication, approximately 20%
of all hearing aid products are returned to manufacturers for credit. Product
returns result, in large part, from lenient return policies. Consumer
protection laws allow consumers to return their hearing aids for a refund if
they are dissatisfied during an initial trial period, which generally ranges
from 30 to 90 days. Many dispensing audiologists take advantage of these
liberal return policies and fit consumers with two or three hearing aids before
selecting a final product. The unused, now custom-fitted, hearing aids are
simply returned to the manufacturers for credit. In addition, particularly
after enduring a time intensive process and paying a high cost for a hearing
aid, a consumer's expectations for product performance may be beyond the
product's capability, or the consumer may not perceive that the hearing aid
offers an appropriate value. As a result, we believe that return rates for
premium products are higher than those for traditional hearing aids.
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Our experience shows approximately 30% of the custom-molded shells
manufacturers produce are returned to manufacturers for a product remake. The
current custom-molding process used to fit hearing aids into the person's ear
canal is inexact and generally requires the hearing care professional to make
small modifications to the shell. If a proper fit cannot be achieved by the
hearing care professional, he or she will often return the product to the
manufacturer to be disassembled and remade, a costly and time-consuming
process.
We estimate that approximately one in five hearing aids are sent to the
manufacturer for repair during its warranty period. A majority of hearing aid
repairs, however, are not due to component failure, but are caused by an
accumulation of earwax in the shell because users do not effectively clean
their hearing aids. The manufacturer's repair process typically consists of
cleaning the hearing aid and replacing wax-clogged components. This is both
time-intensive and costly for all parties involved.
Our Technology Solution
By simultaneously applying several innovative technologies to achieve
improved sound quality, tiny size, comfortable fit and superior reliability, we
have developed a new generation of premium-performance hearing aids designed to
address the limitations of traditional hearing aids. Our key technologies
include the following:
Digital Signal Processing Technologies
The core of our technology is our proprietary digital sound processing, or
DSP, technologies, which were developed by three world-renowned experts in
sound dynamics and digital signal processing. First, Dr. Douglas Chabries, Dean
of the College of Engineering and Technology at Brigham Young University,
developed a new algorithm for processing audio signals based on an improved
understanding of the physical operation of the human cochlea. Then,
collaborating with Dr. Thomas Stockham, Jr., digital audio pioneer at the
Massachusetts Institute of Technology and later Professor of Engineering at the
University of Utah, Chabries refined and patented the core digital sound
processing technology used in our hearing aids. Finally, Dr. Carver Mead,
Professor of Computer Science at the California Institute of Technology, joined
Chabries and Stockham to miniaturize the technology and further develop it for
specific application to the human auditory system.
Using the advancements of our technological founders and this new
understanding of human hearing, our proprietary DSP technologies implement a
patented set of algorithms. These algorithms pre-process the incoming sound and
present it to the impaired cochlea in a way that restores natural loudness
perception and preserves the cues necessary for speech understanding. In
addition, our DSP technologies process sound at a rate we believe to be
significantly faster than other hearing aids. Traditionally, hearing aids have
not processed sounds quickly enough to allow a wearer to "localize" sounds, or
ascertain which direction a sound is coming from. We believe that our products
are the first to solve this problem, thus providing a much more natural hearing
experience and restoring lost localization and directionality of sound.
Single Chip Solution
Using state-of-the-art chip design capabilities, we have embedded our
proprietary digital sound processing, or DSP, technologies into a single chip
that is the smallest, most sophisticated DSP chip available in a hearing aid
today. No other hearing aid company has introduced a single-chip DSP solution.
This proprietary DSP chip is an advanced, energy-efficient integrated circuit
that powers remarkable frequency-specific, level-dependent, multi-channel
features. The result of this convergence of advanced hearing science and
leading edge digital technology is a family of hearing aids that delivers a
more natural, lifelike listening and communication experience and addresses the
specific auditory needs of the hearing impaired.
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This integrated circuit contains proprietary technology in the form of our
DSP core, analog-to-digital and digital-to-analog converters and on-chip
memory.
. The analog-to-digital converter connects directly to a microphone and
converts the changing output signal from an analog level to a digital
number. Our analog-to-digital converter incorporates several proprietary
design features that represent significant advancements over analog-to-
digital converters contained in competitive products.
. Our DSP core executes the fixed, proprietary algorithm using one of two
sets of internally stored, programmable coefficients, or prescriptions.
The DSP core then processes the stream of numbers from the analog-to-
digital converter and sends them to the digital-to-analog converter.
. The digital-to-analog converter converts the numbers received from the
DSP core to a pulse-width-modulated waveform, which drives the miniature
loudspeaker, or receiver.
. The on-chip memory stores consumer prescriptions, user specific
information and manufacturing data.
Our DSP core contains nine independent compression channels. These nine
independent channels allow for precise control of both the frequency response
(frequency-dependent gain) and loudness response (level-dependent gain).
Approximating a graphic equalizer, our hearing aids break the world of sound
down into more than twice as many distinct channels as most other popular
hearing aids on the market. As a result, our hearing aids can be fine-tuned to
within 1 dB of prescriptive targets at one-half octave intervals across a
frequency range from 500 to 6,000 Hz. This precision allows a wearer's
prescriptive requirements to be matched with unprecedented accuracy.
[Diagram of Sonic Innovations' DSP core. A microphone is on the left connected
to nine independent channels. The channels are labelled from top to bottom:
500Hz, 750Hz, 1000Hz, 1500Hz, 2000Hz, 4000Hz, 5000Hz and 6000Hz. These channels
are in turn connected to a receiver.]
Advancements in Materials Science
Using proprietary advancements in materials technology, our CONFORMA product
utilizes a soft disposable foam tip that, when placed in a wearer's ear canal,
conforms quickly and precisely to the shape of the canal, providing an instant
fit and increased comfort for the wearer. This stands in contrast to
traditional hearing aids that utilize custom-made, hard plastic shells. This
disposable tip also addresses a leading cause of hearing aid failures--a
natural build-up of earwax.
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EXPRESSfit Software
In order to ensure that our new model of human hearing and state-of-the-art
technologies are properly programmed to the individual needs of the hearing aid
wearer, we have developed a proprietary programming system, EXPRESSfit.
EXPRESSfit enables our hearing aids to be easily configured by the hearing care
professional to the unique needs of the wearer. The advanced technology of our
sophisticated DSP chip is programmed by our software to make sure that sounds
within each half octave frequency range are amplified appropriately in the
right contrasts to sounds in every other channel. Initially presented on a
novel hand-held PalmPilot platform, it has also been adapted to work within
NOAH, a popular PC-based industry programming and fitting standard. We believe
that our software solution is an integral part of ensuring that our
technological advances appropriately target and meet the needs of each
individual hearing aid consumer.
Our Products
We have packaged our sophisticated, proprietary technologies into a broad
line of premium digital hearing aids which offer what we believe is superior
sound quality, smaller size, enhanced personalization and increased reliability
at competitive prices. All of our products incorporate our proprietary DSP
platform and are programmable to address the hearing loss of the individual
user. We currently sell our branded products both as completed hearing aids and
as partial hearing aids, or faceplates, to distributors who then market
finished hearing aids under our brand names. With our branded products, we also
offer a software programming system, EXPRESSfit, which enables these products
to be individually configured to the unique needs of the wearer, leading to a
substantial improvement in sound quality. In addition, we sell hearing aid
components consisting of our DSP platform to established hearing aid
manufacturers who then market their private label products containing our DSP
platform.
Our Current Products
NATURA. We launched our first brand, NATURA, in the United States in
September 1998 and expanded distribution to Europe, Japan, Australia and Canada
in 1999. NATURA, the first product to incorporate our proprietary DSP
technologies, provides what we believe is the best sound quality available in
traditionally configured hearing aids. The NATURA product line is available in
the four traditional hearing aid configurations, completely-in-the-canal, in-
the-canal, in-the-ear and behind-the-ear. Due to the smaller than usual DSP
chip used, NATURA products are smaller than most traditional hearing aids.
CONFORMA. We launched our novel completely-in-the-canal hearing aid,
CONFORMA, in the United States in March 2000. Our CONFORMA product introduces a
new, innovative hearing aid configuration which delivers a fast, comfortable
fit in the smallest hearing aid available, eliminating the need to custom mold
a hard plastic shell to fit the wearer's ear canal.
CONFORMA physically consists of two parts. The first is a tiny core about the
diameter of a pencil eraser that contains the product's electronics and our
proprietary DSP chip, a smaller and slightly modified configuration of the chip
used in the NATURA product line. The second component of CONFORMA is a vented,
flexible, disposable soft tip that comes in multiple sizes, fits snugly around
the core, and conforms quickly and precisely to the shape of the ear canal.
CONFORMA is the first product with the potential to address all of the major
limitations of traditional hearing aids and significantly alter the way hearing
aids are made and sold. Equipped with our proprietary DSP technologies,
CONFORMA delivers superior sound quality with improved speech intelligibility.
CONFORMA fits far down the ear canal of the wearer, making it nearly invisible
and eliminating the stigma of wearing a hearing aid. The foam tip allows the
wearer to achieve a custom
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fit in a single visit and provides superior comfort versus the hard plastic
shell of traditional custom-molded models. We have priced CONFORMA to provide a
superior price/value package to the consumer.
CONFORMA directly addresses the major factors leading to the high rates of
returns, remakes and repairs associated with traditional hearing aids. Because
CONFORMA is not custom-molded, should a wearer choose to return CONFORMA, the
hearing care professional can simply repackage it for resale to another
consumer rather that returning it to the manufacturer for credit. As a
standardized product, CONFORMA eliminates the need for costly remakes. The
disposable nature of the tip eliminates the major cause of manufacturer repairs
by allowing the wearer to simply replace the tip at regular intervals to avoid
the build-up of earwax in the unit.
Hearing Aid Components. We sell hearing aid components consisting of our DSP
platform to established hearing aid companies. These companies incorporate our
DSP platform into hearing aids of their own design that they then sell under
their own brands.
Our Future Products
We are currently directing our new product development efforts beyond
CONFORMA primarily in the areas of DSP chip enhancements and software
revisions. We are developing an enhanced DSP chip that incorporates advanced
electronic noise reduction to improve speech intelligibility. We plan to
introduce this new chip in our NATURA line in March 2000, and in CONFORMA later
in the year. We are also developing directional capability for our behind-the-
ear NATURA hearing aid that we intend to introduce in the fourth quarter of
2000. Further back in the development pipeline, we are working on improved
feedback suppression, wireless programming capabilities and specific
enhancements to the CONFORMA integrated circuit to make it smaller and to
increase the power to address more severe hearing losses. Based on our
cumulative experience to date with tens of thousands of fittings, we are
further modifying our EXPRESSfit software to improve programming ease and
enhance the integrated circuit's processing capabilities. As we develop future
generation technology, we intend to establish it first in our branded products
before making it available to other hearing aid manufacturers.
Business Strategy
Our mission is to be the best hearing aid company in the world by delivering
a superior product that appeals not only to those consumers who currently use
or have tried hearing aids, but also to the 80% of the hearing impaired
population that historically has chosen not to purchase hearing aids. Key
elements of our strategy include the following:
. Continue to Introduce Innovative Products. As a technological leader
in the industry, we intend to continue to invest significantly in
research and development in order to introduce new products and
product improvements more rapidly than is typical in our industry.
For example, in the first half of 2000, we plan to launch both our
new CONFORMA product and the next generation of NATURA, which will
incorporate an integrated circuit with improved noise reduction
technology.
. Expand Our Distribution. We currently sell our branded products to
over 1,000 of the approximately 12,000 hearing care professionals in
the United States. We are expanding our sales force in the United
States to increase the penetration of our branded products with
hearing care professionals who dispense premium digital products. We
believe that the evolution of the current distribution channel,
combined with the characteristics of our branded products,
particularly the ease of fitting and the anticipated reduction in
hearing aid returns, remakes and repairs, will create new
distribution opportunities. We are exploring alternative and
emerging retail channels,
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including selling through large hearing care chains and other chain-
based retailers. Outside the United States, we are actively pursuing
additional distribution partners to increase our geographic reach.
. Sell Our DSP Platform. We sell our DSP platform to selected
established hearing aid companies that have approached us seeking to
benefit from our superior technology. We believe that this strategy
can accelerate market acceptance of our technology and be a
significant source of revenue.
. Increase Brand Awareness. In order to differentiate our products and
reach a greater percentage of potential consumers, we have
undertaken a brand-oriented approach to our marketing and selling
efforts. We are targeting hearing care professionals and expanding
our direct-to-consumer advertising and promotion efforts.
. Achieve Economies of Sale. We expect that, as sales volumes
increase, per unit production costs of our products will decline. In
addition, CONFORMA offers an opportunity to standardize the
production process and avoid the custom-molding processes used by
other hearing aid manufacturers and in our NATURA line. We believe
that this can enable us to achieve further economies of scale.
Sales and Marketing
Hearing aids have traditionally been dispensed (sold to the consumer) by
hearing care professionals. Due to the hearing care professional's influence
over a consumer's choice of a hearing aid brand, we believe that developing and
maintaining strong relationships with hearing care professionals is the most
critical aspect of our sales and marketing strategy. As a result, we aim to
deliver a high level of customer service and support to our hearing care
professionals. In addition, we believe that this high level of customer service
is imperative for building our brands, particularly in the U.S. professional
channel.
In the United States, according to the Better Hearing Institute there are
approximately 5,000 degreed audiologists and 7,000 hearing aid dispensers. We
position our products as premium-priced, superior performance hearing aids and
therefore, our direct sales force has targeted only a select number of these
hearing care professionals who are capable of and interested in dispensing
high-end premium digital hearing aids. In 1999, we sold our branded products
directly to over 1,000 hearing care professional accounts in the United States.
Our U.S. sales force is currently comprised of ten field sales people, three
full-time trainers, a number of regional part-time trainers and three inside
sales people. This group both sells to and trains hearing care professionals in
order to differentiate our brands and to ensure proficiency with programming
and fitting. We also advertise our products to hearing care professionals
through promotional materials, trade publications and conventions. Our sales
force is responsible for executing cooperative advertising programs jointly
with specific customers to generate consumer demand for our brands.
Outside the United States, we sell our branded products through a network of
established distributors throughout much of Europe, Japan, Canada and
Australia. In 1998, we established Sonic Innovations A/S, a wholly owned
subsidiary located in Denmark, to drive European sales and marketing efforts.
Sonic Innovations A/S sells to hearing aid distributors in most European Union
markets, who in turn sell to their established customer bases of hearing care
professionals. Sonic Innovations A/S also sells our branded products on a
direct basis to hearing care professionals in Germany, Europe's largest hearing
aid market. In Japan, we have entered into an agreement with Hoya Healthcare
Corporation to serve as our exclusive distributor of branded products. See
"Certain Transactions--Hoya Healthcare Corporation." Distribution agreements
generally cover multi-year periods and are terminable for non-performance.
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To further our marketing effort, we use world class advertising, public
relations and market research agencies. These organizations work in tandem with
our internal marketing team to communicate the brands' advantages to customers.
We are planning to implement a direct-to-consumer branded advertising and
promotion strategy that reflects our belief that both consumers and hearing
care professionals are important to the success of our products.
We believe that the evolution of the current distribution channel, combined
with the characteristics of our branded products, particularly the ease of
fitting and reduced hearing aid returns, remakes and repairs, will create new
distribution opportunities. We are exploring alternative and emerging retail
channels, including selling through large hearing care chains and other chain-
based retailers.
Customers
In 1999, approximately 47% of our net sales were derived from sales of our
branded products through over 1,000 health care professionals in the United
States, with about 600 of these accounts purchasing on a regular basis.
Approximately 17% of our net sales came from sales of our branded products
outside the United States, principally through distributors. Sales of hearing
aid components, consisting of our DSP platform, to established hearing aid
manufacturers comprised the remaining 36% of net sales in 1999. Sales of our
hearing aid components to Starkey Laboratories, Inc., which sells its own brand
of digital hearing aids based on our DSP platform, comprised approximately 26%
of our net sales. Starkey is obligated to make minimum purchases for 2000 and
2001 that are greater than the purchases it made in 1999. Sales of our hearing
aid components to Rion Co., Ltd., which operates in Japan, accounted for 10% of
our net sales.
Research and Development
We continue to work on both product improvements and new product development,
and we expect to continue both activities in the future at increasing levels.
We intend to use product improvements and new product development to enhance
our competitive position in the market. As of December 31, 1999, there were 34
employees actively involved in research, development and regulatory activities.
Their skills include audiology, clinical research, integrated circuit
engineering, software engineering and materials science. For the years ended
December 31, 1997, 1998 and 1999, we spent $3.9 million, $5.8 million and $7.0
million, respectively, on research and development.
Intellectual Property
We seek to protect our intellectual property through patents and non-
disclosure agreements. We hold three U.S. patents, and we are the exclusive
licensee for hearing aid and hearing protection applications under two patents
held by Brigham Young University. We have 27 patent applications pending, and
we have drafted four other patent applications, which we expect to file in the
first half of 2000.
Under our 1995 license agreement with BYU, which we amended in 1996, we have
an exclusive worldwide license to utilize specified technology owned by BYU.
The technology includes two patents involving digital signal processing, audio
signal processing and hearing compression, including the fundamental sound
processing algorithm incorporated into our DSP platform. Under this agreement,
which expires in 2014, the expiration of the last claim of the patents, we are
responsible for the payment of all fees and costs associated with filing and
maintaining patent rights. As consideration for the license, we issued 96,843
shares of our common stock to BYU and agreed to pay BYU fees aggregating
$580,000. We have paid $330,000 of these fees, and we will pay $100,000 in 2000
and $150,000 in 2001.
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In 1997, we entered into another license agreement with BYU giving us the
perpetual right to use specified "noise suppression" technologies owned by BYU.
We have exclusive worldwide rights to use these technologies in hearing aid and
hearing protection applications and a non-exclusive right to use them for other
applications. We are also required to make royalty payments to BYU equal to
0.5% of gross sales derived from products containing the licensed technologies.
Because these technologies had not been incorporated in the products we sold in
1998 and 1999, we paid the annual minimum royalty of $50,000 in each of those
years.
In 1998, we entered into a license agreement with K/S HIMPP, a Danish
partnership, that owns approximately 200 patents that are considered essential
for the production of programmable hearing aids. We are required to pay K/S
HIMPP a royalty equal to 3% of our net sales from our products, all of which
incorporate portions of the licensed technologies. In connection with the
formation of K/S HIMPP, a number of our competitors acquired a paid-up license
for a flat fee of $2.0 million. These companies do not have to pay any further
royalties to K/S HIMPP for the use of the licensed technologies.
In 1999, in order to settle a claim by one of our competitors that all of our
products infringed on patents it held, we entered into a license agreement
under which we agreed to pay a royalty equal to 1.5% of our net sales from
hearing aids and components from October 1998 through September 2001.
We also rely on trade secret information, technical know-how and innovation
to continuously expand our proprietary position. We require our employees and
consultants to execute non-disclosure and assignment of inventions agreements
upon commencement of their employment or engagement.
Manufacturing
We have manufacturing facilities in Salt Lake City, Utah, Eagan, Minnesota
and Copenhagen, Denmark. We perform the majority of our manufacturing at our
Eagan site near Minneapolis, where the presence of many major hearing aid and
medical device companies has created a skilled labor pool that we have been
able to leverage to our advantage. Our manufacturing operations consist of the
following activities:
. overseeing the production of the integrated circuit used in our
products;
. assembling and testing the electronic subsystems;
. fabricating custom earmolds;
. integrating the electronic components into the hearing aid shell; and
. testing and calibrating the finished hearing aid.
We assemble our custom NATURA completely-in-the-canal, in-the-canal and in-
the-ear products according to specifications received from hearing care
professionals. After receiving an impression of the wearer's ear canal and
programming requirements of the hearing aid, the custom earmold shell and
electronic circuitry are assembled. Our NATURA behind-the-ear products are
assembled using a standard plastic housing and are not custom-molded for a
wearer's ear.
In contrast, CONFORMA is assembled using standardized components, consisting
of electronic circuitry, a tiny metal housing and disposable foam tips, and
thus eliminates custom-molding steps associated with traditionally configured
hearing aids, including our NATURA products. In addition, CONFORMA is
programmed by the hearing care professional at the time of sale to meet the
specific auditory needs of the wearer. We are currently producing our initial
CONFORMA products internally.
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However, we recently selected a manufacturer experienced in producing high-
quality, standardized electronic devices in volume and anticipate that we will
eventually outsource all production of the CONFORMA product to this
manufacturer.
We rely on several sole source or limited source suppliers and manufacturers
for key components used in our products, including the proprietary integrated
circuit used in all of our products and the foam tip used in the CONFORMA
product. See "Risk Factors--We rely on several important suppliers and
manufacturers, and the loss of these suppliers or the services of these
manufacturers may harm our business."
Competition
We believe that although the hearing aid marketplace is highly fragmented,
competition is fiercely intense. There are approximately 32 companies who have
a manufacturing and marketing presence in the hearing aid industry, down from
nearly 70 in 1990. Consolidation in the hearing aid industry has accelerated in
the last two years, as evidenced by the acquisitions of Dahlberg/Miracle Ear,
ReSound and Philips.
We compete with companies such as Siemens GmbH, Starkey Laboratories Inc.,
Widex A/S, William Demant Holding A/S (through its Oticon, and Bernafon
subsidiaries) and Great Nordic (through its GN ReSound division), all of which
have established products and substantially greater financial, sales and
marketing, manufacturing and development resources than we currently possess.
Our competitors may develop products that are more effective in treating
hearing loss than our own products, thus rendering our technologies and
products obsolete or uncompetitive.
The digital segment of the hearing aid industry is characterized by
increasing competition and rapid new product introductions. The proliferation
of digital hearing aids is likely to lead to increasing price pressure and
intense marketing campaigns as each company tries to differentiate its product
from the others.
We compete primarily on the basis of:
. sound quality;
. technology;
. size, particularly in completely-in-the-canal models;
. quality;
. comfort;
. reliability;
. price;
. ease of fitting the hearing aid;
. sales and distribution capabilities; and
. customer service, support and training.
We believe we compete favorably with respect to each of these factors.
The hearing aid industry has seen notable change in the past three years, and
the introduction of competitive products can have a significant impact on our
operations. Our success will depend on our ability to create advanced
technology rapidly, apply technology cost-effectively, attract and retain
highly skilled personnel, obtain necessary patent protections and manufacture
and successfully market and sell in a variety of distribution channels.
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Employees
As of December 31, 1999, we had 211 employees, including 17 in
administration, 32 in sales support and marketing, 34 in research, development
and regulatory, 102 in operations and 26 in European operations. None of our
employees are represented by a labor union. We have not experienced any work
stoppages, and we consider our relations with our employees to be good.
Facilities
We lease approximately 12,000 square feet of manufacturing and office space
in Eagan, Minnesota, under a five-year lease expiring in December 2004. In Salt
Lake City, Utah, we lease approximately 55,000 square feet of manufacturing and
office space under a five-year lease expiring in August 2004. Our Denmark
subsidiary leases approximately 2,000 square feet of office and manufacturing
space in Copenhagen under a two-year lease expiring in July 2000. We believe
that we have sufficient manufacturing capacity to satisfy demand for our
products in the near future. Any significant increase in manufacturing capacity
will require the hiring and training of additional qualified manufacturing
personnel.
Government Regulation
Our products are regulated as medical devices. Accordingly, product
development, labeling, manufacturing processes and promotional activities are
subject to extensive review and rigorous regulation by government agencies in
countries in which we sell our products.
In the United States, the FDA regulates the design, manufacture,
distribution, preclinical and clinical study, clearance and approval of medical
devices. Medical devices are classified in one of three classes on the basis of
the controls necessary to reasonably assure their safety and effectiveness. Our
products are Class I devices, the least stringent class, which only requires
general controls, including labeling, premarket notification and adherence to
the FDA's Quality System regulations.
Before a new hearing aid that is not exempt from the FDA's requirements can
be introduced to the market in the United States, the manufacturer must obtain
FDA clearance through a 510(k) Premarket Notification or obtain FDA approval.
Our fitting and programming system and CONFORMA hearing instrument received
premarket clearance through the 510(k) process as a Class I device. Our other
hearing aids are also Class I devices and have been exempted from the 510(k)
process. After marketing clearance, manufacture and distribution of our
products are subject to continuing regulation by the FDA. We are subject to
routine inspections by the FDA to determine compliance with facility
registration, product listing requirements, medical device reporting
regulations and Quality System requirements. The Quality System regulation is
similar to good manufacturing practices and relates to product testing and
quality assurance as well as the maintenance of records and documentation.
Sales of medical device products outside the United States are subject to
foreign regulatory requirements that vary widely from country to country. The
time required to obtain approvals required by other countries may be longer or
shorter than that required for FDA clearance or approval, and requirements for
licensing may differ from FDA requirements. This disparity in the regulation of
medical devices may result in more rapid product approvals in some countries
than in the United States, while approvals in countries such as Japan may
require more time than in the United States.
In order to market our products in the 15 member countries of the European
Union, we are required to obtain CE mark certification. CE mark certification
is an international symbol of adherence
43
<PAGE>
to certain quality assurance standards and compliance with the European Medical
Devices Directives, including the certification of our Quality System. ISO 9001
certification in conjunction with demonstrated performance to the medical
device directive is one of the alternatives available to meet the CE mark
requirements. We have met the requirements of ISO 9001 for all of our
manufacturing sites, and our products sold in the EU bear the CE mark of
quality.
Legal Proceedings
We are not a party to any material legal proceedings.
44
<PAGE>
MANAGEMENT
Directors and Executive Officers
The following table sets forth our directors and executive officers and their
ages as of December 31, 1999:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Andrew G. Raguskus...... 54 President and Chief Executive Officer and Director
Stephen L. Wilson....... 46 Vice President and Chief Financial Officer
Jorgen Heide............ 61 Vice President, International and OEM Division
Weston O. Ison.......... 59 Vice President, Quality and Regulatory
Gregory N. Koskowich,
Ph.D. ................. 39 Vice President, Research and Development
Michael D. Monahan...... 53 Vice President, U.S. Professional Division
Orlando P. Rodrigues.... 38 Vice President, Consumer Development Division
Anthony B. Evnin,
Ph.D.(1)............... 58 Director
Luke B. Evnin,
Ph.D.(2)............... 36 Director
Kevin J. Ryan(2)........ 59 Director
G. Gary Shaffer......... 45 Director
Sigrid Van Bladel,
Ph.D.(2)............... 34 Director
Allan M. Wolfe,
M.D.(1)................ 62 Director
</TABLE>
- --------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Andrew G. Raguskus joined Sonic Innovations in September 1996 as President,
Chief Executive Officer and Director. Mr. Raguskus was Chief Operating Officer
for Sonic Solutions, Inc., a maker of digital audio workstations, during 1996.
He was Senior Vice President of Operations for ReSound Corporation, a hearing
aid company, from 1991 to 1995. Prior to joining ReSound, Mr. Raguskus held
positions with various technology companies, including Sun Microsystems, Inc.
and General Electric's Medical Systems Division, where he developed computer
systems for GE's line of CAT scanners. Mr. Raguskus earned a bachelor's degree
in electrical engineering from Rensselaer Polytechnic Institute and is a
graduate of GE's MPA management program.
Stephen L. Wilson joined Sonic Innovations in October 1999 as Vice President
and Chief Financial Officer. From 1997 to 1999, Mr. Wilson was Executive Vice
President and Chief Financial Officer and Secretary of Computer Motion, Inc., a
medical robotics company. From 1990 to 1997, he was Vice President Finance and
Chief Financial Officer of St. Jude Medical, Inc., a medical device company.
Mr. Wilson is a director of Angeion Corporation. He earned a bachelor's degree
in accounting from the University of Connecticut and is a certified public
accountant.
Jorgen Heide joined Sonic Innovations in March 1997 as Vice President of
Operations and became Vice President of the International and OEM Division in
1999. From 1992 through early 1997, Mr. Heide served as Director of Technology,
Vice President of Manufacturing, Vice President of Technology and finally, as
Vice President of Worldwide Technical Services, for ReSound Corporation. From
1984 to 1992, he was Vice President of Research and Development for the
microsurgery division of Smith and Nephew, Richards Medical Company. Mr. Heide
earned his masters degree in electrical engineering from Frederiksberg Tekiske
Skole in Copenhagen, Denmark. Mr. Heide has been granted seven U.S. patents for
inventions relating to hearing aids.
Weston O. Ison joined Sonic Innovations in November 1999 as Vice President of
Quality and Regulatory. From 1992 to late 1999, Mr. Ison was Vice President of
Quality, Customer Service, and Operations Planning and prior to that, Director
of Quality of America National Can. Mr. Ison's previous experience included 19
years at General Electric Company, where he led the quality control group in
the introduction of GE's line of CAT scanners. He earned a bachelor's degree in
electrical engineering from the University of Utah and is a graduate of GE's
manufacturing management program.
45
<PAGE>
Gregory N. Koskowich, Ph.D. joined Sonic Innovations in June 1997 as Vice
President, Engineering. Previously, Dr. Koskowich was Vice President of Product
Development at IMP, Inc., a developer of custom mixed-signal integrated
circuits, from 1995 to 1997. From 1992 through 1995, Dr. Koskowich was Manager
of Microelectronics Engineering for ReSound Corporation. Dr. Koskowich earned a
doctorate in electrical engineering from the University of Washington and holds
master's and bachelor's degrees in electrical engineering from the University
of Calgary. He has several patents, inventions and journal publications to his
credit.
Michael D. Monahan joined Sonic Innovations in March 1998 as Vice President
of Sales and became Vice President of the U.S. Professional Division in 1999.
Previously, Mr. Monahan was Director of Sales of Enact, Inc., a medical
information company, from 1997 to 1998, National Sales Manager for HDC
Corporation, a medical company, from 1996 to 1997 and Sales Manager for Menlo
Care, Inc., a medical device company, from 1992 to 1996. Mr. Monahan was
previously Director of Sales, Director of Corporate Accounts and Regional
Manager for Ivac Corporation (a subsidiary of Eli Lilly and Co.). Mr. Monahan
earned a bachelor's degree in business administration from California State
College.
Orlando P. Rodrigues joined Sonic Innovations in January 1998 as Vice
President of Marketing and became Vice President of the Consumer Development
Division in 1999. From 1993 to 1998, Mr. Rodrigues was Director of Marketing
and Group Product Director for the Vision Care Group of Alcon, Inc., a
subsidiary of Nestle S.A. From 1983 to 1993, he was Director of Strategic
Marketing, Director of Lens Care Marketing, Senior Product Manager and
Territory Manager for Allergan, Inc. Mr. Rodrigues earned a bachelor's degree
in biochemistry and a bachelor's degree in managerial studies from Rice
University.
Anthony B. Evnin, Ph.D. has been a director of Sonic Innovations since
October 1995. He has been a General Partner of Venrock Associates since 1975.
Dr. Evnin serves on the boards of Caliper Technologies Corp., Ribozyme
Pharmaceuticals, Inc., Triangle Pharmaceuticals, Inc. and a number of private
companies. Dr. Evnin earned his bachelor's degree from Princeton University and
earned a Ph.D. in chemistry from Massachusetts Institute of Technology.
Luke B. Evnin, Ph.D. has been a director of Sonic Innovations since October
1995. He has been a General Partner of MPM Asset Management LLC since February
1998. Prior to that, Dr. Evnin was a General Partner for Accel Partners, a
venture capital firm, from September 1994 to February 1998. Dr. Evnin serves on
the boards of EPIX Medical, Inc., a pharmaceutical company, and several private
companies. Dr. Evnin earned a bachelor's degree in molecular biology from
Princeton University and earned a Ph.D. in biochemistry from the University of
California at San Francisco.
Kevin J. Ryan has been a director of Sonic Innovations since June 1999. He
has been Chairman, President and Chief Executive Officer of Wesley Jessen
VisionCare, Inc., a manufacturer of contact lenses since June 1995. Prior to
that, Mr. Ryan was President of Biosource Technologies Inc., a
biopharmaceuticals company, from 1991 to 1995. Mr. Ryan is a graduate of Notre
Dame University.
G. Gary Shaffer has been a director of Sonic Innovations since October 1997.
He is a General Partner at Morgenthaler Ventures, a venture capital firm, which
he joined in 1987. Prior to 1987, he was a marketing executive for Spectra-
Physics, a laser manufacturer. He currently serves on the boards of several
private companies including Agility Communications, Coalescent Surgical, Inc.,
LuMend, Inc., NeuroControl Corporation and Thermage, Inc. He earned a
bachelor's degree in engineering sciences from Dartmouth College and an M.B.A.
from Stanford University.
46
<PAGE>
Allan M. Wolfe, M.D. has been a director of Sonic Innovations since October
1995. He has been a General Partner of Utah Ventures, a venture capital firm,
since 1988. Dr. Wolfe earned a bachelor's degree in American civilization from
Cornell University and an M.D. from New York University School of Medicine.
Sigrid Van Bladel, Ph.D. has been a director of Sonic Innovations since
October 1997. She has been a partner of New Enterprise Associates, since 1994.
Her current board memberships include Acorn Cardiovascular, Alsius Corporation,
EndoVasix, Myogen and Spiration. Dr. Van Bladel earned a "Licenciaat" in
chemistry/biochemistry and a Ph.D. in molecular biology from the University of
Ghent, Belgium and an M.B.A. from Stanford University.
Our board of directors currently consists of seven members. Prior to the
closing of this offering, our board of directors will be divided into three
classes, with each director serving a three-year term and one class being
elected at each year's annual meeting of stockholders. Dr. Luke Evnin and
Mr. Ryan will be in the class of directors whose initial term expires at the
2001 annual meeting of stockholders. Dr. Anthony Evnin, Mr. Shaffer and Dr. Van
Bladel will be in the class of directors whose initial term expires at the 2002
annual meeting of the stockholders. Dr. Wolfe and Mr. Raguskus will be in the
class of directors whose initial term expires at the 2003 annual meeting of
stockholders.
Executive officers are elected by the board of directors and serve until
their successors have been duly elected and qualified. Anthony Evnin is the
father of Luke Evnin. Other than the foregoing, there are no family
relationships among any of our directors or officers.
Board Committees
Our board of directors has an audit committee and a compensation committee.
The audit committee consists of Dr. Luke Evnin, Mr. Ryan and Dr. Van Bladel.
The audit committee reviews our financial statements and accounting practices
and makes recommendations to the board of directors regarding the selection of
independent public accountants. The compensation committee consists of Dr.
Anthony Evnin and Dr. Wolfe. The compensation committee makes recommendations
to the board of directors concerning salaries and incentive compensation for
our officers and employees and administers our stock plans.
Director Compensation
Directors are not paid any fee or other cash compensation for acting as a
director, although directors are reimbursed for reasonable expenses incurred in
attending board or committee meetings. In July 1998, each of our outside
directors (or venture capital firms associated with the director) at that time
was granted an option to purchase 4,211 shares of common stock at an exercise
price of $0.95 per share. These options vest at the rate of 1/24th each month
from the grant date. Each director was granted an additional option to purchase
4,211 shares of common stock at an exercise price of $2.85 per share in June
1999. This option vests at the rate of 25% one year from the date of grant and
1/48th each month thereafter such that full vesting will be achieved in four
years. Mr. Ryan was granted an option to purchase 13,158 shares of common stock
at an exercise price of $2.85 per share in June 1999. This option vests at the
rate of 25% one year from the date of grant and 1/48th each month thereafter
such that full vesting will be achieved in four years.
Compensation Committee Interlocks and Insider Participation
None of the members of the compensation committee is currently, or has ever
been at any time since our formation, one of our officers or employees, nor has
served as a member of the board of directors or compensation committee of any
entity that has one or more officers serving as a member of our board of
directors or compensation committee.
47
<PAGE>
Executive Compensation
The following table sets forth the compensation paid by us during 1999 to our
chief executive officer and to our four other most highly compensated executive
officers who received salary and bonus compensation of more than $100,000
during 1999:
<TABLE>
<CAPTION>
Long Term
Compensation
------------
Awards
------------
Annual
Compensation Securities
---------------- Underlying All Other
Name and Position Salary Bonus Options Compensation
- ----------------- -------- ------- ------------ ------------
<S> <C> <C> <C> <C>
Andrew G. Raguskus................. $231,000 $55,000 105,264 $ --
President and Chief Executive
Officer
Jorgen Heide....................... 193,333 45,000 63,158 --
Vice President, International and
OEM Division
Orlando P. Rodrigues............... 190,000 -- 63,158 --
Vice President, Consumer
Development Division
Gregory N. Koskowich............... 176,250 35,000 63,158 --
Vice President, Research and
Development
Michael D. Monahan................. 145,833 -- -- --
Vice President, U.S. Professional
Division
</TABLE>
Stock Options Granted in the Fiscal Year Ended December 31, 1999
The following table sets forth information with respect to stock options
granted during the fiscal year ended December 31, 1999 to each of the named
executive officers. All options were granted under our 1993 Stock Plan. The
following options were granted at exercise prices equal to the fair market
value of our common stock as determined by our board of directors on the dates
of grant.
The percentage of options granted is based on an aggregate of 1,087,105
options granted by us during the fiscal year ended December 31, 1999 to our
employees, including the named executive officers. The potential realizable
value amounts in the last two columns of the following chart represent
hypothetical gains that could be achieved for the respective options if
exercised at the end of the option term. The assumed 5% and 10% annual rates of
stock price appreciation from the date of grant to the end of the option term
are provided in accordance with rules of the SEC and do not represent our
estimate or projection of the future common stock price. Actual gains, if any,
on stock option exercises are dependent on the future performance of the common
stock, overall market conditions and the option holder's continued employment
through the vesting period.
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------
Potential Realizable
Value at Assumed
Number of % of Total Annual Rates of Stock
Securities Options Price Appreciation for
Underlying Granted to Exercise Option Terms
Options Employees Price Per Expiration -----------------------
Name Granted in Fiscal Year Share Date 5% 10%
- ---- ---------- -------------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Andrew G. Raguskus...... 105,264(1)(2) 9.7% $5.70 11/19/2009 $ 377,340 $ 956,253
Jorgen Heide............ 63,158(1) 5.8 5.70 11/19/2009 226,402 573,748
Orlando P. Rodrigues.... 63,158(2) 5.8 5.70 11/19/2009 226,402 573,748
Gregory N. Koskowich.... 63,158(2) 5.8 5.70 11/19/2009 226,402 573,748
Michael D. Monahan...... -- -- -- -- -- --
</TABLE>
- --------
(1) Options granted to Mr. Heide and options to purchase 52,632 shares granted
to Mr. Raguskus vest at the rate of 25% of the shares on the first
anniversary of the date of grant and 1/48th of
48
<PAGE>
the shares each calendar month thereafter, such that full vesting occurs
four years after the date of grant.
(2) Options granted to Mr. Rodrigues and Dr. Koskowich and options to purchase
52,632 shares granted to Mr. Raguskus vest on November 19, 2005 or earlier
if specified performance criteria, as approved by our board of directors,
are met.
Aggregate Option Exercises In 1999 and Year-End Values
The following table sets forth the number of shares acquired upon the
exercise of stock options during 1999 and the number of shares covered by both
exercisable and unexercisable stock options held by each of the named
executive officers at December 31, 1999.
<TABLE>
<CAPTION>
Number Of
Securities Underlying Value Of Unexercised
Shares Unexercised Options In-The-Money Options
Acquired At Fiscal Year-End At Fiscal Year-End (2)
on Value ------------------------- -------------------------
Exercise Realized (1) Exercisable Unexercisable Exercisable Unexercisable
--------- ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Andrew G. Raguskus...... -- -- 155,626 238,324 $1,118,574 $1,129,232
Jorgen Heide............ 28,948 $47,185 26,482 112,992 182,809 453,744
Orlando P. Rodrigues.... -- -- 47,698 120,724 333,359 511,119
Gregory N. Koskowich.... 6,579 35,724 13,159 109,210 89,745 446,378
Michael D. Monahan...... -- -- 31,580 47,368 215,849 319,260
</TABLE>
- --------
(1) The value realized reflects the fair market value of our common stock
underlying the option on the date of exercise as determined by our board
of directors minus the exercise price of the option.
(2) The value of unexercised in-the-money options is based on a value of $7.60
per share, the fair market value of our stock on December 31, 1999 as
determined by our board of directors.
Employment Agreements and Change-of-Control Arrangements
We have agreed to provide Gregory N. Koskowich with a severance payment of
six month's salary in the event that we terminate his employment. We have
agreed to provide Orlando P. Rodrigues with a severance package of six month's
salary and benefits in the event that we terminate his employment without
cause. In addition, in the event of an acquisition of Sonic Innovations, all
of the 78,948 shares of common stock subject to the option granted upon his
employment shall immediately vest. All 63,158 shares of common stock subject
to the option granted to Michael D. Monahan upon his employment will
immediately vest upon an acquisition of Sonic Innovations. We have agreed to
provide Stephen L. Wilson with a severance package of one year's salary, bonus
and benefits if we terminate his employment. In the event that Mr. Wilson is
terminated upon a change of control of Sonic Innovations, he will receive two
year's salary and bonus and all of his outstanding options will immediately
vest.
Pursuant to a resolution of the Board of Directors, half of the shares
subject to the initial options granted to our executive officers upon
commencing their employment shall immediately vest in the event of an
acquisition of Sonic Innovations (with the exception of Messrs. Rodrigues and
Monahan, whose benefits upon an acquisition are described above).
Employee Benefit Plans
1993 Stock Plan
Our 1993 Stock Plan was adopted by our board of directors and approved by
our stockholders in 1993. The 1993 Stock Plan provides for the granting to our
employees of incentive stock options
49
<PAGE>
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended, and for the granting to employees, directors and independent
contractors of nonstatutory stock options. As of December 31, 1999, options to
purchase 2,580,844 shares were outstanding under the 1993 Stock Plan and
335,682 shares remained available for future grant. The 1993 Stock Plan is
administered by the compensation committee, which has sole discretion and
authority, consistent with the provisions of the 1993 Stock Plan, to determine
which eligible participants will receive options, the time when options will be
granted, the terms of options granted and the number of shares which will be
subject to options granted under the 1993 Stock Plan.
The exercise price of incentive stock options must at least be equal to the
fair market value of a share of common stock on the date the option is granted
(110% with respect to optionees who own at least 10% of the voting power of all
classes of our stock). Nonstatutory options shall have an exercise price of not
less than 85% of the fair market value of a share of common stock on the date
such option is granted. Payment of the exercise price may be made in cash, by
delivery of shares of our common stock, waiver of compensation due or accrued
or, if approved by the administrator, through the delivery of a promissory
note. The compensation committee has the authority to determine the time or
times at which options granted under the 1993 Stock Plan become exercisable,
provided that options must expire no later than ten years from the date of
grant (five years with respect to optionees who own at least 10% of the voting
power of all classes of our stock).
2000 Stock Plan
Our board of directors intends to adopt the 2000 Stock Plan in connection
with this offering. Shares available for grant under the 1993 Stock Plan will
be transferred to the 2000 Stock Plan and reserved for issuance thereunder. No
further grants shall then be made under the 1993 Stock Plan. The maximum
aggregate number of shares of common stock that may be optioned and sold under
the 2000 Stock Plan is expected to be 1,578,947 shares (not including available
shares transferred from the 1993 Stock Plan) plus additional shares to be added
on each January 1st equal to the lesser of (i) 5% of our then outstanding
shares, (ii) 789,474 shares, or (iii) a lesser amount as determined by our
board of directors. Other terms of the 2000 Stock Plan are substantially
similar to those of the 1993 Stock Plan as described above. The 2000 Stock Plan
must be approved by the stockholders.
2000 Employee Stock Purchase Plan
Our board of directors intends to adopt the 2000 Employee Stock Purchase Plan
to qualify as an "employee stock purchase plan" under Section 423 of the
Internal Revenue Code. The plan will be implemented with two-year offering
periods with purchases occurring at six-month intervals commencing on the
completion of this offering. We anticipate initially reserving an aggregate of
263,158 shares of common stock for issuance under the plan plus an annual
increase to be added on each January 1st equal to the lesser of (i) 105,263
shares, (ii) 1% of the outstanding shares on such date, or (iii) a lesser
amount as determined by our board of directors. The initial offering period
will conclude on June 30, 2002. The plan will be administered by our board of
directors or a committee of our board. Employees will be eligible to
participate if they are full time employees. The plan permits eligible
employees to purchase common stock through payroll deductions, but purchases
may not exceed 5,263 shares of common stock, or 10% of an employee's
compensation. In addition, the right to purchase common stock under all
employee purchase plans may not accrue in excess of $20,000 worth of stock for
in any calendar year. The price of stock purchased under the plan will be 85%
of the lower of the fair market value of the common stock at the beginning of
the two year offering period or the applicable purchase date. Employees may end
their participation in the offering at any time during the offering period, and
participation ends automatically on termination of employment. Our board of
directors may at any time amend or terminate the plan, except that no
50
<PAGE>
such amendment or termination may adversely affect shares previously purchased
under the plan. In addition, our board of directors may not, without
stockholder approval, materially increase the number of shares of common stock
available for issuance, alter the purchase price formula so as to reduce the
purchase price payable for shares of common stock or materially modify the
eligibility requirements for participation or the benefits available to
participants. The plan will continue in effect for a term of ten years.
401(k) Plan
We have a Section 401(k) Profit Sharing Plan. The 401(k) plan is a tax-
qualified plan covering all full-time employees who are over 21 years of age.
Under the 401(k) plan, participants generally may elect to defer a portion of
their compensation. In addition, at the discretion of the board of directors,
Sonic Innovations may make matching contributions into the 401(k) plan for all
eligible employees. Sonic Innovations has not made any contributions to the
401(k) plan to date.
Advisory Board
We have formed a scientific advisory board to assist us in better serving the
needs of hearing impaired individuals as we move into an era increasingly
dominated by information exchange and technology. The purpose of the advisory
board is to promote insight into hearing impairment and potential hearing aid
technology, as well as to provide guidance for research and development
investment. The advisory board will also review trends in medicine, audiology,
technology, and dispensing practices to determine what will influence future
hearing heath care. Specifically, the advisory board will, among other things,
review:
. application of outer and inner hair cell relationships to speech
processing;
. electronic feedback suppression/cancellation;
. hearing aid signal processing design;
. DSP technologies;
. auditory implants;
. fitting and verification procedures; and
. fitting algorithms.
The members of the advisory board are:
Jeannette S. Johnson, Ph.D. is the Chairperson of the advisory board and was
our Vice President of Regulatory and Clinical Affairs from 1996 through
December 1999. Dr. Johnson is experienced in audiological research, regulatory
compliance, quality systems, education and training, and international
marketing. She was instrumental in providing clinical and regulatory guidance
in getting our NATURA brand to market, as well as in our obtaining ISO 9001
approval and CE Mark certification. Prior to joining us, Dr. Johnson was Vice
President of Corporate Regulatory, Quality and Clinical Affairs for ReSound
Corporation from 1989 to 1996 where she was instrumental in opening the
European and Japanese markets. Prior to that, Dr. Johnson managed clinical
research for the hearing health group within the Life Sciences Sector at the 3M
Company. While at 3M, she directed multi-site field trials to establish safety
and efficacy of cochlear implants for use by children and adults. Earlier, Dr.
Johnson managed audiology programs for the Province of British Columbia and the
Republic of Korea (as a member of the Peace Corps) and was on the faculty of
the University of Southern California and Central Washington State University.
Dr. Johnson has over three decades of experience in audiology and related
fields and has personally fit over 10,000 hearing aids on patients. Dr. Johnson
earned doctoral and master's degrees in audiology from Northwestern University
and a bachelor's degree from the University of Wisconsin at Milwaukee.
51
<PAGE>
Douglas M. Chabries, Ph.D. is the Dean of the College of Engineering and
Technology at Brigham Young University and is recognized internationally as an
authority on digital speech processing and adaptive compression technologies.
He has been a BYU faculty member since 1978. From 1970 to 1978, Dr. Chabries
researched and designed signal processing technologies for underwater acoustic
homing weapons for the U.S. Navy. Dr. Chabries received a B.S. in Electrical
Engineering from the University of Utah, a M.S. in Electrical Engineering from
the California Institute of Technology, and a Ph.D. from Brown University. He
has participated with the National Academy of Science panel on noise
suppression for improvement of speech intelligibility, has been issued
ten patents in the areas of adaptive signal processing and digital hearing
enhancements, and has published numerous professional articles.
Richard W. Christiansen, Ph.D. is Associate Dean of the College of
Engineering and Technology at Brigham Young University and is recognized
internationally as an authority on digital signal processing algorithms used in
pattern detection and recognition and noise removal. He has been a BYU faculty
member since 1978 and is currently Professor of Electrical and Computer
Engineering and Director of the Digital Signal Processing Laboratory and Center
for Signal Processing. Dr. Christiansen received a B.S. in Electrical
Engineering from Rutgers University, an M.S. in Physics from the University of
New Mexico and a Ph.D. in Electrical Engineering from the University of Utah.
He has been issued five patents in the areas of data compression, hearing
enhancement and noise suppression and has authored or co-authored over 40
technical publications.
Robyn M. Cox, Ph.D. is Professor of Audiology and Director of the Hearing Aid
Research Laboratory, School of Audiology and Speech-Language Pathology, at the
University of Memphis. Dr. Cox's research interests include hearing aid fitting
strategies, especially for nonlinear hearing aids, documenting outcomes in
hearing aid rehabilitation with the elderly, the relationship of non-auditory
variables to hearing aid fitting outcomes, and prediction of fitting outcomes
before the fitting. Dr. Cox received a degree in Speech Therapy from the
University of Queensland, Australia, a B.S. in Speech and Hearing and a M.A. in
Audiology and Psychology at Ball State University and a Ph.D. in Audiology from
Indiana University.
David A. Fabry, Ph.D. is Section Head, Audiology, Department of
Otorhinolaryngology, at the Mayo Clinic. He is an Associate Professor at the
Mayo Graduate School of Medicine as well as an Adjunct Associate Professor,
Department of Communication Disorders, at the University of Minnesota. Dr.
Fabry is the President-Elect and Director of the American Academy of Audiology,
and is the Editor of the American Journal of Audiology. In addition, he is an
active member of the American National Standards Institute (ANSI), a member of
the Hearing Instrument Dispenser's Practical Examination Committee of the
Minnesota Department of Health, and participates in the SBIR Study Section of
the National Institute of Health. Dr. Fabry is also a member of a number of
other audiology groups and is an editorial consultant for a number of audiology
publications. Dr. Fabry has presented at many national and international
meetings and has authored or co-authored 40 technical publications. Dr. Fabry
received a B.A. in Psychology, an M.A. in Audiology, and a Ph.D. in Speech and
Hearing Science, all from the University of Minnesota.
52
<PAGE>
CERTAIN TRANSACTIONS
Since January 1, 1997, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which we were or are to be
a party in which the amount involved exceeds $60,000, and in which any
director, executive officer, holder of more than 5% of our common stock or any
member of the immediate family of any of these people had or will have a direct
or indirect material interest other than compensation agreements and other
arrangements described in "Management" and the transactions described below.
Sales of Our Preferred Stock, Convertible Notes and Warrants
The following table summarizes the private placement transactions since
January 1, 1997 in which we sold preferred stock, convertible notes and
warrants to our directors, executive officers, 5% stockholders and persons and
entities affiliated with them.
<TABLE>
<CAPTION>
No. of Shares of
Preferred Stock
----------------------------
No. of Shares
Convertible Subject to
Series B Series C Series D Notes Warrants
-------- --------- --------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Entities affiliated with
Accel Partners......... 437,777 495,855 263,158 $853,876 44,942
Entities affiliated with
Morgenthaler Ventures.. -- 1,315,790 283,012 601,563 31,662
Entities affiliated with
MPM Asset Management... -- -- 1,894,738 850,442 44,761
Entities affiliated with
New Enterprise
Associates (NEA)....... -- 1,315,791 283,012 708,312 37,280
Utah Ventures........... 58,005 93,176 32,895 30,000 1,579
Entities affiliated with
Venrock Associates..... 437,775 495,853 263,159 853,876 44,944
Entities affiliated with
The Travelers Insurance
Company................ 218,888 247,928 161,364 438,145 23,063
</TABLE>
Many of the members of our board of directors are affiliated with entities
that have invested in Sonic Innovations since January 1, 1997. Dr. Anthony
Evnin is a General Partner of Venrock Associates. Dr. Luke Evnin is a General
Partner of MPM Asset Management and previously was a General Partner at Accel
Partners. Mr. Shaffer is a General Partner of Morgenthaler Ventures. Dr. Van
Bladel is a Partner of New Enterprise Associates (NEA). Dr. Wolfe is a General
Partner of Utah Ventures.
Preferred Stock. The shares of Series B Preferred Stock described in the
table above were issued in May 1997 at a price of $1.35 per share. The shares
of Series C Preferred Stock described in the table above were issued in October
1997 at a price of $3.04 per share. The shares of Series D Preferred Stock
described in the table above were issued in October 1998 at a price of $3.80
per share.
Convertible Notes and Warrants. During July and August of 1999, we sold 6%
convertible promissory notes in the aggregate principal amount of $4,500,000.
The principal and interest on those notes will convert upon the closing of this
offering into common stock at the initial public offering price. Based on the
initial public offering price of $14.00 per share, each $1,000 of principal and
interest will convert into 71 shares of common stock. As part of the sale of
the convertible notes, we also issued warrants exercisable for 236,853 shares
of common stock at a per share price of $3.80.
53
<PAGE>
Hoya Healthcare Corporation
In December 1999, we entered into an agreement with Hoya Healthcare
Corporation that provides for Hoya to become our exclusive distributor of
branded products, including NATURA and CONFORMA, in Japan. We have retained the
rights to sell specified hearing aid componentry to other companies that
distribute in the Japanese market. In connection with the strategic alliance,
Hoya agreed to purchase $10.0 million of our 6% convertible promissory notes.
Hoya purchased $4.0 milion of the notes on December 31, 1999 and $3.0 million
on March 31, 2000, all of which will convert into shares of our common stock at
93% of the initial public offering price. Hoya will purchase the remaining $3.0
million of notes on the closing of this offering and immediately convert them
at the IPO price.
Other Transactions
Ross Ryding, our Vice President of Operations, joined Sonic Innovations in
January 1999. He beneficially owned an information services company that
provided services to us in exchange for $263,536 in 1997, $583,788 in 1998, and
$266,281 in 1999. Our relationship with this company terminated in the third
quarter of 1999.
From time to time, we have granted stock options to some of our officers and
directors. See "Management--Director Compensation" and "--Stock Options Granted
in the Fiscal Year Ended December 31, 1999."
We believe that the shares issued in the above described transactions were
sold at the then fair market value, as determined by the Board of Directors,
and that the terms of all the above described transactions were no less
favorable than we could have obtained from unaffiliated third parties.
54
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our common stock as of December 31, 1999, and as adjusted to
reflect the sale of the common stock in this offering, by:
. each person, or group of affiliated persons, who is known by us to own
beneficially more than 5% of the common stock;
. each of our directors;
. each executive officer named in the Summary Compensation Table; and
. all of our directors and executive officers as a group.
<TABLE>
<CAPTION>
Percentage
of Shares
Number of Beneficially Owned
Shares ----------------------
Beneficially Before After
Name of Beneficial Owner Owned(1) Offering Offering
- ------------------------ ------------ --------- ---------
<S> <C> <C> <C>
Entities affiliated with Venrock
Associates........................... 2,364,712 15.5% 12.5%
30 Rockefeller Plaza #5508
New York, NY 10112
Entities affiliated with Accel
Partners (2)......................... 2,367,962 15.5 12.5
428 University Ave.
Palo Alto, CA 94301
Entities affiliated with MPM Asset
Management........................... 2,001,741 13.1 10.6
601 Gateway Blvd., Suite 360
South San Francisco, CA 94080
Entities affiliated with New
Enterprise Associates(2)............. 1,691,257 11.1 9.0
2490 Sand Hill Road
Menlo Park, CA 94025
Entities affiliated with Morgenthaler
Venture Partners(2).................. 1,677,825 11.0 8.9
2730 Sand Hill Road
Menlo Park, CA 94025
Entities affiliated with The Travelers
Insurance Company.................... 1,213,353 7.9 6.4
205 Columbus Blvd.
Hartford, CT 06183
Hoya Healthcare Corporation........... 751,919 4.9 4.0
Shinjuku i-Land Tower
8F. 5-1, Nishi-Shinjuku 6-chome
Shinjuku-ku, Tokyo 163-1308
Japan
Andrew G. Raguskus(3)................. 338,399 2.2 1.8
Jorgen Heide(4)....................... 59,813 * *
Gregory N. Koskowich, Ph.D.(5)........ 63,050 * *
Michael D. Monahan(6)................. 34,868 * *
Orlando P. Rodrigues(7)............... 48,793 * *
Anthony B. Evnin, Ph.D.(8)............ 2,368,045 15.5 12.5
Luke B. Evnin, Ph.D.(9)............... 4,272,752 28.0 22.6
Kevin J. Ryan......................... -- * *
G. Gary Shaffer(10)................... 1,677,825 10.9 8.8
Sigrid Van Bladel, Ph.D.(11).......... 1,691,257 11.1 9.0
Allan M. Wolfe, M.D.(12).............. 675,370 4.4 3.6
All directors and executive officers
as a group(13) (13 persons).......... 11,335,435 72.2 58.8
</TABLE>
55
<PAGE>
- --------
* Represents less than 1% of our outstanding common stock.
(1) Based on 15,267,481 shares outstanding as of December 31, 1999, assuming
the conversion of the convertible preferred stock and convertible
promissory notes and the exercise of the warrants as described in the
first paragraph after the table under "Summary--The Offering" on page 6.
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, subject to community property
laws, where applicable. Shares of common stock subject to options or
warrants that are presently exercisable or exercisable within 60 days are
deemed to be beneficially owned by the person holding such options for the
purpose of computing the percentage ownership of such, but are not treated
as outstanding for the purpose of computing the percentage of any other
person.
(2) Includes options exercisable for 3,333 shares of common stock within 60
days of December 31, 1999.
(3) Includes options exercisable for 173,135 shares of common stock within 60
days of December 31, 1999. Excludes options that vest upon reaching
specified performance milestones.
(4) Includes shares subject to options exercisable for 30,865 shares of common
stock within 60 days of December 31, 1999.
(5) Includes shares subject to options exercisable for 16,995 shares of common
stock within 60 days of December 31, 1999. Excludes options that vest upon
reaching specified performance milestones.
(6) Represents shares subject to options exercisable within 60 days of
December 31, 1999.
(7) Represents shares subject to options exercisable within 60 days of
December 31, 1999. Excludes options that vest upon reaching specified
performance milestones.
(8) Includes 2,364,712 shares of common stock held by entities associated with
Venrock Associates, of which Dr. Anthony Evnin is a General Partner. Dr.
Anthony Evnin shares the right to vote such shares with other fund-
affiliated entities but disclaims beneficial interest in those shares.
Includes options exercisable for 3,333 shares of common stock exercisable
within 60 days of December 31, 1999.
(9) Includes 2,001,741 shares of common stock held by entities associated with
MPM Asset Management and 2,271,011 shares of common stock held by some of
the entities associated with Accel Partners, all of which Dr. Luke Evnin
is a General Partner. Dr. Luke Evnin shares the right to vote such shares
with other fund-affiliated entities but disclaims beneficial ownership in
those shares. Includes options exercisable for 3,333 shares of common
stock within 60 days of December 31, 1999.
(10) Represents shares beneficially owned by entities affiliated with
Morgenthaler Ventures, of which Mr. Shaffer is a General Partner. Mr.
Shaffer shares the right to vote such shares with other general partners
but disclaims beneficial ownership in the fund. Includes options
exercisable for 3,333 shares of common stock within 60 days of December
31, 1999.
(11) Represents shares beneficially owned by entities affiliated with New
Enterprise Associates, of which Dr. Van Bladel is a Partner. Dr. Van
Bladel disclaims beneficial ownership in those shares. Includes options
exercisable for 3,333 shares of common stock within 60 days of December
31, 1999.
(12) Represents shares beneficially owned by Utah Ventures, of which Dr. Wolfe
is a General Partner. Dr. Wolfe shares the right to vote such shares with
other fund-affiliated entities but disclaims beneficial ownership in those
shares. Includes options exercisable for 3,333 shares of common stock
within 60 days of December 31, 1999.
(13) Includes options exercisable for 426,584 shares of common stock within 60
days of December 31, 1999.
56
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
Immediately following the closing of this offering, our authorized capital
stock will consist of 70,000,000 shares of common stock, $0.001 par value per
share, and 5,000,000 shares of preferred stock, $0.001 par value per share. As
of December 31, 1999, there were outstanding 15,267,481 shares of common stock
held of record by 92 stockholders, warrants to purchase 37,964 shares of common
stock and options to purchase 2,580,844 shares of common stock.
Common Stock
Subject to preferences that may apply to shares of preferred stock
outstanding at the time, the holders of outstanding shares of common stock are
entitled to receive dividends out of assets legally available therefor at such
times and in such amounts as our board of directors may from time to time
determine. Each stockholder is entitled to one vote for each share of common
stock held on all matters submitted to a vote of stockholders. Cumulative
voting for the election of directors is not provided for in our certificate of
incorporation, which means that the holders of a majority of the shares voted
can elect all of the directors then standing for election. Our board of
directors is divided into three classes, with each director serving a three-
year term and one class being elected at each year's annual meeting of
stockholders. The common stock is not entitled to preemptive rights and is not
subject to conversion or redemption. Each outstanding share of common stock is,
and all shares of common stock to be outstanding upon completion of this
offering will be, fully paid and nonassessable.
Preferred Stock
Pursuant to our certificate of incorporation, our board of directors has the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of preferred stock in one or more series and to fix the designations,
powers, preferences, privileges, and relative participating, optional or
special rights as well as the qualifications, limitations or restrictions
thereof, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater than
the rights of the common stock. Our board of directors, without stockholder
approval, can issue preferred stock with voting, conversion or other rights
that could adversely affect the voting power and other rights of the holders of
common stock. Preferred stock could thus be issued quickly with terms
calculated to delay or prevent a change in control or make removal of
management more difficult. Additionally, the issuance of preferred stock may
have the effect of decreasing the market price of the common stock, and may
adversely affect the voting and other rights of the holders of common stock. At
present, we have no plans to issue any of the preferred stock following this
offering.
Warrants
Upon the closing of this offering, we will have warrants outstanding with our
bank to purchase 17,258 shares of common stock at $3.04 per share that expire
in May 2003. We also have warrants outstanding with our bank to purchase 20,706
shares of common stock at $3.80 per share, which expire in December 2004. The
bank is entitled to antidilution protection in the event we issue shares of
common stock at a price less than $3.80 per share and is also entitled to
registration rights as described below.
Registration Rights
The holders of 12,942,342 shares of common stock and warrants to purchase
37,964 shares of common stock have the right to require us to register those
shares under the Securities Act of 1933.
57
<PAGE>
If we register any of our common stock for our own account or for the account
of other security holders, these holders are entitled to include their shares
of common stock in the registration, subject to the ability of the underwriters
to limit the number of shares included in the offering under certain
circumstances. In addition, subject to limitations contained in the
registration rights agreement, the holders of 12,942,342 shares of common stock
may require that we use our best efforts to register their shares if the
holders of at least 30% of those shares make the request. Furthermore, the
holders of at least 20% of those shares may require us to register their shares
on a Form S-3 registration statement when we are eligible to use Form S-3. We
will bear all fees, costs and expenses of any such registration, other than
underwriting discounts and commissions.
Delaware Anti-Takeover Law and Charter Provisions
Provisions in our certificate of incorporation and bylaws may have the effect
of making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of us. Such provisions could
limit the price that investors might be willing to pay in the future for shares
of our common stock. These provisions allow us to issue preferred stock without
any vote or further action by the stockholders, require advance notification of
stockholder proposals and nominations of candidates for election as directors,
and eliminate cumulative voting in the election of directors. In addition, our
bylaws provide that special meetings of the stockholders may be called only by
the board of directors and that the authorized number of directors may be
changed only by resolution of the board of directors. These provisions may make
it more difficult for stockholders to take corporate actions and could have the
effect of delaying or preventing a change in control.
In addition, we are subject to Section 203 of the Delaware General
Corporation Law. This law prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder, unless any of the
following conditions are met. First, this law does not apply if prior to the
date of the transaction, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder. Second, the law does not apply
if upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at least
85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned by persons who are directors and also
officers and those shares owned by employee stock plans in which employee
participants do not have the right to determine confidentially whether shares
held subject to the plan will be tendered in a tender or exchange offer. Third,
the law does not apply if, at or after the date of the transaction, the
business combination is approved by the board of directors and authorized at an
annual or special meeting of stockholders, and not by written consent, by the
affirmative vote of at least 66 2/3% of the outstanding voting stock which is
not owned by the interested stockholder.
Transfer Agent and Registrar
The Transfer Agent and Registrar for our common stock will be American Stock
Transfer & Trust Company. The Transfer Agent's telephone number is (718) 921-
8217.
58
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Immediately prior to this offering, there was no public market for our common
stock. Future sales of substantial amounts of common stock in the pubic market
could adversely affect the market price of our common stock.
Upon completion of this offering, we will have outstanding an aggregate of
18,867,481 shares of common stock, assuming no exercise of options after
December 31, 1999. Of these shares, the 3,600,000 shares sold in this offering
will be freely tradable without restriction or further registration under the
Securities Act, except for any shares purchased by "affiliates" of Sonic
Innovations as that term is defined in Rule 144 under the Securities Act.
Shares purchased by affiliates may generally only be sold pursuant to an
effective registration statement under the Securities Act or in compliance with
limitations of Rule 144 as described below.
The remaining 15,267,481 shares of common stock held by existing stockholders
were issued and sold by us in reliance on exemptions from the registration
requirements of the Securities Act. 15,242,459 of these shares will be subject
to "lock-up" agreements providing that the stockholders will not offer, sell or
otherwise dispose of any of the shares of common stock owned by them for a
period of 180 days after the date of this prospectus. Goldman, Sachs & Co.,
however, may in its sole discretion, at any time without notice, release all or
any portion of the shares subject to lock-up agreements. The 15,267,481 shares
will become eligible for sale as follows:
<TABLE>
<CAPTION>
Shares Eligible
Date Available for Resale For Sale Comment
- ------------------------------------------ --------------- -------
<S> <C> <C>
Immediately............................... 25,022 Shares not subject to lock-up agreements
180 days (October 28, 2000)............... 2,080,709 Lock-up released; shares freely tradable
180 days (October 28, 2000)............... 12,409,831 Lock-up released; shares saleable
under Rules 144 and 701
Various dates beginning in December 2000.. 751,919 Shares saleable under Rule 144
</TABLE>
Immediately after the completion of this offering, we intend to file a
registration statement on Form S-8 under the Securities Act to register all of
the shares of common stock issued or reserved for future issuance under our
stock option plans and our stock purchase plan. Based upon the number of shares
subject to outstanding options as of December 31, 1999 and currently reserved
for issuance under our stock plans, this registration statement would cover
approximately 4,758,465 shares in addition to annual increases in the number of
shares available under the stock option plans and stock purchase plan pursuant
to the terms of such plans. Shares registered under the registration statement
will generally be available for sale in the open market immediately after the
180 day lock-up agreements expire (October 28, 2000) or earlier in Goldman,
Sachs & Co.'s sole discretion.
Also beginning six months after the date of this offering, holders of
12,942,342 shares of our common stock, including shares issuable upon
conversion of preferred stock, will be entitled to rights with respect to
registration of these shares for sale in the public market. See "Description of
Capital Stock--Registration Rights." Registration of these shares under the
Securities Act would result in these shares becoming freely tradable without
restriction under the Securities Act immediately upon effectiveness of the
registration.
59
<PAGE>
Rule 144
In general, under Rule 144 as currently in effect, beginning 180 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year would be entitled to sell in "broker's
transactions" or to market makers, within any three-month period, a number of
shares that does not exceed the greater of:
. 1% of the number of shares of common stock then outstanding (which will
equal approximately 188,675 shares immediately after this offering); or
. the average weekly trading volume in the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are generally subject to the availability of current
public information about Sonic Innovations.
Rule 701
In general, under Rule 701, any of our employees, directors, officers,
consultants or advisors who purchase shares from us in connection with a
compensatory stock or option plan or other written agreement before the
effective date of this offering is entitled to sell such shares 180 days after
the effective date of this offering in reliance on Rule 144, in the case of
affiliates, without having to comply with the holding period and notice filing
requirements of Rule 144 and, in the case of non-affiliates, without having to
comply with the public information, volume limitation or notice filing
requirements of Rule 144.
60
<PAGE>
UNDERWRITING
Sonic Innovations and the underwriters named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to
some conditions, each underwriter has severally agreed to purchase the number
of shares indicated in the following table. Goldman, Sachs & Co., Deutsche Bank
Securities Inc. and U.S. Bancorp Piper Jaffray Inc. are the representatives of
the underwriters.
<TABLE>
<CAPTION>
Number
Underwriters of Shares
------------ ---------
<S> <C>
Goldman, Sachs & Co. .............................................. 1,760,000
Deutsche Bank Securities Inc. ..................................... 800,000
U.S. Bancorp Piper Jaffray Inc..................................... 640,000
Advest, Inc........................................................ 40,000
Robert W. Baird & Co. Incorporated................................. 40,000
Chatsworth Securities LLC.......................................... 40,000
Dain Rauscher Incorporated......................................... 40,000
First Security Van Kasper.......................................... 40,000
ING Barings LLC.................................................... 40,000
Edward D. Jones & Co., L.P......................................... 40,000
Prudential Securities Incorporated................................. 40,000
Raymond James & Associates, Inc.................................... 40,000
SG Cowen Securities Corporation.................................... 40,000
---------
Total Underwriters............................................... 3,600,000
=========
</TABLE>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 540,000
shares from Sonic Innovations to cover such sales. They may exercise that
option for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same
proportion as set forth in the table above.
The following table shows the per share and total underwriting discount to be
paid to the underwriters by Sonic Innovations. Such amounts are shown assuming
both no exercise and full exercise of the underwriters' option to purchase
540,000 additional shares.
<TABLE>
<CAPTION>
Paid by Sonic Innovations
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ 0.98 $ 0.98
Total.............................................. $3,528,000 $4,057,200
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the underwriters to securities dealers may be sold at a
discount of up to $0.58 per share from the initial public offering price. Any
such securities dealers may resell any shares purchased from the underwriters
to selected other brokers or dealers at a discount of up to $0.10 per share
from the initial public offering price. If all the shares are not sold at the
initial offering price, the representatives may change the offering price and
the other selling terms.
Sonic Innovations and its officers, directors and principal stockholders have
agreed with the underwriters not to dispose of or hedge any of their common
stock or securities convertible into or exchangeable for shares of common stock
during the period from the date of this prospectus
61
<PAGE>
continuing through the date 180 days after the date of this prospectus, except
with the prior written consent of the representatives. This agreement does not
apply to our issuance of securities pursuant to any existing employee benefit
plans or in connection with acquisition transactions, provided that the
recipients of such securities agree not to dispose of or hedge any of such
securities for the same 180-day period. See "Shares Eligible for Future Sale"
for a discussion of transfer restrictions.
At the request of Sonic Innovations, the underwriters have reserved for sale,
at the initial public offering price, up to 360,000 shares of common stock for
directors, employees and friends of Sonic Innovations. There can be no
assurance that any of the reserved shares will be so purchased. The number of
shares available for sale to the general public in the offering will be reduced
by the number of reserved shares sold. Any reserved shares not so purchased
will be offered to the general public on the same basis as the other shares
offered hereby.
Prior to this offering, there has been no public market for the common stock.
The initial public offering price for the common stock has been negotiated
between Sonic Innovations and the representatives of the underwriters. Among
the factors considered in determining the initial public offering price of the
shares, in addition to prevailing market conditions, were Sonic Innovations'
historical performance, estimates of Sonic Innovations' business potential and
earnings prospects, an assessment of Sonic Innovations' management and the
consideration of the above factors in relation to market valuations of
companies in related businesses.
The common stock has been approved for quotation on The Nasdaq National
Market under the symbol "SNCI."
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering.
Stabilizing transactions consist of bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of such underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on The Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed five
percent of the total number of shares offered.
Sonic Innovations estimates that its share of the total expenses of the
offering, excluding underwriting discount, will be approximately $950,000.
Sonic Innovations has agreed to indemnify the several underwriters against
specified liabilities, including liabilities under the Securities Act of 1933.
62
<PAGE>
VALIDITY OF THE COMMON STOCK
The validity of the common stock offered by this prospectus will be passed
upon for Sonic Innovations by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, Palo Alto, California, and for the underwriters by Sullivan &
Cromwell, Washington, D.C. As of the date of this prospectus, an investment
partnership composed of current and former members of and persons associated
with Wilson Sonsini Goodrich & Rosati, Professional Corporation, and an
individual member of Wilson Sonsini Goodrich & Rosati, Professional
Corporation, beneficially own an aggregate of 7,415 shares of Sonic Innovations
common stock.
EXPERTS
The consolidated financial statements of Sonic Innovations, Inc. and
subsidiary as of December 31, 1998 and 1999 and for each of the three years in
the period ended December 31, 1999 and Schedule II included in this prospectus
and elsewhere in the registration statement have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their reports
with respect thereto, and are included herein in reliance upon the authority of
said firm as experts in giving said reports.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act with respect to the shares sold in this offering. This
prospectus does not contain all of the information set forth in the
registration statement and the exhibits and schedules thereto. For further
information with respect to us and our common stock, reference is made to the
Registration Statement and the exhibits and schedules filed as a part thereof.
You should read the documents filed with the SEC as exhibits to the
registration statement for a more complete description of the matter involved.
We will be filing quarterly and annual reports, proxy statements and other
information with the SEC. You may read and copy any document that we file at
the public reference facilities of the SEC at Room 1024, 450 Fifth Street,
N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference rooms. Our SEC filings are also available
to the public from the SEC's web site at http://www.sec.gov.
63
<PAGE>
SONIC INNOVATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999............. F-3
Consolidated Statements of Operations for Each of the Three Years in the
Period Ended December 31, 1999.......................................... F-4
Consolidated Statements of Stockholders' Deficit for Each of the Three
Years in the Period Ended December 31, 1999............................. F-5
Consolidated Statements of Cash Flows for Each of the Three Years in the
Period Ended December 31, 1999.......................................... F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Sonic Innovations, Inc.:
We have audited the accompanying consolidated balance sheets of Sonic
Innovations, Inc. (a Delaware corporation) and subsidiary (collectively, the
"Company") as of December 31, 1998 and 1999, and the related consolidated
statements of operations, stockholders' deficit and cash flows for each of the
three years in the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Sonic Innovations, Inc. and subsidiary as of December 31, 1998 and 1999, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1999 in conformity with accounting
principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Salt Lake City, Utah
February 3, 2000 (except with respect to the
matters discussed in Note 13 as to
which the date is May 1, 2000)
F-2
<PAGE>
SONIC INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
Equity at
December 31, December 31,
-------------------------- 1999
1998 1999 (Note 13)
------------ ------------ -------------
(unaudited)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............ $ 11,929,540 $ 5,939,255
Accounts receivable, net............. 1,647,632 4,924,684
Inventories.......................... 243,620 2,368,373
Prepaid expenses and other........... 258,764 697,525
------------ ------------
Total current assets................ 14,079,556 13,929,837
------------ ------------
PROPERTY AND EQUIPMENT:
Furniture and office equipment....... 1,169,804 2,104,136
Machinery and equipment.............. 977,784 2,083,518
Computer equipment................... 1,222,108 1,730,600
Leasehold improvements............... 123,423 107,762
------------ ------------
3,493,119 6,026,016
Less accumulated depreciation and
amortization........................ (976,736) (2,288,332)
------------ ------------
Net property and equipment.......... 2,516,383 3,737,684
------------ ------------
OTHER ASSETS......................... 276,495 794,530
------------ ------------
Total assets........................ $ 16,872,434 $ 18,462,051
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
CURRENT LIABILITIES:
Line of credit....................... $ 770,429 $ 1,966,142 $ --
Convertible promissory notes,
including accrued interest.......... -- 8,064,476
Current portion of capital lease
obligations......................... 547,842 863,585
Current portion of technology license
obligation.......................... 170,000 100,000
Accounts payable..................... 2,128,017 3,873,661
Accrued payroll related expenses..... 788,735 1,577,895
Other accrued expenses............... 968,345 2,602,699
------------ ------------
Total current liabilities........... 5,373,368 19,048,458
LONG-TERM LIABILITIES:
Capital lease obligations, net of
current portion..................... 1,440,400 1,935,445
Technology license obligation, net of
current portion..................... 250,000 150,000
------------ ------------
Total liabilities................... 7,063,768 21,133,903
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes
2, 3, 4, 5 and 6)
MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK:
Series B, 4,635,378 shares designated
and outstanding (aggregate
liquidation preference of $6,367,561
as of December 31, 1999)-none
outstanding pro forma............... 7,428,356 7,951,574
Series C, 4,161,692 shares
designated, 4,144,434 shares
outstanding (aggregate liquidation
preference of $12,599,034 as of
December 31, 1999)-none outstanding
pro forma........................... 13,619,934 14,609,593
Series D, 3,381,579 shares
designated, 3,294,223 and 3,303,697
shares outstanding, respectively
(aggregate liquidation preference of
$12,554,000 as of December 31,
1999)-none outstanding pro forma.... 12,613,727 13,568,395
------------ ------------
Total mandatorily redeemable
convertible preferred stock........ 33,662,017 36,129,562 --
------------ ------------
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, Series A
convertible, $.001 par value;
449,277 shares designated and
outstanding (aggregate liquidation
preference of $356,913 as of
December 31, 1999) none outstanding
pro forma........................... 341,711 341,711 --
Common stock, $.001 par value;
35,000,000 shares authorized,
1,279,857 and 1,449,367 shares
outstanding, respectively--
14,619,054 shares pro forma......... 1,280 1,449 14,619
Additional paid-in capital........... 247,672 6,257,288 50,779,867
Deferred stock-based compensation.... -- (3,612,620) (3,612,620)
Accumulated deficit.................. (24,440,197) (41,777,602) (41,777,602)
Accumulated other comprehensive
loss................................ (3,817) (11,640) (11,640)
------------ ------------ ------------
Total stockholders' equity
(deficit).......................... (23,853,351) (38,801,414) $ 5,392,624
------------ ------------ ------------
Total liabilities and
stockholders' equity (deficit)... $ 16,872,434 $ 18,462,051
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
SONIC INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1997 1998 1999
----------- ------------ ------------
<S> <C> <C> <C>
Net sales............................. $ -- $ 2,142,958 $ 28,694,146
Cost of sales (exclusive of $46,709 of
stock-based compensation shown
below)............................... -- 2,056,225 17,061,973
----------- ------------ ------------
Gross profit...................... -- 86,733 11,632,173
----------- ------------ ------------
Operating expenses:
Selling, general and administrative
(exclusive of $840,495 of stock-
based compensation shown below).... 1,470,958 8,443,791 17,342,410
Research and development (exclusive
of $138,286 of stock-based
compensation shown below).......... 3,855,170 5,832,131 7,015,298
Stock-based compensation............ -- -- 1,025,490
----------- ------------ ------------
Total operating expenses.......... 5,326,128 14,275,922 25,383,198
----------- ------------ ------------
Operating loss........................ (5,326,128) (14,189,189) (13,751,025)
----------- ------------ ------------
Other income (expense):
Interest expense.................... (50,603) (185,447) (990,005)
Interest and other income........... 141,849 496,614 124,657
Foreign currency exchange loss...... -- -- (289,487)
----------- ------------ ------------
Total other income (expense)...... 91,246 311,167 (1,154,835)
----------- ------------ ------------
Net loss.............................. (5,234,882) (13,878,022) (14,905,860)
Accretion on mandatorily redeemable
convertible preferred stock.......... (593,403) (1,561,470) (2,431,545)
----------- ------------ ------------
Net loss applicable to common
stockholders......................... $(5,828,285) $(15,439,492) $(17,337,405)
=========== ============ ============
Basic and diluted net loss per common
share................................ $ (8.23) $ (15.61) $ (12.72)
=========== ============ ============
Weighted average number of common
shares outstanding................... 708,403 988,844 1,363,221
=========== ============ ============
Unaudited pro forma information (Note
13):
Net loss applicable to common
stockholders....................... $(14,399,610)
============
Basic and diluted net loss per
common share....................... $ (1.02)
============
Weighted average number of common
shares outstanding................. 14,114,948
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SONIC INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Series B, C and D
Mandatorily Redeemable Series A
Convertible Preferred Convertible Deferred
Stock (Non-Equity) Preferred Stock Common Stock Additional Stock-based Accumu-
---------------------- ---------------- ---------------- Paid-in Compre- Compen- lated
Shares Amount Shares Amount Shares Amount Capital hensive Loss sation Deficit
---------- ----------- ------- -------- --------- ------ ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
December 31,
1996............ 3,312,067 $ 4,635,962 400,693 $281,710 681,489 $ 681 $ 88,791 $ -- $ -- $ (3,172,420)
Exercise of
common stock
options......... 34,210 35 6,565
Extension of
life of certain
stock options... 22,400
Series B
preferred stock
issued for
services........ 9,266 24,999
Sale of Series B
preferred stock,
net of issuance
costs........... 1,314,045 1,825,192
Sale of Series C
preferred stock,
net of issuance
costs........... 4,118,421 12,475,783
Series B
preferred stock
accretion....... 447,336 (447,336)
Series C
preferred stock
accretion....... 146,067 (146,067)
Other
comprehensive
income.......... 51,221
Net loss........ (5,234,882) (5,234,882)
---------- ----------- ------- -------- --------- ------ ---------- ------------ ----------- ------------
Comprehensive
loss............ $ (5,183,661)
============
BALANCE,
December 31,
1997............ 8,753,799 19,555,339 400,693 281,710 715,699 716 117,756 $ -- -- (9,000,705)
Exercise of
common stock
options......... 564,158 564 129,916
Exercise of
Series A
preferred stock
warrants........ 48,584 60,001
Series C
preferred stock
issued for
services........ 26,013 79,032
Series D
preferred stock
issued for
services........ 4,737 18,000
Sale of Series D
preferred stock,
net of issuance
costs........... 3,289,486 12,448,176
Series B
preferred stock
accretion....... 494,867 (494,867)
Series C
preferred stock
accretion....... 919,052 (919,052)
Series D
preferred stock
accretion....... 147,551 (147,551)
Other
comprehensive
loss............ (55,038) --
Net loss........ (13,878,022) (13,878,022)
---------- ----------- ------- -------- --------- ------ ---------- ------------ ----------- ------------
Comprehensive
loss............ $(13,933,060)
============
BALANCE,
December 31,
1998............ 12,074,035 33,662,017 449,277 341,711 1,279,857 1,280 247,672 $ -- -- (24,440,197)
Exercise of
common stock
options......... 169,510 169 52,335
Series D
preferred stock
issued for
services........ 9,474 36,000
Series B
preferred stock
accretion....... 523,218 (523,218)
Series C
preferred stock
accretion....... 989,659 (989,659)
Series D
preferred stock
accretion....... 918,668 (918,668)
Accelerated
vesting of
certain stock
options......... 170,000
Warrants granted
with convertible
promissory
notes........... 945,000
Warrants granted
with debt
agreement....... 204,171
Deferred stock-
based
compensation.... 4,638,110 (4,638,110)
Stock-based
compensation.... 1,025,490
Other
comprehensive
loss............ (7,823)
Net loss........ (14,905,860) (14,905,860)
---------- ----------- ------- -------- --------- ------ ---------- ------------ ----------- ------------
Comprehensive
loss............ $(14,913,683)
============
BALANCE,
December 31,
1999............ 12,083,509 $36,129,562 449,277 $341,711 1,449,367 $1,449 $6,257,288 $(3,612,620) $(41,777,602)
========== =========== ======= ======== ========= ====== ========== =========== ============
<CAPTION>
Accumu-
lated
Other
Compre-
hensive
Income/
(Loss) Total
--------- -------------
<S> <C> <C>
BALANCE,
December 31,
1996............ $ -- $ (2,801,238)
Exercise of
common stock
options......... 6,600
Extension of
life of certain
stock options... 22,400
Series B
preferred stock
issued for
services........ --
Sale of Series B
preferred stock,
net of issuance
costs........... --
Sale of Series C
preferred stock,
net of issuance
costs........... --
Series B
preferred stock
accretion....... (447,336)
Series C
preferred stock
accretion....... (146,067)
Other
comprehensive
income.......... 51,221 51,221
Net loss........ (5,234,882)
--------- -------------
Comprehensive
loss............
BALANCE,
December 31,
1997............ 51,221 (8,549,302)
Exercise of
common stock
options......... 130,480
Exercise of
Series A
preferred stock
warrants........ 60,001
Series C
preferred stock
issued for
services........ --
Series D
preferred stock
issued for
services........ --
Sale of Series D
preferred stock,
net of issuance
costs........... --
Series B
preferred stock
accretion....... (494,867)
Series C
preferred stock
accretion....... (919,052)
Series D
preferred stock
accretion....... (147,551)
Other
comprehensive
loss............ (55,038) (55,038)
Net loss........ -- (13,878,022)
--------- -------------
Comprehensive
loss............
BALANCE,
December 31,
1998............ (3,817) (23,853,351)
Exercise of
common stock
options......... 52,504
Series D
preferred stock
issued for
services........ --
Series B
preferred stock
accretion....... (523,218)
Series C
preferred stock
accretion....... (989,659)
Series D
preferred stock
accretion....... (918,668)
Accelerated
vesting of
certain stock
options......... 170,000
Warrants granted
with convertible
promissory
notes........... 945,000
Warrants granted
with debt
agreement....... 204,171
Deferred stock-
based
compensation.... --
Stock-based
compensation.... 1,025,490
Other
comprehensive
loss............ (7,823) (7,823)
Net loss........ (14,905,860)
--------- -------------
Comprehensive
loss............
BALANCE,
December 31,
1999............ $(11,640) $(38,801,414)
========= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
SONIC INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................. $ (5,234,882) $(13,878,022) $(14,905,860)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation and amortization...... 192,176 735,715 1,361,741
Preferred stock issued for
services.......................... 24,999 97,032 36,000
Expense related to remeasurement of
stock options..................... 22,400 -- 170,000
Gain on sale of marketable
securities........................ (12,466) (323,466) --
Gain on sale of property and
equipment......................... (4,077) (4,096) --
Non-cash interest on convertible
promissory notes.................. -- -- 393,750
Stock-based compensation........... -- -- 1,025,490
Changes in assets and liabilities:
Accounts receivable, net.......... -- (1,647,632) (3,352,140)
Inventories....................... -- (243,620) (2,148,704)
Prepaid expenses and other........ (34,241) (223,035) (180,392)
Other assets...................... (154,176) (115,805) (519,939)
Technology license obligation..... (30,000) (50,000) (170,000)
Accounts payable and accrued
expenses......................... 617,288 3,112,008 4,326,628
------------ ------------ ------------
Net cash used in operating
activities..................... (4,612,979) (12,540,921) (13,963,426)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment... (124,939) (544,687) (1,151,852)
Purchase of marketable securities.... (11,493,305) -- --
Proceeds from sale of marketable
securities.......................... 2,370,834 10,500,000 --
Proceeds from sale of property and
equipment........................... 109,420 -- --
Payment received on note receivable.. 33,536 -- --
------------ ------------ ------------
Net cash provided by (used in)
investing activities........... (9,104,454) 9,955,313 (1,151,852)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible
promissory notes.................... -- -- 8,500,000
Line of credit borrowings, net....... -- 770,429 1,195,713
Principal payments on long-term debt
and capital lease obligations....... (136,610) (607,781) (632,277)
Deferred public offering costs....... -- -- (69,661)
Proceeds from exercise of common
stock options....................... 6,600 130,480 52,504
Proceeds from issuance of preferred
stock, net of issuance costs........ 14,300,975 12,448,176 --
Proceeds from exercise of preferred
stock warrants, net of issuance
costs............................... -- 60,001 --
------------ ------------ ------------
Net cash provided by financing
activities..................... 14,170,965 12,801,305 9,046,279
------------ ------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS........... -- (3,817) 78,714
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.................... 453,532 10,211,880 (5,990,285)
CASH AND CASH EQUIVALENTS, beginning
of year............................. 1,264,128 1,717,660 11,929,540
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of
year................................ $ 1,717,660 $ 11,929,540 $ 5,939,255
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for
interest.......................... $ 50,603 $ 178,447 $ 444,177
SUPPLEMENTAL DISCLOSURE OF NONCASH
FINANCING AND INVESTING ACTIVITIES:
Equipment acquired under capital
leases............................ $ 842,118 $ 1,757,975 $ 1,443,025
Mandatorily redeemable convertible
preferred stock accretion......... $ 593,403 $ 1,561,470 $ 2,431,545
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) NATURE OF OPERATIONS
Sonic Innovations, Inc. (the "Company") began its operations in 1991 and
reincorporated in Delaware in 1997. The Company designs, manufactures and
markets advanced digital hearing aids designed to provide the highest levels of
satisfaction for hearing impaired customers. Capitalizing on a new
understanding of human hearing, the Company has developed patented digital
signal processing, or DSP, technologies and embedded them in the smallest
single-chip DSP platform ever installed in a hearing aid. The Company launched
its first branded line, NATURA, in September 1998. The Company sells finished
hearing aids, partial hearing aids and hearing aid components to hearing care
professionals, distributors and other hearing aid manufacturers in the United
States, and much of Europe, Japan, Australia and Canada.
The Company has incurred operating losses since its inception. The Company is
subject to a number of risks associated with companies in a similar stage of
operations, including dependence on key employees for technology and support,
potential competition from larger, more established companies, the need to
penetrate the market with new products and the ability to obtain adequate
financing to support its growth. The Company's activities to date have been
financed primarily through private placements of equity securities, including
preferred stock issuances of $14,300,000 in 1997 and $12,400,000 in 1998, and
borrowings under a credit facility established in 1998. The Company raised
additional capital by issuing $8,500,000 million of convertible promissory
notes in 1999. The Company is seeking additional capital through the issuance
of equity securities, but there can be no assurance that additional funding
will be available to the Company on acceptable terms, if at all.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Sonic
Innovations, Inc. and its wholly owned subsidiary, Sonic Innovations A/S, a
Danish corporation. All significant intercompany balances and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and revenues and expenses, as well as the disclosure of contingent
assets and liabilities. Actual results could differ from those estimates.
Sales, Sales Returns and Concentrations of Credit Risk
The Company sells its branded products directly to hearing care professionals
in the United States and through a network of established distributors in much
of Europe, Japan, Australia and Canada. The Company also sells hearing aid
components to other hearing aid manufacturers. Sales are recognized when
products are shipped. Net sales consist of product sales less provisions for
sales returns, which are made at the time of sale. The Company has a 90-day
return period for its branded products, does not allow returns of its component
products and accounts for returns in accordance with SFAS No. 48. The
provisions for sales returns aggregated $696,000 and $10,088,000 in 1998 and
1999, respectively. As of December 31, 1998 and 1999, allowances for sales
returns of $282,000 and $1,974,000, respectively, were reflected as a reduction
in accounts receivable.
F-7
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenues related to the sale of extended warranties are deferred and
recognized on a straight-line basis over the warranty period. As of December
31, 1999, deferred warranty revenue of $87,000 was included in other accrued
expenses.
The Company performs ongoing credit evaluations of its customers and provides
for doubtful accounts, which have been within management's expectations. As of
December 31, 1998 and 1999, the allowances for doubtful accounts were $51,400
and $461,000, respectively. During 1999, the Company had two significant
customers which comprised 26% and 10% of net sales. As of December 31, 1999,
these two customers combined accounted for approximately 38% of the net
accounts receivable balance.
Warranty Costs
At the time of sale, the Company provides for the cost of remaking and
repairing products under warranty. These costs are included in cost of sales.
The warranty period is generally one or two years for branded products and 30
to 120 days for component products. Because of the length of the warranty
period, adjustments to the originally recorded provisions may be necessary from
time to time. In 1998 and 1999, the provisions for warranty costs were $200,000
and $1,318,000, respectively. As of December 31, 1998 and 1999, the warranty
reserve was $83,000 and $364,000, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid, short-term investments purchased
with an original maturity of three months or less to be cash equivalents. As of
December 31, 1998 and 1999, cash equivalents consisted of certificates of
deposit and money market funds totaling $11,197,596 and $47,403, respectively.
Restricted Cash
In July 1999, the Company entered into a lease for its headquarters facility
that required the Company to deposit $560,000 into a restricted account for the
benefit of the landlord in the event of payment default. This amount may be
reduced provided certain financial milestones are met. Upon completion of an
IPO which raises a minimum of $20,000,000, the restricted account may be
reduced to a one-month security deposit of $101,323. As of December 31, 1998
and 1999, $50,000 was on deposit in a restricted account as collateral for a
merchant services agreement. Both of these deposits are long-term in nature and
classified as other assets.
Marketable Securities
During 1998, the Company had marketable securities consisting primarily of
short-term government and corporate securities which were recorded at fair
value. During 1999, the Company had no marketable securities. The proceeds from
sales of available-for-sale marketable securities during 1997 and 1998 were
$2,370,834 and $10,500,000, respectively. The realized gains on those sales
were $12,466 and $323,466 for the years ended December 31, 1997 and 1998,
respectively.
F-8
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Inventories
Inventories are stated at the lower of cost or market value using the FIFO
(first-in, first-out) method. Inventories at December 31, 1998 and 1999
consisted of the following:
<TABLE>
<CAPTION>
1998 1999
-------- ----------
<S> <C> <C>
Raw materials.......................................... $239,257 $1,365,443
Components............................................. -- 501,111
Work in process........................................ 4,363 159,059
Finished goods......................................... -- 342,760
-------- ----------
$243,620 $2,368,373
======== ==========
</TABLE>
Provision is made to reduce excess and obsolete inventories to their
estimated net realizable values. As of December 31, 1998 and 1999, the reserves
for excess and obsolete inventories were $60,000 and $250,000, respectively.
Purchase Commitments
The Company reviews its firm purchase commitments at each reporting date to
determine if commitments are at prices in excess of net realizable value. To
the extent such commitments exceed net realizable value, the Company's policy
is to recognize a loss in the period in which an impairment in value becomes
evident. There were no losses recognized in 1997, 1998 and 1999.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
calculated using the straight-line method over the estimated useful lives of 7
years for furniture and fixtures and 3 to 5 years for machinery and equipment.
Leasehold improvements are amortized over the lease term of up to 5 years.
Upon the retirement or other disposition of property and equipment, the cost
and related accumulated depreciation or amortization are removed from the
accounts. The resulting gain or loss is included in other income (expense).
Major renewals and betterments are capitalized while minor expenditures for
maintenance and repairs are charged to expense as incurred.
Patent Costs
During 1997, 1998 and 1999, the Company expensed direct costs associated with
obtaining and filing patents of $105,000, $148,000 and $342,000, respectively.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash, cash
equivalents, accounts receivable, accounts payable, debt instruments and
mandatorily redeemable convertible preferred stock. The Company believes that
the carrying amounts of its financial instruments approximate their fair
values. The estimated fair values have been determined using appropriate market
information and valuation methodologies.
Foreign Currency Translation
The accounts of Sonic Innovations A/S are translated into U.S. dollars using
the exchange rate at the balance sheet date for assets and liabilities and the
weighted average exchange rate for the period for revenues, expenses, gains and
losses. Translation adjustments are recorded as a separate component of
comprehensive income (loss). Gains or losses resulting from foreign currency
transactions are included in other income (expense).
F-9
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive Income (Loss)
For the year ended December 31, 1997, other comprehensive income consisted of
unrealized gains on marketable securities. For the year ended December 31,
1998, the components of other comprehensive loss consisted of a $3,817 foreign
currency translation adjustment and a $51,221 reclassification adjustment
related to an unrealized gain becoming a realized gain on marketable
securities. For the year ended December 31, 1999, other comprehensive loss
consisted of a foreign currency translation adjustment.
Research and Development
Research and development costs, which include basic research, development of
useful ideas into new products, continuing support and enhancement of existing
products and regulatory and clinical activities, are expensed as incurred.
Advertising
Advertising costs are expensed as incurred. Advertising costs for 1998 and
1999 were $562,000 and $2,606,000, respectively. No advertising costs were
incurred in 1997.
Net Loss Per Common Share
Basic and diluted net loss per common share were computed by dividing net
loss applicable to common stockholders by the weighted average number of common
shares outstanding. Common stock equivalents were not considered since their
effect would be antidilutive, thereby decreasing the net loss per common share.
As of December 31, 1999, common stock equivalents consisted of options for
2,580,844 shares; warrants for 285,169 shares (assuming conversion into common
stock of 17,258 shares of Series C preferred stock and 31,058 shares of Series
D preferred stock issuable upon exercise of outstanding warrants); $8,500,000
of convertible promissory notes convertible at either 93% or 100% of the
Company's initial public offering price; and 12,532,786 shares of convertible
preferred stock convertible on a share-for-share basis into common stock.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133") "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 requires the
recognition of all derivatives as either assets or liabilities in the balance
sheet and the measurement of those instruments at fair value. Gains and losses
resulting from changes in the values of those derivatives would be accounted
for depending on the use of the derivative and whether it qualifies for hedge
accounting. SFAS No. 133 is expected to be effective for the Company's year
ending December 31, 2001. The Company currently expects this new pronouncement
to have no material impact on its financial statements.
(3) LINE OF CREDIT
The Company has a lending arrangement with a bank that includes a line of
credit agreement providing for maximum borrowings of $4,000,000 (subject to
various limitations). Borrowings under the line of credit at December 31, 1999
were $1,966,142 and bear interest at the bank's prime rate plus 2.0% (10.5% at
December 31, 1999). The agreement expires on June 30, 2000. Borrowings under
the line of credit are secured by substantially all assets of the Company. The
line of credit requires financial and other covenants that include the
maintenance of a specified level of tangible
F-10
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
net worth, as well as restrictions on incurring additional unsubordinated
indebtedness, pledging or encumbering the Company's assets, paying dividends
and entering into mergers and acquisitions. As of December 31, 1999, the
Company was in compliance with all covenants. In connection with obtaining the
line of credit, the Company issued warrants to the bank to purchase 31,058
shares of Series D convertible preferred stock at an exercise price of $3.80
per share. The Company can reduce the number of shares issued pursuant to these
warrants to 20,706 shares if the Company completes an initial public offering
by May 31, 2000. The warrants expire in December 2004. The estimated fair value
of the warrants at the grant date of $204,000 was recorded as a debt issuance
cost and is being amortized over the term of the agreement. Subsequent to year-
end, the Company repaid all borrowings under the line of credit.
This line of credit replaced a $5,000,000 line of credit that was established
in 1998 which bore interest at the bank's prime rate plus 0.5% (8.25% at
December 31, 1998). Borrowings under that line of credit at December 31, 1998
were $770,429. During 1999, the Company's non-compliance with certain financial
covenants under the 1998 line of credit was permanently waived by the bank upon
entering into the new agreement.
The Company's maximum borrowings under the lines of credit during 1998 and
1999 were $770,429 and $1,966,142, respectively. During 1998 and 1999, the
Company had weighted average outstanding borrowings under the line of credit
agreement of $250,000 and $1,750,000, respectively with weighted average
interest rates of 8.80% and 8.51%, respectively.
(4) CAPITAL LEASE OBLIGATIONS
At December 31, 1998 and 1999, the Company held certain property and
equipment with a cost of $2,653,575 and $3,544,067, respectively, under capital
lease agreements with a bank. As of December 31, 1998 and 1999, the Company had
recorded accumulated amortization of $630,077 and $845,382, respectively,
related to these assets.
The following is a schedule by year of future minimum lease payments under
capital lease obligations together with the present value of the net minimum
lease payments at December 31, 1999:
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
2000........................................................... $1,116,669
2001........................................................... 864,299
2002........................................................... 791,238
2003........................................................... 509,805
2004........................................................... 101,675
----------
Total net minimum lease payments............................... 3,383,686
Less amount representing interest.............................. (584,656)
----------
Present value of net minimum lease payments.................... 2,799,030
Current portion................................................ (863,585)
----------
Long-term portion.............................................. $1,935,445
==========
</TABLE>
In connection with entering into a capital lease agreement in 1998, the
Company issued warrants to a bank to purchase 17,258 shares of the Company's
Series C preferred stock at an
F-11
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
exercise price of $3.04 per share. The warrants expire in May 2003. The fair
value of the warrants was determined to be insignificant at the date of grant.
During 1999, the Company's non-compliance with certain financial covenants of
the capital lease agreement was permanently waived by the bank.
(5) CONVERTIBLE PROMISSORY NOTES
In July 1999, the Company issued $4,500,000 of convertible promissory notes
to existing preferred stockholders. The notes accrue interest at an annual rate
of 6% and principal and accrued interest automatically convert into shares of
common stock upon the closing of the Company's IPO at the IPO price. If there
is no IPO, the notes automatically convert into common stock on August 3, 2000
at a price of $3.80 per share. In connection with selling these notes, the
Company issued warrants for the purchase of 236,853 shares of its common stock
at $3.80 per share. The warrants expire on the earliest of: (i) July 29, 2002;
(ii) the closing of the Company's IPO; or (iii) the closing of an acquisition
of the Company. The Company allocated the $4,500,000 of proceeds between the
notes and the warrants based upon the relative fair values at the date of
issuance. This resulted in allocating $3,555,000 to the notes and $945,000 to
the warrants. The difference between the face amount of the notes and the
amount allocated to the notes is recorded as interest expense over the term of
the notes.
In December 1999, the Company issued a $4,000,000 convertible promissory note
to Hoya Healthcare Corporation ("Hoya"), a Japanese company that distributes
the Company's branded products in Japan. The note accrues interest at an annual
rate of 6% and automatically converts into shares of common stock upon the
closing of the Company's IPO at 93% of the IPO price. The contingent beneficial
conversion feature of 93% of the IPO price has a fair value of $280,000. This
amount will be recorded as additional interest expense if and when the
contingency (completion of an IPO) is resolved. Under the convertible note
purchase agreement, Hoya has agreed to purchase an additional $6,000,000 of
convertible promissory notes according to the following schedule:
. If the IPO occurs by March 31, 2000, on the effective date of the IPO
Hoya will purchase a $6,000,000 convertible note which will be
immediately converted to common stock at the IPO price.
. If the IPO occurs between April 1, 2000 and June 30, 2000, Hoya will
purchase (i) a $3,000,000 convertible note on March 31, 2000 which will
be converted on the effective date of the IPO at 93% of the IPO price
and (ii) a $3,000,000 convertible note on the effective date of the IPO
which will be immediately converted at the IPO price.
. If the IPO occurs after June 30, 2000, Hoya will purchase (i) a
$3,000,000 convertible note on March 31, 2000 and (ii) a $3,000,000
convertible note on June 30, 2000, both of which will be converted on
the effective date of the IPO at 93% of the IPO price.
If there is no IPO, the Company must repay the notes with interest one year
from the date of Hoya's purchase of the notes.
F-12
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(6) COMMITMENTS
Operating Leases
The Company leases various equipment and office space under noncancelable
operating leases that expire at various dates through 2004. Rental expense for
equipment and office space for the years ended December 31, 1997, 1998 and 1999
was $156,475, $279,062 and $835,198, respectively. Future minimum lease
payments under noncancelable leases at December 31, 1999 were as follows:
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
2000........................................................ $1,430,607
2001........................................................ 1,453,680
2002........................................................ 1,441,647
2003........................................................ 1,467,508
2004........................................................ 1,032,918
----------
$6,826,360
==========
</TABLE>
The Company subleases office space in its Salt Lake City facility. Sublease
revenue totaled $30,080 in 1999. Revenue from subleases is expected to be
$169,876 in 2000, $153,917 in 2001 and $99,606 in 2002.
Brigham Young University Technology License Agreements
In 1995, the Company entered into a license agreement, as amended in 1996,
with Brigham Young University ("BYU"). The agreement provides the Company with
an exclusive worldwide license to utilize certain technology, including patents
and patents pending involving hearing aid signal processing, audio signal
processing and hearing compression. The agreement remains in effect until the
expiration of the latest patent right in 2013 and can be terminated by BYU in
the event of circumstances outlined in the agreement. During the term of the
agreement, the Company is responsible for the payment of all fees and costs
associated with filing and maintaining patent rights. As consideration for the
license, the Company issued 96,843 shares of its common stock to BYU, paid a
license fee of $80,000 during 1995 and agreed to pay an additional license fee
of $500,000 as follows: $30,000 in 1996, $50,000 in 1997, $70,000 in 1998,
$100,000 in 1999, $100,000 in 2000 and $150,000 in 2001. The Company may (but
is not entitled to) receive a credit against the $500,000 license fee for
certain approved research conducted through BYU. The Company is required to
make royalty payments to BYU equal to 50% of any consideration received from
sublicensing, assigning or transferring the licensed technology. This agreement
may be terminated without cancellation fees. Amounts paid and owed under the
agreement have been accounted for as purchased research and development and
expensed accordingly. The Company has classified as a current liability the
portion of its license obligations due within the next year.
In 1997, the Company entered into a separate license agreement with BYU to
utilize certain "noise suppression" technologies owned by BYU. The agreement
remains in effect indefinitely, unless terminated by BYU in the event of
circumstances outlined in the agreement. As consideration for the license, the
Company paid a license fee of $50,000, which was expensed during 1997. The
Company is also required to make royalty payments to BYU in the amount of 0.5%
of the adjusted gross sales of the licensed products sold or otherwise
transferred to an end user, with an annual minimum royalty of $50,000. Royalty
payments are to be paid as long as the Company uses this
F-13
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
technology. This agreement may be terminated without cancellation fees. During
1998 and 1999, royalties expensed under this agreement were $50,000 because the
related technology has not yet been incorporated into the Company's products.
The Company expects to begin selling products incorporating this technology
during the second quarter of 2000. The Company is also required to pay a "pass
through royalty" of 50% on any transfer of technology to a third party that is
not an end user. No such royalties were incurred or paid in 1997, 1998 and
1999.
K/S HIMPP License Agreement
In 1998, the Company entered into a license agreement with K/S HIMPP, a
Danish partnership, whereby the Company purchased the rights to use technology
covered by approximately 200 patents owned by K/S HIMPP that are considered
essential for the sale of programmable hearing aids. In connection with this
agreement, the Company is required to pay K/S HIMPP a royalty equal to 3% of
net sales of related products. HIMPP royalty expense in 1998 and 1999 totaled
$85,000 and $429,000, respectively. The agreement remains in effect until 2013.
Other License Agreement
In 1999, the Company entered into a license agreement to resolve a claim of
patent infringement made by a competitor under which the Company pays a 1.5%
royalty on all net sales of hearing aids for the period October 1998 through
September 2001, at which time the license will be paid in full. Royalty expense
pertaining to the agreement was $463,000 in 1999.
Supplier Purchase Commitment
In 1997, the Company entered into an agreement with an integrated circuit
manufacturer to purchase integrated circuits used in the Company's products.
The agreement provides the manufacturer with a non-exclusive, non-sublicensable
license to use the Company's technology for non-hearing applications. In
return, the manufacturer granted the Company a license to minor improvements or
enhancements made to the technology by the manufacturer for hearing
applications. The Company made purchases totalling approximately $1,239,000 and
$151,000 in 1999 and 1998, respectively. The agreement requires the Company to
make future minimum purchases based on a fixed minimum number of integrated
circuits at a fixed price per integrated circuit. Non-cancelable minimum
commitments are as follows:
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
2000...................................................... $1,125,000
2001...................................................... 2,475,000
2002...................................................... 750,000
-----------
$4,350,000
===========
</TABLE>
The Company purchases all of its integrated circuits from this manufacturer.
Should this manufacturer be unable to provide the Company with these integrated
circuits, the ability of the Company to produce products for sale could be
materially impaired. The Company purchases other components including receivers
and microphones from a limited number of suppliers.
Employment Agreements
The Company has entered into employment agreements with various officers and
key employees that provide for, among other things, minimum annual base
salaries, bonuses and
F-14
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
severance arrangements. The employment agreements may be terminated by either
party. As of December 31, 1999, the Company had accrued an aggregate of
approximately $247,000 for discretionary bonuses related to these agreements.
(7) INCOME TAXES
Net loss before income taxes consisted of the following components for the
years ended December 31, 1997, 1998 and 1999:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ----------- -----------
<S> <C> <C> <C>
Domestic................................ $5,234,882 $13,471,481 $13,746,935
Foreign................................. -- 406,541 1,158,925
---------- ----------- -----------
Total................................. $5,234,882 $13,878,022 $14,905,860
========== =========== ===========
</TABLE>
Deferred tax assets and liabilities are determined based on the differences
between the financial reporting and tax bases of assets and liabilities using
enacted tax rates expected to apply when differences are expected to be settled
or realized. As of December 31, 1998 and 1999, the components of the deferred
tax assets were as follows:
<TABLE>
<CAPTION>
1998 1999
----------- ------------
<S> <C> <C>
Net operating loss carryforwards.............. $ 5,231,548 $ 9,631,272
Start-up costs capitalized for tax reporting
purposes..................................... 2,628,157 2,147,135
Receivables allowances........................ 124,480 872,820
Reserves and other differences................ 314,356 276,135
----------- ------------
8,298,541 12,927,362
Valuation allowance........................... (8,298,541) (12,927,362)
----------- ------------
$ -- $ --
=========== ============
</TABLE>
A valuation allowance for the total net deferred tax assets was recorded due
to the uncertainty of realization of the assets based upon the limited
operating history of the Company, the lack of profitability to date and no
assurance of future profitability.
As of December 31, 1999, the Company had net operating loss carryforwards for
federal income tax reporting purposes totaling approximately $24,478,000 and
foreign net operating loss carryforwards of approximately $1,565,000. The
foreign net operating loss carryforwards expire in 2003 and 2004, the federal
net operating loss carryforwards expire as follows:
<TABLE>
<CAPTION>
Year Arising Year Expiring
------------ -------------
<C> <S> <C>
1992 2007.............................................. $ 43,000
1993 2008.............................................. 66,000
1994 2009.............................................. 108,000
1995 2010.............................................. 401,000
1996 2011.............................................. 992,000
1997 2012.............................................. 2,708,000
1998 2018.............................................. 8,940,000
1999 2019 ............................................. 11,220,000
-----------
$24,478,000
===========
</TABLE>
F-15
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Internal Revenue Code contains provisions that reduce or limit the
availability and utilization of net operating loss carryforwards if certain
changes in ownership have taken place or will take place. In December 1993 and
September 1995, changes in the ownership of the Company resulted in limitations
on all pre-existing net operating loss carryforwards of the Company. As a
result, management estimates that approximately $103,000 of the Company's net
operating loss carryforwards arising in 1992 and 1993 are limited to
utilization of approximately $15,000 per year, and that approximately $409,000
of the Company's net operating loss carryforwards arising in 1994 and 1995 are
limited to utilization of approximately $140,000 per year. If the annual
limited amount is unutilized in any particular year, it remains available on a
cumulative basis through the expiration date of the applicable net operating
loss carryforwards.
Additionally, the Company anticipates that the public sale of its stock may
result in another ownership change on or about the public sale date depending
upon the number of shares sold and various other factors. If an ownership
change occurs, the Company's net operating loss carryforwards arising in 1996
through the public sale date will be limited to utilization of an annual amount
not to exceed the value of the Company on the ownership change date multiplied
by the Federal long-term tax-exempt rate (the rate is fixed monthly and was
5.73% as of February 2000).
(8) PREFERRED STOCK
The Company's certificate of incorporation authorizes the issuance of
13,907,895 shares of preferred stock with terms and preferences designated
therein. As of December 31, 1999, the Company had designated 449,277 shares as
Series A convertible ("Series A"), 4,635,378 shares as Series B redeemable,
convertible ("Series B"), 4,161,692 shares as Series C redeemable, convertible
("Series C"), and 3,381,579 shares as Series D redeemable, convertible ("Series
D").
During 1997, 1,314,045 shares of Series B were sold for $1,825,192 in cash,
9,266 shares of Series B were issued for services performed totaling $24,999,
and 4,118,421 shares of Series C were sold for $12,520,000 in cash. Direct
costs associated with the sale of Series C of $44,217 were netted against the
proceeds from the sale.
During 1998, warrants for the purchase of 48,584 shares of Series A with an
exercise price of $1.24 per share were exercised for cash totaling $60,001,
26,013 shares of Series C were issued for services performed totaling $79,032,
3,289,486 shares of Series D were sold for $12,500,000 in cash and 4,737 shares
of Series D were issued for services performed totaling $18,000. Direct costs
associated with the sale of Series D of $51,824 were netted against the
proceeds from the sale.
During 1999, the Company issued 9,474 shares of Series D for services
totaling $36,000.
Series A, B, C and D preferred stock are convertible at any time, at the
option of the holders, at the initial rate of one common share for each
preferred share. The number and kind of securities issuable upon conversion is
subject to adjustment from time to time upon the occurrence of certain events
as outlined in the certificate of incorporation and the sales agreements. The
preferred stockholders are entitled to one vote for each share of common stock
into which such holder's preferred stock is convertible. In addition, the
preferred stockholders are entitled to elect seven of the eight members of the
Board of Directors. In the event of the occurrence of any liquidation event,
the holders of Series A have preference over the common stockholders up to
their invested capital and the holders of Series B, C and D have preference
over the Series A and common stockholders up to the Series B, C and D invested
capital. The preferred stockholders have entered into agreements with the
Company that provide piggyback and demand registration rights.
F-16
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Shares of Series B, C and D are redeemable on or after October 23, 2003 at
the election of 66 2/3 of each Series' holders. The redemption prices are equal
to the prices paid for each Series plus 7% for each year outstanding. As a
result of the mandatory redemption features, as of December 31, 1999, the
carrying values of Series B, C and D have been increased by $523,218, $989,659
and $918,668, respectively, to accrete each Series to its redemption value.
The holders of Series B, C and D are entitled to noncumulative per share
dividends of $0.13, $0.30 and $0.38, respectively, payable when and if declared
by the Board of Directors. As of December 31, 1999, no dividends had been
declared.
(9) STOCK-BASED COMPENSATION
Stock Options
The Company's 1993 Stock Plan (the "Plan") provides for the issuance of a
maximum of 3,894,737 shares of common stock to officers, directors, consultants
and other employees. The Plan allows for the grant of incentive or nonqualified
stock options and stock purchase rights and is administered by the Board of
Directors. The Board of Directors determines the quantity, type of award, and
terms and conditions, including any vesting conditions. The maximum term of an
option may not exceed ten years and the Plan will expire in 2003. As of
December 31, 1999, 335,516 shares were available for grant under the Plan.
Options generally vest over a four-year period from the grant date.
The Company accounts for stock options issued to employees, officers and
directors under Accounting Principles Board Opinion No. 25 ("APB No. 25") and
those issued to consultants or nonemployees are accounted for under Statement
of Financial Accounting Standards No. 123 ("SFAS No. 123"). Under APB No. 25,
compensation cost is recognized if an option's exercise price is below the
intrinsic fair market value of the Company's stock at the grant date. Under
SFAS No. 123, compensation cost is recognized for the fair market value of each
option as estimated on the date of grant using the Black-Scholes option pricing
model. If compensation expense for all stock options had been determined
consistent with SFAS No. 123, the Company's net loss and diluted net loss per
common share would have been increased as follows:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ----------- -----------
<S> <C> <C> <C>
Net loss:
As reported......................... $5,234,882 $13,878,022 $14,905,860
Pro forma........................... 5,253,529 13,944,130 15,134,313
Basic and diluted net loss per common
share:
As reported......................... 8.23 15.61 12.72
Pro forma........................... 8.25 15.68 12.88
</TABLE>
F-17
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the Company's stock option activity for 1997, 1998 and 1999 is
as follows:
<TABLE>
<CAPTION>
Weighted Average
Shares Exercise Price
--------- ----------------
<S> <C> <C>
Outstanding at December 31, 1996............... 1,011,053 $0.23
Granted in 1997................................ 368,947 0.29
Exercised in 1997.............................. (34,210) 0.19
Forfeited or expired in 1997................... (92,105) 0.21
---------
Outstanding at December 31, 1997............... 1,253,685 0.25
Granted in 1998................................ 1,127,789 0.97
Exercised in 1998.............................. (564,158) 0.23
Forfeited or expired in 1998................... (37,933) 0.40
---------
Outstanding at December 31, 1998............... 1,779,383 0.70
Granted in 1999................................ 1,087,105 4.33
Exercised in 1999.............................. (169,510) 0.30
Forfeited or expired in 1999................... (116,134) 1.27
---------
Outstanding at December 31, 1999............... 2,580,844 2.23
=========
</TABLE>
As of December 31, 1999, there were options for 774,278 shares of common
stock exercisable at a weighted average exercise price of $.70 per share.
Stock options outstanding as of December 31, 1999 were as follows:
<TABLE>
<CAPTION>
Weighted
Average
Number of Remaining Number of
Options Contractual Options
Exercise Price Outstanding Life Exercisable
-------------- ----------- ----------- -----------
<S> <C> <C> <C>
$0.19.................................. 174,649 3.76 172,895
0.27.................................. 289,399 5.13 126,242
0.48.................................. 174,474 8.03 111,228
0.67.................................. 327,453 8.28 167,779
0.95.................................. 94,559 8.59 40,453
1.14.................................. 169,763 8.78 49,421
1.43.................................. 284,145 8.96 77,949
1.90.................................. 43,158 9.14 1,996
2.85.................................. 202,289 9.41 --
3.80.................................. 415,526 9.79 26,315
5.70.................................. 347,368 9.89 --
7.60.................................. 58,061 9.95 --
--------- -------
2,580,844 774,278
========= =======
</TABLE>
The fair market value of each option is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997, 1998 and 1999: risk-free interest rates of
7.00%, 6.75% and 6.33%, respectively; expected dividend yields of zero percent;
volatility of zero percent; and expected lives of 7 years.
During 1997, the Company expensed $22,400 related to the remeasurement of
certain stock option values due to changing their exercisable lives from 7
years to 10 years. During 1999, the
F-18
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company expensed $170,000 related to the remeasuring of certain stock option
values due to accelerating their vesting dates.
In connection with the issuance of certain stock options to employees in
1999, the Company recorded deferred stock-based compensation in the aggregate
amount of approximately $4,638,000, representing the difference between the
deemed fair value of the Company's common stock for accounting purposes and the
exercise price of stock options at the date of grant. The Company is amortizing
the deferred stock-based compensation over the option vesting periods of three
to six years. For the year ended December 31, 1999, amortization expense was
$1,025,490. At December 31, 1999, the remaining stock-based compensation of
approximately $3,613,000 will be amortized as follows: $2,061,000 in 2000,
$917,000 in 2001, $422,000 in 2002, $156,000 in 2003, $40,000 in 2004 and
$17,000 in 2005. The amount of deferred stock-based compensation expense to be
amortized in future periods could decrease if the related options are
forfeited.
Warrants
At December 31, 1999, the following warrants to purchase common or preferred
stock were outstanding:
<TABLE>
<CAPTION>
Exercise
Warrants Price
-------- --------
<S> <C> <C>
Issued in connection with 1999 convertible promissory notes
(See Note 5) .............................................. 236,853 $3.80
Issued in connection with 1999 bank lending arrangement..... 31,058 3.80
Issued in connection with 1998 bank lending arrangement..... 17,258 3.04
-------
Total warrants outstanding at December 31, 1999............. 285,169
=======
</TABLE>
The warrants issued in connection with the 1999 bank lending arrangement will
be decreased to 20,706 shares if the Company completes an IPO by May 31, 2000.
The warrants issued in connection with the 1998 and 1999 bank lending
arrangement expire in May 2003 and December 2004, respectively.
During 1998, the Company received $60,001 in cash upon the exercise of
warrants. These warrants had been granted in connection with the issuance of
convertible notes payable in 1993, and provided for the purchase of 48,584
shares of Series A preferred stock at $1.24 per share.
(10) EMPLOYEE 401(k) PLAN
In 1997, the Company established an employee savings and retirement plan that
is a salary deferral plan under Section 401(k) of the Internal Revenue Code.
The Company's matching contributions are determined annually by the board of
directors. The Company did not make matching contributions to this plan in
1997, 1998 or 1999.
(11) SEGMENT INFORMATION
The Company currently operates through two geographic operating segments--
Sonic Innovations, Inc., a U.S.-based operation, and Sonic Innovations A/S, a
Denmark-based operation. Sonic Innovations, Inc. sells products in the U.S. and
internationally, except for Europe. Sonic Innovations A/S sells products
exclusively in Europe. The Company generally evaluates its operating results on
a company-wide basis because (1) the principal components of all products are
sourced
F-19
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
from the United States and (2) all research and development and considerable
marketing and administrative support are globally provided from the United
States. However, management reviews the operating results of Sonic Innovations
A/S to make decisions about resource allocation and to assess performance.
The table below presents information for the Company's geographical operating
segments for 1998 and 1999.
<TABLE>
<CAPTION>
United
1998 States Europe Total
---- ------------ ---------- ------------
<S> <C> <C> <C>
Net sales to external customers... $ 2,142,958 $ -- $ 2,142,958
Operating loss.................... (13,782,648) (406,541) (14,189,189)
Identifiable segment assets....... 16,711,206 161,228 16,872,434
Net property and equipment........ 2,461,196 55,187 2,516,383
<CAPTION>
United
1999 States Europe Total
---- ------------ ---------- ------------
<S> <C> <C> <C>
Net sales to external customers... $ 24,507,471 $4,186,675 $ 28,694,146
Operating loss.................... (12,882,547) (868,478) (13,751,025)
Identifiable segment assets....... 15,423,589 3,038,462 18,462,051
Net property and equipment........ 3,609,646 128,038 3,737,684
</TABLE>
U.S. net sales include export sales.
In 1998, all sales were to customers located in the United States. In 1999,
sales representing more than 5% of the Company's net sales by country are as
follows:
<TABLE>
<S> <C>
United States................................ $20,724,523
Japan........................................ 2,926,417
Other........................................ 5,043,206
-----------
Total...................................... $28,694,146
===========
</TABLE>
A number of risks are inherent in international transactions. Fluctuations in
the exchange rates between the U.S. dollar and other currencies could increase
the sales price of the Company's products in international markets where the
prices of the Company's products are denominated in U.S. dollars or lead to
currency exchange losses where the prices of the Company's products are
denominated in local currencies.
The Company had two significant customers in 1999 which comprised 26% and 10%
of total net sales. The loss of either of these customers would have a material
adverse effect on the Company. There were no such customer concentrations in
1998.
(12) RELATED PARTY TRANSACTION
The Company's Vice President of Operations joined the Company in January
1999. He beneficially owned an information services consulting company that
provided services to the Company in exchange for $263,536, $583,788 and
$266,281 in 1997, 1998 and 1999, respectively.
F-20
<PAGE>
SONIC INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(13) SUBSEQUENT EVENTS
Reverse Stock Split
On March 22, 2000, the Board of Directors approved a 1 for 1.9 reverse stock
split for the holders of common and preferred stock. This stock split has been
retroactively reflected in the accompanying consolidated financial statements
for all years presented.
Unaudited Pro Forma Information
The Board of Directors has authorized the Company to file a Registration
Statement with the Securities and Exchange Commission permitting the Company to
sell shares of common stock in an initial public offering ("IPO"). If the IPO
is consummated as presently anticipated, all of the outstanding preferred
shares will be converted into 12,532,786 shares of common stock. In addition,
the convertible promissory notes and related accrued interest will be converted
into common stock in accordance with the applicable conversion terms as
described in Note 5. At an IPO price of $14.00 per share, the convertible
promissory notes and accrued interest as of December 31, 1999 would convert
into 636,901 shares of common stock. The conversion amounts will vary depending
upon the actual date of conversion. Also, warrants to purchase 236,853 common
shares at $3.80 per share will expire at the IPO date, if not exercised.
The unaudited pro forma balance sheet information reflects the conversion of
preferred stock and convertible promissory notes into common stock as if such
conversion had occurred as of December 31, 1999.
The unaudited pro forma income statement information assumes that the
conversions of preferred stock and convertible promissory notes and the
exercise of warrants occurred as of January 1, 1999, or the date of issuance of
the convertible instruments, if later. Reconciliations of the numerator and the
denominator used for purposes of computing the unaudited pro forma basic and
diluted net loss per common share are as follows:
<TABLE>
<S> <C>
Numerator:
Net loss applicable to common stockholders................. $(17,337,405)
Reversal of interest expense on convertible promissory
notes..................................................... 506,250
Reversal of accretion of preferred stock................... 2,431,545
------------
Pro forma net loss applicable to common stockholders....... $(14,399,610)
============
Denominator:
Weighted average number of common shares outstanding....... 1,363,221
Effect of conversion of preferred stock.................... 12,530,385
Effect of conversion of convertible promissory notes....... 134,960
Exercise of warrants....................................... 86,382
------------
Pro forma weighted average number of common shares
outstanding............................................... 14,114,948
============
</TABLE>
F-21
<PAGE>
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No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 8
Forward-Looking Statements............................................... 17
Use of Proceeds.......................................................... 18
Dividend Policy.......................................................... 18
Capitalization........................................................... 19
Dilution................................................................. 20
Selected Consolidated Financial Data..................................... 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Business................................................................. 29
Management............................................................... 45
Certain Transactions..................................................... 53
Principal Stockholders................................................... 55
Description of Capital Stock............................................. 57
Shares Eligible for Future Sale.......................................... 59
Underwriting............................................................. 61
Validity of the Common Stock............................................. 63
Experts.................................................................. 63
Where You Can Find Additional Information................................ 63
Index to Consolidated Financial Statements............................... F-1
</TABLE>
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Through and including May 26, 2000 (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 a dealer's obligation to deliver a prospectus when
acting as an underwriter and with respect to an unsold allotment or
subscription.
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3,600,000 Shares
Sonic Innovations, Inc.
Common Stock
---------------
[LOGO OF SONIC INNOVATIONS]
---------------
Goldman, Sachs & Co.
Deutsche Banc Alex. Brown
U.S. Bancorp Piper Jaffray
Representatives of the Underwriters
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