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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended: December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number 000-23767
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SYMPHONIX DEVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0376250
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2331 ZANKER ROAD,
SAN JOSE, CALIFORNIA 95131-1107
(address of principal executive offices) (zip code)
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Registrant's telephone number, including area code: (408) 232-0710
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock,
$.001 par value
(TITLE OF CLASS)
-----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of voting stock held by non-affiliates of the
registrant as of February 12, 1999 was approximately $15,546,168 based upon the
last sales price reported for such date on the NASDAQ National Market System.
For purposes of this disclosure, shares of Common Stock held by persons who hold
more than 5% of the outstanding shares of Common Stock and shares held by
officers and directors of the registrant, have been excluded in that such
persons may be deemed to be affiliates. This determination is not necessarily
conclusive.
At February 12, 1999, registrant had outstanding 12,205,793 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III of this Form 10-K is incorporated by
reference to the definitive proxy statement for the annual meeting of
stockholders of the Company which will be filed no later than 120 days after
December 31, 1998.
TABLE OF CONTENTS
Page
----
PART I 1
ITEM 1. BUSINESS 2
ITEM 2. PROPERTIES 26
ITEM 3. LEGAL PROCEEDINGS 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26
PART II 26
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 26
ITEM 6. SELECTED FINANCIAL DATA 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 29
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. 59
PART III 59
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 59
ITEM 11. EXECUTIVE COMPENSATION 61
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 61
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 61
PART IV 61
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 61
SIGNATURES 66
-i-
PART I
THIS ANNUAL REPORT ON FORM 10-K (THE "ANNUAL REPORT") CONTAINS CERTAIN FORWARD-
LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE
ACT OF 1934, AS AMENDED, (THE "EXCHANGE ACT"), INCLUDING STATEMENTS THAT
INDICATE WHAT THE COMPANY "BELIEVES", "EXPECTS" AND "ANTICIPATES" OR SIMILAR
EXPRESSIONS. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES
AND OTHER FACTORS WHICH MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF
THE COMPANY TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, THE INFORMATION
CONTAINED UNDER THE CAPTIONS "PART I, ITEM 1, BUSINESS," AND "PART II, ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" IN THIS ANNUAL REPORT. THE READER IS CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENT'S
ANALYSIS ONLY AS OF THE DATE OF THIS ANNUAL REPORT. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISION OF THESE FORWARD-
LOOKING STATEMENTS. THE READER IS STRONGLY URGED TO READ THE INFORMATION SET
FORTH UNDER THE CAPTIONS "PART I, ITEM 1, BUSINESS," AND "PART II, ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" FOR A MORE DETAILED DESCRIPTION OF THESE SIGNIFICANT RISKS AND
UNCERTAINTIES.
1
ITEM 1. BUSINESS
Overview
Symphonix Devices, Inc. ("Symphonix" or the "Company") is a developer of
proprietary semi-implantable and implantable products, or soundbridges, for the
management of moderate to severe hearing impairment. In 1994, mild to severe
hearing impairment affected approximately 26 million people in the United
States, or 10% of the population, of whom approximately 17 million people were
classified as moderately or severely hearing impaired. The Company believes that
its family of Vibrant soundbridges, designed to overcome the inherent
limitations of traditional hearing devices, represent a novel approach in the
management of hearing impairment. The Company's initial products, the Vibrant P,
Vibrant HF and Vibrant D soundbridges, are semi-implantable devices which
mechanically drive the three small bones of the middle ear to overcome the
user's hearing impairment. The Vibrant P soundbridge is a second generation
product that is similar to the first generation Vibrant soundbridge but is
designed to permit a greater degree of customization to address the specific
needs of a particular user's hearing loss and expand the types of hearing loss
that can be managed by the Company's products. The Vibrant HF soundbridge is
designed for people with a noise-induced high frequency hearing loss and the
Vibrant D soundbridge incorporates digital signal processing.
In September 1996, the Company initiated clinical trials of the first
generation Vibrant soundbridge in both the United States and Europe. The
Company initiated clinical trials of the Vibrant P soundbridge in Europe in July
1997 and in the United States in March 1998. In November 1998, the Company
initiated clinical trials of the Vibrant HF soundbridge in both Europe and the
United States. The Company has received permission to affix the CE mark in the
European Union to the Vibrant P and Vibrant HF soundbridges, and began selling
activities for the Vibrant P soundbridge in March 1998. The Company plans to
commence selling activities for the Vibrant HF soundbridge in Europe after it
has gathered clinical data on a limited number of patients. As of January 31,
1999, approximately 180 patients have been implanted with the Company's
soundbridges.
The Hearing Impairment Market
Background
The human ear consists of three regions: the outer ear, the middle ear and the
inner ear. The outer ear consists of the external auricle and the ear canal. The
ear canal is a passageway through which sound waves reach the middle ear. The
outer ear is separated from the middle ear by the tympanic membrane, commonly
referred to as the eardrum. The middle ear is a chamber that contains three tiny
bones, the malleus, the incus, and the stapes, that together are known as the
ossicles. The ossicles form a chain from the tympanic membrane to the inner ear.
The inner ear includes the cochlea, which is a fluid-filled structure that
contains a large number of delicate sensory hair cells that are connected to the
auditory nerve.
Sound, which is a wave-like vibration of the air, enters the ear canal and is
slightly amplified by the natural resonant characteristics of the ear canal.
These sound waves cause vibration of the tympanic
2
membrane and are amplified and transmitted to the fluid filling the inner ear by
the motion of the ossicles. The waves created in the fluid pass through the
snail-shaped cochlea and stimulate the delicate sensory hair cells. These hair
cells generate electrochemical signals that are detected by the auditory nerve
and are then subsequently interpreted by the brain as sound.
The signals that are interpreted by the brain as sound are distinguished by
frequency and intensity. The frequency of sound is perceived as pitch and is
measured in cycles per second, or Hertz ("Hz"). The normal human ear perceives
sounds in the range of 20 to 18,000 Hz, although most components of human speech
are generally in the range of 400 to 4,000 Hz. A more subtle aspect of frequency
is that certain letters of the alphabet are spoken at a different frequency than
others. For example, certain consonants such as "m," "n" and "g" and all vowels
are spoken at relatively low frequencies while other consonants and sounds such
as "t," "s," "f" and "sch" are spoken at higher frequencies. Accordingly, at a
given volume, certain letters may be more audible than others.
The intensity of sound is perceived as loudness and is measured in decibels
("dB"). The lowest level of intensity at which an individual perceives sound is
known as the threshold of hearing. The range in decibels from a person's
threshold of hearing to the level at which the person perceives sound to be
uncomfortably loud is known as the dynamic range. Both the threshold of hearing
and the dynamic range vary with the frequency of sound. An individual with
normal hearing can comfortably hear sounds ranging in intensity from
approximately 30 dB to 100 dB.
[ILLUSTRATION OF EAR ANATOMY]
Hearing Impairment
Hearing impairment can adversely effect a person's quality of life and
psychological well-being. Hearing impaired people often withdraw from
discussions and other social interactions to avoid frustration and embarrassment
from not being able to fully participate in and understand conversations.
Difficulty in communicating effectively can lead to negative emotions and
attitudes, increased stress levels and reduced self-confidence, sociability and
effectiveness in the workplace. In addition, recent studies suggest that hearing
impairment may be linked to physiological complications, such as heart disease.
Audiologists typically classify the hearing impaired population into four
categories: mild, moderate, severe and profound. In 1994, the total hearing
impaired population in the United States was approximately 26 million people, of
whom approximately 17 million were classified as either moderately or severely
hearing impaired.
While the exact causes of hearing impairment are varied and unclear, hearing
impairment can be characterized according to its physiological source. There are
two general categories of hearing impairment, conductive and sensorineural,
although sometimes a combination of the two may arise. Conductive hearing
impairment results from diseases or disorders that limit the transmission of
sound through the outer and/or middle ear. Conductive hearing impairment is
often treated surgically with an implanted prosthesis to replace part or all of
the ossicles. The Company believes that people with a
3
conductive hearing loss represent a small portion of the total hearing impaired
population.
Sensorineural hearing impairment occurs in the inner ear and/or neural
pathways and, the Company believes, accounts for the vast majority of hearing
impairment. In patients with sensorineural hearing impairment, the external and
middle ear function normally. The sound vibrations pass undisturbed through the
eardrum and ossicles, and fluid waves are created in the cochlea. However,
because some or many of the delicate sensory hair cells inside the cochlea have
degenerated or been damaged, the inner ear cannot detect the full intensity and
quality of the sound. Sensorineural hearing impairment typically occurs as a
result of aging or exposure to loud noise over a protracted period of time.
As people age, their level of hearing deteriorates and the dynamic range of
audible frequencies is compressed, especially at the higher frequencies. While
approximately 10% of the United States population is hearing impaired, based on
1994 data, this percentage increases to an average of approximately 25% for
individuals over 55 years of age. The Company believes that with the growth and
aging of the population, the hearing impaired population will continue to
increase throughout the industrialized world. With the increasing exposure to
noise in modern society, it has been observed that people may experience noise
induced hearing loss from aircraft, automobiles, lawn mowers and high powered
stereo equipment as well as military service and machinery within the workplace.
Existing Therapies
The traditional approaches to management of sensorineural hearing impairment
have been the use of hearing aids and cochlear implants. Hearing aids are the
most common devices used to manage mild to severe sensorineural hearing
impairment. Cochlear implants have been used for the narrow segment of the
sensorineural market represented by profound hearing impairment. However, both
approaches have significant limitations in addressing their respective markets.
Hearing Aids. The following table, based upon 1996 and 1997 articles in the
Hearing Journal, illustrates the ownership of traditional hearing aids by the
hearing impaired population in 1994. Approximately 18% of the hearing aid owners
did not use their device.
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Type of Hearing Impaired Hearing Aid Market
Hearing Population Owners Penetration of
Impairment (millions) (millions) Hearing Aids
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Mild 8.0 0.3 4%
Moderate 13.2 2.9 22%
Severe 3.9 2.0 51%
Profound 1.1 0.4 36%
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Total 26.2 5.6 21%
==========================================================================================================================
4
Hearing aids are acoustic drive devices that amplify sound to increase
the movement of the tympanic pmembrane and thereby indirectly vibrate the
ossicles in an attempt to overcome the decrease in sensitivity of the delicate
sensory hair cells inside the cochlea. The first electrically enhanced hearing
aid was invented about a hundred years ago and consisted of a microphone,
amplifier, battery and speaker. More recently, hearing aid manufacturers have
increased the sophistication of sound processing, often using digital
technology, to provide features such as programmability and multi-band
compression, allowing different degrees of amplification at different
frequencies. Hand-held programmers have also been developed to compensate for
the inability of hearing aids to adequately process sound in a variety of
acoustic environments. In addition, as technology has enabled greater
miniaturization, less obtrusive hearing aids have become available. Although
there have been continued advancements in hearing aid device technology, for
optimal performance all or part of the device must fit tightly in the ear canal,
which results in significant drawbacks, including the following:
Distorted sound quality. Obstructing the ear canal with either all or part of
the hearing aid creates an effect known as occlusion, where outside sounds
such as music are overwhelmed by internal sounds such as breathing or talking.
Because the ear canal's natural resonance is significantly altered, the
resulting sound can be unnatural and highly distorted.
Acoustic feedback. Feedback is a high pitched squeal which results when a
speaker and microphone are placed in close proximity and the sound from the
speaker is loud enough to be picked up by the microphone. The problem of
feedback is magnified since the volume of these devices must be turned up to
not only compensate for the patient's hearing impairment but to overcome the
reduction in sound caused by the blockage of the ear canal by the hearing aid.
In addition, as hearing aids have been manufactured in smaller configurations,
the problem of feedback has become inherently greater due to the closer
proximity of the speaker to the microphone.
Poor localization. Occlusion also results in the inability to differentiate
the direction of sounds, as well as the inability to adequately differentiate
between background noise and more important sounds, such as conversation.
Social stigma. Many hearing aid users and potential users perceive a strong
social stigma related to wearing a hearing aid.
Discomfort. Hearing aids have been manufactured in smaller configurations in
an attempt to address the perceived social stigma associated with wearing
these devices. Since a tight fitting ear piece is required for optimal
performance, the smaller versions of these devices must be placed deeper in
the ear canal, which can cause substantial discomfort.
Reliability. Hearing aids require frequent maintenance, in part due to their
placement in the ear canal, where ear wax can cause problems with the speaker
or dampen the sound produced by the hearing aid. Hearing aids generally have
to be replaced every three or four years, either because of loss, damage or
obsolescence. The need for periodic replacement increases the lifetime cost of
wearing a hearing aid. Traditionally, most hearing aid users have paid for
these devices directly.
5
As a result of these problems, the benefits perceived by hearing aid users are
generally very low. An article in the 1996 Hearing Journal reported that only
approximately 53% of all hearing aid users are satisfied. Reflecting this low
level of user satisfaction, in 1996 hearing aid manufacturers experienced
product return rates ranging from 14% to 26%. Despite the inherent limitations
of hearing aids, in 1995, approximately 1.7 million hearing aids were sold in
the United States, representing a retail market of approximately $1.2 billion.
The United States market represents approximately 38% of the worldwide hearing
aid market. The Company estimates that the worldwide retail market for hearing
aids exceeded $3.0 billion in 1995.
Cochlear Implants. Cochlear implants were originally developed for people who
have a profound hearing loss and are essentially deaf. The cochlear implant is
inserted into the inner ear in a highly invasive and non-reversible surgery,
that destroys residual hearing. The implant electrically stimulates the
auditory nerve through an electrode array that provides audible cues to the user
which are not interpreted by the brain as normal sound. Users generally require
intensive and extended counseling, speech therapy, and training following
surgery to be able to properly interpret these cues and achieve any benefit.
Best results are achieved with adults whose hearing loss develops later in life
or with children. Recently, some cochlear implants have been indicated for
severe hearing loss. However, cochlear implants have been controversial both
because of strong resistance from portions of the deaf community and because of
the irreversible nature of the surgery in which the cochlea is invaded and any
residual hearing is destroyed. Accordingly, the Company does not believe that
cochlear implants will achieve significant market penetration beyond their
initial indication of profound hearing impairment. The Company estimates that,
in 1997, the worldwide market for cochlear implants was under $100 million.
The Symphonix Solution
The Company is developing a family of proprietary semi-implantable and
implantable products, or soundbridges, for the management of moderate to severe
hearing impairment. The Company's family of Vibrant soundbridges is based on its
patented core technology, the Floating Mass Transducer ("FMT"). The FMT is a
tiny transducer that is designed to enhance hearing by precisely mimicking and
amplifying the movements of the ossicles by converting sound into mechanical
vibrations. While conventional approaches have indirectly driven the ossicles by
amplifying sound to increase the vibrations of the tympanic membrane, the FMT is
attached directly to the ossicles and enhances the natural movement of these
vibratory structures. This in turn generates enhanced stimulation of the
delicate sensory hair cells in the inner ear. The FMT receives electrical
signals from an Audio Processor, which picks up sound from the environment and
converts these sounds into electrical signals. The Audio Processor transmits the
signals to an implant under the skin. As a result, the ear canal is not
obstructed, the natural resonance of the ear is maintained and an amplified,
natural sound quality is achieved.
The Company's soundbridges are implanted in a two hour surgery that can be
performed on an outpatient basis utilizing the techniques which are similar to
those employed in routine otologic
6
procedures. Based on preclinical studies, the Company believes that the surgical
procedure can be reversed without clinically meaningful damage to the patient's
residual hearing. The Company believes that its family of Vibrant soundbridges
offers a number of significant benefits, including:
Improved sound quality and speech intelligibility. By leaving the ear canal
unobstructed and the natural resonance undisturbed, a more natural sound
quality is obtained over a broader range of frequencies, and the user's
ability to understand speech is expected to be greater.
Elimination of acoustic feedback. Since the Vibrant soundbridge mechanically
drives the ossicles, it does not generate any acoustic feedback.
Improved sound localization. Users are able to comprehend the acoustic sound
environment, identify specific sounds and their source and differentiate
sounds from background noise.
Minimized social stigma. In the semi-implantable versions of the Company's
soundbridges, the only external component is located behind the ear and
generally hidden by the user's hair. As a result, social stigma is minimized.
The totally implantable versions of the Company's soundbridges are being
designed with no external components, and aesthetic considerations would be
completely eliminated.
Improved comfort. No part of the Vibrant soundbridge is inserted in the ear
canal, resulting in increased comfort for users of the Vibrant soundbridge.
Improved reliability. Since no components of the Vibrant soundbridge are in
the ear canal, the reliability problems caused by wax and moisture are
eliminated.
Strategy
The Company's objectives are to establish its family of Vibrant soundbridges
as the standard of care worldwide for the management of moderate to severe
hearing impairment and to establish Symphonix as the leading company in the
hearing management market. The following are key elements of the Company's
strategy:
Demonstrate improved quality of life. The Company intends to promote the
potential benefits of its products to the hearing impaired population in order
to expand the market to include not only current dissatisfied hearing aid
users but also former users who have abandoned hearing aids due to either
previous dissatisfaction or perceived social stigma. The Company believes that
achieving real patient benefit in the form of improved quality of life will be
an important factor in differentiating its products from the traditional
approaches to hearing management.
Develop surgeon and audiologist endorsement of the Company's family of
soundbridges. The Company intends to position its family of Vibrant
soundbridges as technologically advanced implants that address an unmet
patient need and add to the products and services that surgeons can offer. The
Company's strategy is to market its soundbridges initially to those
specialists in otology who are currently most active in ear surgery and,
thereafter, to the general population of ENT
7
surgeons. Because the surgical procedure for implementing the Vibrant
soundbridge utilizes many of the same techniques employed by surgeons trained
and experienced in cochlear implant surgery, the Company believes that surgeon
training will not be a significant impediment to market acceptance. An
additional element of the Company's strategy is to build awareness among
audiologists of the Company's soundbridges to encourage the referral of
patients to surgeons.
Leverage the Company's patented core technology. The Company intends to
leverage its patented core FMT technology to develop new soundbridges and
enhancements to its current technology. The Company intends to continue to
dedicate significant resources to research and development to further develop
its technology base and to expand the market it addresses through development
of a family of alternate configurations of soundbridges. The Company has
developed the Vibrant P soundbridge to permit a degree of customization to
address the specific needs of a particular patient, and is developing the
Vibrant D soundbridge to permit an even greater degree of customization along
with the additional benefit of digital signal processing, and the Vibrant HF
soundbridge to provide a benefit suited to those individuals who have a noise-
induced hearing loss at high frequencies but relatively normal hearing at
lower frequencies.
Protect and enhance the Company's proprietary position. The Company intends
to continue to aggressively pursue proprietary protection for its technologies
and products. The Company has 7 patents issued in the United States, one
patent issued internationally and 31 patents pending both in the United States
and internationally covering a number of fundamental aspects of the FMT and
related technologies.
Products Under Development
Symphonix is developing proprietary semi-implantable and implantable
soundbridges, utilizing the Company's core FMT technology to manage hearing
impairment. The Company believes that the Vibrant P, Vibrant HF and Vibrant D
soundbridges will enable the Company to address a significant portion of the
moderate to severe hearing impairment market currently not satisfied with
traditional hearing aid devices. In addition, the Company is developing the
Vibrant TI soundbridge which is being designed to be totally implantable with no
external components.
The Vibrant P, Vibrant HF and Vibrant D soundbridges utilize the same implant,
with the differences in function being provided by modifications to the external
Audio Processor, its software and programming unit. Utilization of a common
implant will allow a user to upgrade the Audio Processor if a user's hearing
changes over time. The following table sets forth the soundbridges under
development by the Company and their development status:
8
================================================================================================================
SOUNDBRIDGE DESCRIPTION HEARING LOSS STATUS(1)
ADDRESSED
================================================================================================================
Vibrant P Second generation semi- Moderate to Pivotal trial enrollment
implantable hearing device with severe completed in the United States;
programmable dual-band analog product sales in Europe
signal processing.
- -------------------------------------------------------------------------------------------------------------------
Vibrant HF Second generation semi-implantable Noise- Pivotal trial approved in the
hearing device designed to address induced high United States and enrollment
noise induced high frequency frequency under way; gathering clinical
hearing loss by using modified loss data in a limited number of
signal processing. patients in Europe
- -------------------------------------------------------------------------------------------------------------------
Vibrant D Third generation semi-implantable Moderate to IDE supplement expected to be
hearing device, with programmable severe submitted in 1999;
3-band digital signal processing.
- -------------------------------------------------------------------------------------------------------------------
Vibrant XP Second generation semi-implantable Severe to Early stage of development
hearing device designed to address profound
more severe hearing impairment by
using modified signal processing
and an externally worn battery
pack, coupled with a modified
implant.
- -------------------------------------------------------------------------------------------------------------------
Vibrant TI Designed to be totally implantable Moderate to In development
with no external components. severe
===================================================================================================================
(1) Regulatory filing dates reflect the Company's plans and are subject to
delay or cancellation depending upon contingencies that may arise in the
development process.
The Company's Vibrant P, Vibrant HF and Vibrant D soundbridges, have both
external and implantable components. The external Audio Processor consists of
(i) a microphone that picks up sound from the environment, (ii) sound processing
circuitry that converts the sound to an electronic signal and modulates the
signal to reduce potential noise interference from broad band electromagnetic
fields and (iii) a small 1.5 volt battery that powers the device. The Audio
Processor is placed on the skull behind the ear and is held in place by magnetic
attraction to an implanted receiver, the VORP (Vibrating Ossicular Prosthesis).
The Audio Processor is small enough to be concealed by the user's hair.
[ILLUSTRATION OF VIBRANT SOUNDBRIDGE IN PLACE]
The VORP converts the electronic signal to a mechanical vibration of the
ossicles in the middle ear. The VORP consists of (i) a receiver unit that
receives the electromagnetic signal through the skin from the external Audio
Processor and breaks down the electrical signal to the appropriate drive signal
for the FMT, (ii) a conductor link that connects the implanted receiver unit to
the FMT and (iii) the FMT itself, which is attached to the incus using a
titanium clip. All of these components are insulated from body chemistry using
well established implantable device materials used in pacemaker and implantable
defibrillator systems.
9
The FMT is a tiny transducer, smaller than a grain of rice, that comprises a
floating magnet contained within a titanium housing. A coil surrounding the
housing generates a small electromagnetic field based on a signal received from
the VORP's receiver unit. The electromagnetic interaction of the magnet and the
coil creates a mechanical vibration of the entire FMT. This vibration enhances
the natural movement of the ossicles, which in turn generates enhanced
stimulation of the delicate sensory hair cells in the inner ear. A critical
element of the proprietary FMT design is the proximity of the magnet to the
electromagnetic field that causes the magnet to vibrate. By keeping the magnet
and the coil close together, the FMT maximizes electromagnetic coupling while
minimizing power consumption.
[LOGO OF PRODUCT ILLUSTRATION]
The surgical procedure for the implantation of the Vibrant soundbridges
involves techniques which are similar to those employed in other common otologic
procedures. The internal receiver unit is implanted below the skin and muscle
behind the ear. The conductor link connecting the receiver unit to the FMT is
placed through the excavated mastoid bone. These steps are similar to those
required for the surgical placement of a cochlear implant receiver. In the
middle ear, the FMT is attached to the ossicles in a manner similar to the way
otologists have traditionally attached ossicular prostheses for management of
conductive hearing loss. Because the surgery involves surgical techniques that
are familiar to ear surgeons, the Company believes that surgeon training will
not be a significant impediment to market acceptance. The procedure may be
performed on an outpatient basis, and generally can be performed in about two
hours. Approximately eight weeks following the surgery, the Audio Processor is
fitted by an audiologist with the appropriate sound processing settings. The
Company's approved Investigational Device Exemption ("IDE") only permits
implantation in one ear. This will generally be the ear with the poorest unaided
functional hearing. Based on preclinical studies, the Company believes that the
surgical procedure can be reversed without damage to the patient's residual
hearing.
Vibrant P soundbridge
The Vibrant P soundbridge is designed to permit, through programming, a degree
of customization to address the specific needs of a particular user's hearing
loss, thereby permitting a broad range of types of hearing loss to be managed.
At the time of fitting, the Audio Processor is connected to a hand-held
programming unit which allows the audiologist to adjust separately the low and
high frequencies. This permits customization to the patient's needs in either
the high or low frequency band.
The Company received approval to affix the CE mark to the Vibrant P
soundbridge in March 1998 and commenced selling activities in the European Union
at that time. The Vibrant P soundbridge has superceded the Company's first
generation Vibrant soundbridge. In the United States, the Company has completed
enrollment in the pivotal phase of a U.S. Food and Administration ("FDA")
approved multi-center study. During the year ended December 31, 1998, the
Company was selected by the FDA to participate in the new, streamlined Pre-
Market Approval ("PMA") process called the modular PMA. Under the modular PMA
process, modules reflecting the content requirements of a traditional PMA are
submitted as they are completed, allowing them to be reviewed and approved in a
sequential manner. To date, the Company has submitted four modules of its PMA
for the Vibrant P soundbridge. There can be no assurance that the Company's
participation in the modular PMA program will lead to the
10
timely approval of the Vibrant P soundbridge, if at all.
Vibrant HF soundbridge
The Vibrant HF soundbridge is being developed to provide a benefit for those
individuals who have a hearing loss at high frequencies but relatively normal
hearing at lower frequencies. Hearing aids usually are limited in effectiveness
at higher frequencies due to acoustic feedback and internal speaker response.
With the increasing exposure to noise in modern society, it has been observed
that people may experience noise-induced hearing loss from aircraft,
automobiles, lawn mowers and high powered stereo equipment as well as military
service and machinery within the workplace. The Vibrant HF soundbridge will be
configured through selective signal processing.
The Company received permission to affix the CE mark to the Vibrant HF
soundbridge in July 1998. The Company is gathering clinical data on the Vibrant
HF soundbridge on a limited number of patients in Europe prior to initiating
full-scale commercial selling activities. In the United States, the Company has
received approval of an IDE supplement to include the Vibrant HF soundbridge in
its existing pivotal trial of the Vibrant P soundbridge. There can be no
assurance, however, that the Company will not be required to submit a separate
PMA for the Vibrant HF soundbridge.
Vibrant D soundbridge
The Vibrant D soundbridge under development is similar to the Vibrant P
soundbridge, but is designed to permit an even greater degree of customization
to address the specific needs of a particular user's hearing loss, through
digital signal processing. Fully automatic and independent sound processing in
three separate frequency bands is provided. At the time of fitting, the Audio
Processor is connected to a programming unit which allows the audiologist to
adjust separately the low, mid and high frequencies. This sophisticated system
will be capable of analyzing sound and automatically adjusting the soundbridge's
response.
The Company intends to seek approval of an IDE supplement for the Vibrant D
soundbridge during 1999 and also to initiate a limited clinical trial in 1999.
There can be no assurance, however, that the Company will not be required to
submit a separate IDE and PMA for the Vibrant D soundbridge.
Vibrant XP soundbridge
The Vibrant XP soundbridge is intended to provide a benefit for those
individuals who have a severe to profound hearing loss with a high level of
speech recognition. Currently, there are only limited treatment options for
such individuals.
The Vibrant XP soundbridge will be configured to provide modified signal
processing and higher output from the FMT, thereby providing additional benefit
for certain people with a severe to profound hearing impairment. Generating this
higher output will require an external body-worn battery pack, similar to those
used for cochlear implants. However, unlike cochlear implants, the Vibrant XP
soundbridge will not require penetration of the inner ear with its attendant
damage to residual hearing.
11
The Company is evaluating alternative technical approaches and may conduct a
feasibility study in 1999 on a limited number of patients in Europe to assess
the viability of this product concept.
Vibrant TI soundbridge
The Company is developing versions of the Vibrant soundbridge for the
management of moderate to severe hearing impairment that are totally implantable
with no external components. The essential function of the FMT for these
products will be the same as in the semi-implantable products. However, all the
functions currently performed by the external Audio Processor are being designed
to be performed by implanted components. The Company believes that the Vibrant
TI soundbridge, if successfully developed, will be applicable especially for
people who are particularly physically active or who are concerned about
aesthetics.
Three critical elements of producing the Vibrant TI soundbridge are the
development of an implantable microphone that can adequately pick up sound from
the external environment, the development of a transcutaneously rechargeable
battery to power the device and the design of the signal processing chip set.
The microphone is being developed internally by the Company and the battery is
being developed under a cooperative development project with a specialized
battery manufacturer. Additionally, the Company has initiated the development,
using third party contractors, of the electronic chip set that will provide the
signal processing electronics for the Vibrant TI soundbridge. However, there
can be no assurance that such components will be successfully developed in a
timely manner, if at all.
Although the Company has commenced selling the Vibrant P soundbridge in the
European Union, all of the Company's other products are in development, and
accordingly, significant revenues from product sales will not be realized for at
least several years, if ever. There can be no assurance that any of the
Company's product development efforts will be successfully completed, that any
of the Company's products will be proven to be safe and effective, that
regulatory approvals will be obtained or labeling claims will be as broad as
sought, that the Company's products will be capable of being produced in
commercial quantities with acceptable yields at reasonable costs, or that any
products, if introduced, will achieve market acceptance.
Clinical Trial Activities
United States
On February 23, 1996, the Company received approval of an IDE for the Vibrant
soundbridge from the FDA. The Vibrant was the Company's first generation semi-
implantable hearing device. The Company completed a Phase I trial under the IDE
and submitted the interim report to the FDA. This trial was limited to five
subjects, including Geoffrey R. Ball, a founder of the Company, at two
investigational sites and was intended to test the safety and provide
preliminary evidence of efficacy of the device and the surgical procedures used
to implant the device. Due to the limited number of subjects evaluated, no
statistically valid conclusions could be made from the results reported to the
FDA.
12
In the Phase I study, the Company observed the following performance
characteristics: increased functional gain at higher frequencies (i.e., >2000
Hz); elimination of occlusion effect; elimination of acoustic feedback;
elimination of placement loss; and reduction of maintenance issues. A self-
assessment questionnaire targeted seven communicative issues (i.e.,
reverberation, familiar talker, reduced cues, background noise, aversion to
sounds, ease of communication, and distortion of sounds). Subject responses
indicated a significant improvement in six of the seven categories with the
Vibrant soundbridge when compared to their current acoustic hearing aid.
In November 1997, the Company filed an IDE supplement summarizing the Phase I
results, finalizing the study protocol and proposed labeling claims, providing
technical information regarding the Vibrant P soundbridge, the Company's second
generation semi-implantable device, and requested permission to proceed to the
pivotal study. In December 1997, the FDA approved the multi-center pivotal
study in 55 subjects at up to 12 sites with the Vibrant P soundbridge. In
November 1998 the Company received FDA approval of an IDE supplement to include
the Vibrant HF soundbridge in this study. The Company has enrolled 55 subjects
in the study. However, because the IDE supplement allowing the inclusion of the
Vibrant HF soundbridge was approved when enrollment was almost complete, only
one of the 55 subjects is to be fitted with a Vibrant HF soundbridge. To
facilitate enrollment of a greater number of subjects who receive the Vibrant HF
soundbridge, on December 22, 1998, the Company requested FDA approval of an IDE
supplement to allow an additional 15 subjects. This IDE supplement was approved
by the FDA on January 19, 1999 and the Company expects to enroll these
additional subjects in 1999.
Of the 55 subjects enrolled in the pivotal study, 37 have had the Audio
Processor fitted and initial results evaluated and 12 subjects have completed
the five-month protocol. The study focuses on five primary end-points: absence
of damage to residual hearing; functional gain; elimination of occlusion;
reduction of acoustic feedback; and improved benefit in relation to the hearing
aid as measured by a standard self-assessment questionnaire. The data on the
limited number of subjects (twelve) evaluated so far appear to be consistent
with the intended claims for the Vibrant P soundbridge.
As of January 31, 1999, 60 subjects have been implanted with the Vibrant P and
Vibrant HF soundbridges in the Company's United States clinical trials.
Europe
In March 1998, the Company completed a multi-center EN 540 clinical trial in
Europe at seven institutions. Clinical sites were located in Germany, Italy, the
Netherlands, the United Kingdom, Switzerland and France. The EN 540 protocol
investigated the safety and performance of the Vibrant soundbridge and the
Vibrant P soundbridge. In the EN 540 trial, 47 subjects were implanted with the
Company's soundbridges, 19 with the first generation Vibrant soundbridge and 28
with the second generation Vibrant P soundbridge. With the Vibrant soundbridge,
performance was only evaluated for functional gain and the results were
comparable to those achieved by the subjects in the United States trial. With
the Vibrant P soundbridge, the subjects demonstrated functional gains as high as
50 dB at 1000 Hz, 55 dB at 1500 Hz, 60 dB at 2000 Hz, 40 dB at 3000 Hz, 50 dB at
4000 Hz, 40 dB at 6000 Hz,
13
and 35 dB at 8000 Hz. These functional gain values reported were at "user
settings" and did not necessarily reflect the maximum functional gains
attainable with the device. The results of the EN540 trial were considered
adequate by the Company's Notified Body for purposes of affixing the CE mark to
the Vibrant P soundbridge.
Subsequent to the completion of the EN540 trial, the Company received
authorization to affix the CE mark to the Vibrant P and HF soundbridges. The
Company has begun selling the Vibrant P soundbridge in Europe, and the Vibrant
HF soundbridge is currently the subject of limited clinical testing. As of
January 31, 1999, approximately 120 patients have been implanted with the
Vibrant P and Vibrant HF soundbridges in Europe including patients implanted in
the Company's EN540 trial as well as patients implanted subsequent to the
completion of the EN540 trial.
There can be no assurance that the Company's clinical trial efforts will
progress as expected, not be delayed or that such efforts will lead to the
successful development of any product. No assurance can be given that any of the
Company's proposed clinical trials will continue to be allowed by the FDA or
other regulatory agencies or that clinical trials will commence as planned. Any
delays in the Company's clinical trials would have a material adverse effect on
the Company's business, financial condition and results of operations. Success
in preclinical studies or early stage clinical trials does not assure success in
later stage clinical trials. Data obtained from preclinical and clinical
activities are susceptible to varying interpretations which could delay, limit
or prevent regulatory approval. Further, there can be no assurance that if such
testing of products under development is completed, any such devices will be
accepted for formal review by the FDA or approved by the FDA for marketing in
the United States.
Research and Development
The Company had 26 employees engaged in research and development, including
regulatory and clinical affairs, as of December 31, 1998. The Company's research
and development has focused on developing its patented core FMT technology,
developing its family of Vibrant soundbridges and conducting appropriate
preclinical and clinical testing. The Company expended approximately $8.3
million and $6.4 million for the years ended December 31, 1998 and 1997,
respectively, on research and development. The Company anticipates that it will
continue to expend substantial resources on completion of the development and
clinical testing of the Vibrant HF and Vibrant D soundbridges, supporting
manufacturing scale-up and the development and clinical testing of the Vibrant
TI soundbridge. In addition, the Company may devote resources to the
development of the Vibrant XP soundbridge and the development of products for
the treatment of conductive hearing loss. Product development involves a high
degree of risk and there can be no assurance that the Company's product
development efforts will result in any commercially successful products.
Manufacturing
The Company currently manufactures its products in limited quantities for
laboratory testing, for its clinical trials and for initial commercial sales.
The manufacture of the Company's soundbridges is a complex operation involving a
number of separate processes, components and assemblies. Each device is
assembled and individually tested by the Company. The manufacturing process
consists primarily of
14
assembly of internally manufactured and purchased components and subassemblies,
and certain processes are performed in an environmentally controlled area. After
completion of the manufacturing and testing processes, implantable devices are
sterilized by a sub-contracted supplier. The Company has no experience
manufacturing its products in the volumes or with the yields that will be
necessary for the Company to achieve significant commercial sales, and there can
be no assurance that the Company can establish high volume manufacturing
capacity or, if established, that the Company will be able to manufacture its
products in high volumes with commercially acceptable yields. The Company will
need to expend significant capital resources and develop manufacturing expertise
to establish commercial-scale manufacturing capabilities. Furthermore, prior to
approval of a PMA, the Company's facilities, procedures and practices will be
subject to a pre-approval inspection by the FDA. The Company's inability to
successfully manufacture or commercialize its soundbridges in a timely matter
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Raw materials, components and subassemblies for the Company's soundbridges are
purchased from various qualified suppliers and are subject to stringent quality
specifications and inspections. The Company conducts quality audits of its key
suppliers, several of whom are experienced in the supply of components to
manufacturers of implantable medical devices, such as pacemakers, defibrillators
and drug delivery pumps. A number of components and subassemblies, such as
silicone, signal processing electronics and implant packaging are provided by
single source suppliers. Certain components of the Vibrant P, Vibrant HF and
Vibrant D soundbridges, the analog and digital signal processing microcircuits,
are provided by sole source suppliers. None of the Company's suppliers is
contractually obligated to continue to supply the Company nor is the Company
contractually obligated to buy from a particular supplier. For certain of these
components and subassemblies, there are relatively few alternative sources of
supply, and establishing additional or replacement suppliers for such components
and subassemblies could not be accomplished quickly. In addition, if the Company
wishes to significantly modify its manufacturing processes or change the
supplier of a critical component, additional approvals will be required from the
FDA before the change can be implemented. Because of the long lead time for some
components and subassemblies that are currently available from a single source,
a supplier's inability or failure to supply such components or subassemblies in
a timely manner or the Company's decision to change suppliers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company's manufacturing facilities are subject to periodic inspection by
regulatory authorities, and its operations must undergo Quality System ("QS")
regulation compliance inspections conducted by the FDA and corresponding state
agencies. Additionally, prior to approval of a PMA, the Company's and its third-
party manufacturers' facilities, procedures and practices will be subject to
pre-approval QS regulation inspections. The Company has been inspected by the
Food and Drug Branch of the California Department of Health Services ("CDHS")
and a Device Manufacturing License has been issued to the Company. The Company
will be required to comply with the QS regulation requirements in order to
produce products for sale in the United States and with applicable quality
system standards and directives in order to produce products for sale in the EU.
Any failure of the Company to comply with the QS regulation or applicable
standards and directives may result in the Company being required to take
corrective actions, such as modification of its policies and procedures. Pending
such corrective actions, the Company could be unable to manufacture or ship any
products, which could have a material
15
adverse effect on the Company's business, financial condition and results of
operations.
Sales, Marketing and Training
The primary market for the Company's products in the United States is well
defined and highly concentrated. Of the approximately 8,000 ENT surgeons in the
United States, approximately 400 are specialists in otology. The Company
believes that it can address this market with a direct sales force. The
Company's strategy is to market its products initially to those specialists in
otology who are currently most active in ear surgery, and, subsequently, to the
general population of ENT surgeons. Because the surgical procedure for
implementing the Company's soundbridges utilizes many of the same techniques
employed by surgeons trained and experienced in cochlear implant surgery, the
Company believes that surgeon training will not be a significant impediment to
market acceptance.
The Company intends to position its family of Vibrant soundbridges as
technologically advanced implants that address an unmet patient need and add to
the products and services that surgeons can offer. Patients who have
traditionally been candidates for a hearing aid often are first seen by an ENT
surgeon, prior to being referred to a hearing device dealer or dispensing
audiologist. Accordingly, endorsement by the surgical community will be an
important goal of the Company's marketing programs. The Company will also seek
to develop a high degree of awareness by and endorsement from audiologists.
The Company intends to promote the benefits of its products to consumers in
order to expand usage to include not only those who are currently dissatisfied
with hearing aids, but also those who have abandoned hearing aids due to either
dissatisfaction or perceived social stigma.
The Company has established a European sales and marketing organization
which, as of December 31, 1998, is comprised of three marketing management and
support personnel located in Basel, Switzerland and three sales managers
performing direct sales activities in Germany, France, the United Kingdom,
Switzerland and Austria. In addition, the Company has hired a sales manager for
South America. The Company's initial selling efforts in Europe have been
targeted primarily at those ENT surgeons specializing in otology. While the
Company intends to continue to market its products to these specialists, it also
plans to focus on the referring physicians, audiologists and the general
population of ENT surgeons in an attempt to increase the number of patients that
are referred to specialist ear surgeons. The Company is also attempting to
gather clinical and other data which it believes will be helpful in obtaining
reasonable reimbursement levels for its products. The Company also has
distributors in Sweden, Denmark, Italy, Spain, Portugal, Belgium, The
Netherlands, Luxembourg, and certain countries in the middle east and North
Africa. The Company has also established a distributor for certain countries in
South America. In other international markets, including Japan, the Company
will seek to establish a network of distributors.
There can be no assurance that the Company will be able to build an adequate
direct sales force or marketing organization in any country, that establishing a
direct sales force or marketing organization will be cost-effective or that the
Company's sales and marketing efforts will be successful. In addition, the
Company has entered into distribution agreements with only a limited number of
international distributors. There can be no assurance that the Company will be
able to enter into similar agreements
16
with other qualified distributors on a timely basis on terms acceptable to the
Company, or at all, or that such distributors will devote adequate resources to
selling the Company's products. Failure to establish an adequate direct sales
force domestically and in select international markets, and to enter into
successful distribution relationships, could have a material adverse effect on
the Company's business, financial condition and results of operations.
Competition
The medical device industry is subject to intense competition in the United
States and abroad. The Company believes its products will compete primarily with
the traditional approaches to managing hearing impairment, principally hearing
aids. Principal manufacturers of acoustic hearing aids include Siemens Hearing
Instruments, Inc., Philips Medical Systems North America Co., Starkey
Laboratories Inc., Beltone Electronics Corp., Dahlberg Inc., ReSound Corp.,
Oticon, Inc., Widex Hearing Aid Co., Inc. and Phonak Inc. There can be no
assurance that the Company's soundbridges will be able to successfully compete
with established hearing aid products. Although, to the Company's knowledge,
none of these acoustic hearing aid manufacturers are currently developing direct
drive devices, there can be no assurance that these potential competitors will
not succeed in developing technologies and products in the future that are more
effective, less expensive than those being developed by the Company or that do
not require surgery. The Company is aware of several university research groups
and development-stage companies that have active research or development
programs related to direct drive sensorineural hearing devices. Research of this
type has been conducted at various sites for over 20 years. In addition, some
large medical device companies, some of which are currently marketing
implantable medical devices, may develop programs in hearing management. Certain
of these companies have substantially greater financial, technical,
manufacturing, marketing and other resources than the Company. In addition,
there can be no assurance that certain of the Company's competitors will not
develop technologies and products that may be more effective in managing hearing
impairment than the Company's products or that render the Company's products
obsolete.
The Company believes that the primary competitive factors in the hearing
management market will be the quality of the hearing enhancement, safety,
whether surgery is required, reliability, endorsement by the surgeon and
audiology communities, patient comfort, cosmetic result and price. The Company
believes that it will be competitive with respect to these factors. Nonetheless,
because the Company's products are either under development or in the very early
stages of commercialization, the relative competitive position of the Company in
the future is difficult to predict.
The medical device industry is characterized by rapid and significant
technological change. Accordingly, the Company's success will depend in part on
its ability to respond quickly to medical and technological change and user
preference through the development and introduction of new products that are of
high quality and that address patient and surgeon requirements.
Patents and Proprietary Technology
In the United States, the Company holds 7 issued patents and 14 pending patent
applications, of which 3 have been allowed but not yet issued. Additionally, the
Company has 1 issued and 17 pending
17
foreign patent applications. These patents and patent applications generally
cover the invention and application of the FMT as well as the specific
application of the FMT and other concepts in the field of hearing impairment. In
addition, the Company has licensed, on a royalty-free basis, a United States
patent covering the magnetic attachment of an external audio processor to an
implanted receiver. The Company's success will depend in part on its ability to
obtain patent protection for its products and processes, to preserve its trade
secrets, and to operate without infringing or violating the proprietary rights
of others.
The patent positions and trade secret provisions of medical device companies,
including those of the Company, are uncertain and involve complex and evolving
legal and factual questions. The coverage sought in a patent application either
can be denied or significantly reduced before or after the patent is issued.
Consequently, there can be no assurance that any patents from pending
applications or from any future patent application will be issued, that the
scope of the patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents will be held valid
if subsequently challenged or that others will not claim rights in or ownership
of the patents and other proprietary rights held by the Company. Since patent
applications are secret until patents are issued in the United States or
corresponding applications are published in other countries, and since
publication of discoveries in the scientific or patent literature often lags
behind actual discoveries, the Company cannot be certain that it was the first
to file patent applications for such inventions.
In addition, there can be no assurance that competitors, many of which have
substantial resources, will not seek to apply for and obtain patents that will
prevent, limit or interfere with he Company's ability to make, use or sell its
products either in the United States or in international markets. Although the
Company has conducted searches of patents issued to other companies, research or
academic institutions or others, there can be no assurance that such patents do
not exist, have not been filed or could not be filed or issued, which contain
claims relating to the Company's technology, products or processes. Patents
issued and patent applications filed in the United States or internationally
relating to medical devices are numerous and there can be no assurance that
current and potential competitors and other third parties have not filed or in
the future will not file applications for, or have not received or in the future
will not receive, patents or obtain additional proprietary rights relating to
products or processes used or proposed to be used by the Company. In addition,
patent applications in foreign countries are maintained in secrecy for a period
after filing. Publication of discoveries in the scientific or patent literature
tends to lag behind actual discoveries and the filing of related patent
applications. There may be pending applications, which if issued with claims in
their present form, might provide proprietary rights to third parties relating
to products or processes used or proposed to be used by the Company. The Company
may be required to obtain licenses to patents or proprietary rights of others.
Further, the laws of certain foreign countries do not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. Litigation or regulatory proceedings, which could result in substantial
cost and uncertainty to the Company, may also be necessary to enforce patent or
other intellectual property rights of the Company or to determine the scope and
validity of other parties' proprietary rights. There can be no assurance that
the Company will have the financial resources to defend its patents from
infringement or claims of invalidity.
The Company also relies upon trade secrets and other unpatented proprietary
technology, and no
18
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to or
disclose the Company's proprietary technology or that the Company can
meaningfully protect its rights in such unpatented proprietary technology. The
Company's policy is to require each of its employees, consultants, investigators
and advisors to execute a confidentiality agreement upon the commencement of an
employment or consulting relationship with the Company. These agreements
generally provide that all inventions conceived by the individual during the
term of the relationship shall be the exclusive property of the Company and
shall be kept confidential and not be disclosed to third parties except in
specified circumstances. There can be no assurance, however, that these
agreements will provide meaningful protection for the Company's proprietary
information in the event of unauthorized use or disclosure of such information.
Recently Public Law 104-208 was signed into law in the United States and
limits the enforcement of patents relating to the performance of surgical or
medical procedures on a body. This law precludes medical practitioners and
health care entities, who practice these procedures, from being sued for patent
infringement. Therefore, depending upon how these limitations are interpreted by
the courts, they could have a material adverse effect on the Company's ability
to enforce any of its proprietary methods or procedures deemed to be surgical or
medical procedures on a body. In certain other countries outside the United
States, patent coverage relating to the performance of surgical or medical
procedures is not available. Therefore, patent coverage in such countries will
be limited to the FMT or to narrower aspects of the FMT.
The medical device industry in general has been characterized by substantial
litigation. Litigation regarding patent and other intellectual property rights,
whether with or without merit, could be time-consuming and expensive to respond
to and could distract the Company's technical and management personnel. The
Company may become involved in litigation to defend against claims of
infringement by the Company, to enforce patents issued to the Company or to
protect trade secrets of the Company. If any relevant claims of third-party
patents are held as infringed and not invalid in any litigation or
administrative proceeding, the Company could be prevented from practicing the
subject matter claimed in such patents, or would be required to obtain licenses
from the patent owners of each such patent, or to redesign its products or
processes to avoid infringement. In addition, in the event of any possible
infringement, there can be no assurance that the Company would be successful in
any attempt to redesign its products or processes to avoid such infringement or
in obtaining licenses on terms acceptable to the Company, if at all.
Accordingly, an adverse determination in a judicial or administrative proceeding
or failure by the Company to redesign its products or processes or to obtain
necessary licenses could prevent the Company from manufacturing and selling its
products, which would have a material adverse effect on the Company's business,
financial condition and results of operations. Although the Company has not been
involved in any litigation to date, in the future, costly and time-consuming
litigation brought by the Company may be necessary to enforce patents issued to
the Company, to protect trade secrets or know-how owned by the Company, or to
determine the enforceability, scope and validity of the proprietary rights of
others.
19
Government Regulation
The Company's medical products, such as the Vibrant soundbridge, are regulated
as medical devices. Accordingly, clinical trials, product development, labeling,
manufacturing processes and promotional activities are subject to extensive
review and rigorous regulation by government agencies in most countries in which
the Company will seek to commercialize its products.
United States
In the United States, the Company's products are subject to applicable
provisions of the United States Federal Food, Drug, and Cosmetic Act ("FDC
Act"), and other federal statutes and regulations governing, among other things,
the design, manufacture, testing, safety, labeling, storage, record keeping,
reporting, approval, advertising and promotion of medical devices. Noncompliance
with applicable requirements can result in warning letters, fines, recalls or
seizure of products, civil penalties, injunctions, total or partial suspension
of production, withdrawal of approval or refusal to approve new marketing
applications and criminal prosecution. Changes in existing requirements or
adoption of new requirements could have a material adverse effect on the
Company's business, financial condition and results of operations.
Pursuant to the FDC Act, the FDA regulates the design, manufacture,
distribution, preclinical and clinical study and approval of medical devices in
the United States. Medical devices are classified in one of three classes (Class
I, Class II or Class III) on the basis of the controls necessary to reasonably
assure their safety and effectiveness. Safety and effectiveness is considered to
be reasonably assured for Class I devices through general controls (e.g.,
labeling, premarket notification and adherence to current QS regulations) and
for Class II devices through the use of additional special controls (e.g.,
performance standards, post-market surveillance, patient registries and FDA
guidelines).
Generally, Class III devices are those which must receive premarket approval
by the FDA to reasonably assure their safety and effectiveness (e.g., life-
sustaining, life-supporting and implantable devices, or new devices which have
been found not to be substantially equivalent to legally marketed devices, or
devices whose safety and effectiveness cannot be reasonably assured through
general controls, even if supplemented by additional special controls). Active
implantable devices, such as the Company's implantable hearing devices, are
considered Class III devices.
Before a new device can be introduced to the market, the manufacturer
generally must obtain FDA clearance through a 510(k) Premarket Notification or
FDA approval through a PMA application. While the Company has no products for
which it expects to seek 510(k) clearance, it may file 510(k) submissions with
respect to future products. A 510(k) clearance will generally only be granted if
the information submitted to the FDA establishes that the device is
"substantially equivalent" to a legally marketed predicate medical device.
Frequently, the FDA will require clinical data in support of a 510(k)
submission, and the 510(k) process can become time-consuming and expensive.
Significant modifications of the labeling, manufacturing and design of any
product that has been cleared through the 510(k) process will require a new
510(k) Premarket Notification, if those modifications could significantly affect
the safety, effectiveness or intended use of the device.
20
A PMA must be submitted if the device cannot be cleared through the 510(k)
process. A PMA must be supported by extensive data, including, but not limited
to, technical, preclinical, clinical trials, manufacturing, and labeling to
demonstrate the safety and effectiveness of the device. The Company believes
that all versions of the Vibrant soundbridge currently under development are
Class III devices and will require a PMA, as will future configurations of
implantable hearing devices. The FDA has recently implemented a new streamlined
PMA process called the modular PMA. Under the modular PMA process, modules
reflecting the content requirements of a traditional PMA can be submitted as
they are completed, allowing them to be reviewed and approved in a sequential
manner.
Before the Company's products can be commercialized in the United States, the
Company must submit, in a PMA, extensive data on preclinical studies and
clinical trials, device design, manufacturing, labeling, promotion and
advertising, as well as other aspects of the product. In addition, the Company
must submit clinical data gathered in trials conducted under an IDE
demonstrating to the satisfaction of the FDA that the product is safe and
effective for its labeling claims, and obtain marketing approval from the FDA.
Phase I of the IDE study has been completed. Phase I was limited to two sites
and five subjects and was intended to test the safety and provide preliminary
evidence of the effectiveness of the device and the surgical procedure used to
implant the device. In November 1997, the Company filed an IDE supplement
summarizing the Phase I results, finalizing the study protocol and proposed
labeling claims, providing technical information regarding the Vibrant P
soundbridge, and requested permission to proceed to the pivotal study. In
December 1997, the FDA approved the multi-center pivotal study in 55 subjects at
up to 12 sites with the second generation Vibrant P soundbridge. In November
1998 the Company received FDA approval of an IDE supplement to include the
Vibrant HF soundbridge in this study. The Company has enrolled 55 subjects in
the study. However, because the IDE supplement allowing the inclusion of the
Vibrant HF soundbridge was approved when enrollment was almost complete only one
of the 55 subjects is to be fitted with a Vibrant HF soundbridge. To facilitate
enrollment of a greater number of subjects who receive the Vibrant HF
soundbridge, on December 22, 1998, the Company requested FDA approval of an IDE
supplement to allow an additional 15 subjects. This IDE supplement was approved
by the FDA on January 19, 1999 and the Company expects to enroll these
additional subjects in 1999. There can be no assurance that the Company's
clinical trial effort will progress as expected, will not be delayed or that
such effort will lead to the successful development of any product. No assurance
can be given that any of the Company's clinical trials will continue to be
allowed by the FDA or other regulatory agencies or that clinical trials will
commence as planned.
Any delays in the Company's clinical trials would have a material adverse
effect on the Company's business, financial condition and results of operations.
Success in preclinical studies or early stage clinical trials does not assure
success in later stage clinical trials. Data obtained from preclinical and
clinical activities are susceptible to varying interpretations which could
delay, limit or prevent regulatory approval. Further, there can be no assurance
that if such testing of products under development is completed, any such
devices will be accepted for formal review by the FDA, or approved by the FDA
for marketing in the United States.
After a PMA is filed, the FDA begins its review of the submitted information,
which generally takes between one and two years, but may take significantly
longer. During this review period, the FDA may
21
request additional information or clarification of information already provided.
Also during the review period, an advisory panel of experts from outside the FDA
will be convened to review and evaluate the application and provide
recommendations to the FDA as to the approvability of the device. In addition,
the FDA will conduct a preapproval inspection of the manufacturing facility to
ensure compliance with QS regulation requirements. There can be no assurance
that the Company will be able to meet the FDA's requirements or that any
necessary approval will be granted in a reasonable time frame, or at all.
New PMAs or PMA supplements are required for significant modifications to the
manufacture, labeling and design of a device that is approved through the PMA
process. Supplements to a PMA often require submission of the same type of
information as a PMA, except that the supplement is limited to information
needed to support any changes from the device covered by the original PMA and
may not require as extensive clinical data or the convening of an advisory
panel.
The PMA process can be expensive, uncertain and can frequently require several
years. Even when a PMA is approved, the FDA may impose restrictions on the
indications for which the device can be marketed. There can be no assurance that
the Company will be able to obtain necessary approvals on a timely basis, or at
all, and delays in obtaining or failure to obtain such approvals, the loss of
previously obtained approvals, or failure to comply with existing or future
regulatory requirements could have an adverse effect on the Company's business,
financial condition and results of operations.
Subsequent to the receipt of an FDA approval, the Company will continue to be
regulated by the FDA with regard to the reporting of adverse events related to
its products, and ongoing compliance with QS regulation. The Company's
manufacturing facility must be registered with the FDA and the CDHS and will be
subject to periodic inspections by the FDA and by the CDHS. A Device
Manufacturing License has been issued by the State of California and this
license must be renewed annually for the Company to continue manufacture of
medical devices in California.
Europe
The primary regulatory environment in Europe is that of the EU which consists
of 15 countries encompassing most of the major countries in Europe. The EU has
adopted numerous directives and standards regulating the design, manufacture,
clinical trial, labeling, and adverse event reporting for medical devices. The
principal directives prescribing the laws and regulations pertaining to medical
devices in the EU are the Medical Devices Directive 93/42/EEC ("MDD") and the
Active Implantable Medical Devices Directive 90/385/EEC ("AIMDD"). In the EU,
the Company's soundbridges will be regulated as active implantables and
therefore be governed by the AIMDD. For products, such as those of the Company,
that have not previously been commercialized in the EU, CE marking is required
prior to initiation of sales in the EU. Certain other countries, such as
Switzerland, have voluntarily adopted laws and regulations that mirror those of
the EU with respect to medical devices.
Devices that comply with the requirements of a relevant directive will be
entitled to bear CE conformity marking, indicating that the device conforms with
the essential requirements of the applicable directive, and accordingly, can be
commercially distributed throughout the EU. The method of assessing conformity
varies depending on the class of the product, but normally involves a
combination of self-assessment by the manufacturer and a third-party assessment
by a Notified Body.
22
This third party assessment may consist of an audit of the manufacturer's
quality system and specific testing of the manufacturer's product. An assessment
by a Notified Body in one country within the EU is required in order for a
manufacturer to commercially distribute the product throughout the EU.
For purposes of determining the necessary steps for assessing conformity,
devices are classified under the Directives as Class I, Class IIa, Class IIb,
Class III, or Active Implantable Medical Devices. Devices having a higher
classification are considered to have a higher risk and, accordingly, are
subject to more controls in order to bear CE marking. The Vibrant soundbridge is
designated as an Active Implantable Medical Device. Essential requirements under
the AIMDD include substantiating that the device meets the manufacturer's
performance claims and that safety issues, if any, constitute an acceptable risk
when weighed against the intended benefits of the device. The two principal
aspects of assessing conformity for Active Implantable Medical Devices are
determinations from the Notified Body that the processes employed in the design
and manufacture of a device qualify as a full quality system in compliance with
applicable standards (e.g., EN ISO 9001, EN 46001 and 90/385/EEC), and that the
technical, preclinical, and clinical data gathered on the device are adequate to
support CE marking.
The Company has undergone an inspection by its Notified Body and its quality
system has been certified by the Notified Body as being in compliance with the
required standards. The Company has received approval to affix the CE mark to
the Vibrant P and Vibrant HF soundbridges. With regard to the Vibrant D
soundbridge, the Company intends to submit the technical data that its Notified
Body has indicated will be required to satisfy the essential requirements of the
AIMDD. To satisfy these requirements, the Company generally must complete a
clinical trial conducted under European clinical trial standards (EN 540) to
determine the safety and performance of the products. The Vibrant HF and
Vibrant D soundbridges utilize the same implanted component as the Vibrant P
soundbridge. Accordingly, the Notified Body did not require additional clinical
data for the Vibrant HF soundbridge. The Notified Body has not yet, but may,
request additional clinical data for the Vibrant D soundbridge. The Company must
continue to pass annual EN ISO 9001, EN 46001 and AIMDD 2.3 quality system
audits in order to retain the authorization to affix the CE mark to its
products.
Once a manufacturer has satisfactorily completed the regulatory compliance
tasks required by the directives and received favorable determinations by the
Notified Body, it is eligible to place the CE mark on its products.
Manufacturers are subject to ongoing regulation under the AIMDD. The quality
system will be subject to periodic audit and recertification, and serious
adverse events must be reported to the authorities in the country where the
incident takes place. If such incidents occur, the manufacturer may have to take
remedial action, including withdrawal of the product from the EU market.
While no additional premarket approvals in individual EU countries are
required, prior to the marketing of a device bearing the CE mark, practical
complications with respect to market introduction may occur. For example,
differences among countries have arisen with regard to labeling requirements.
Also, as the directives do not cover reimbursement and distribution practices,
differences may occur in these and other areas.
23
Third-Party Reimbursement
The Company believes that its products will generally be purchased by
hospitals and clinics upon the recommendation of a surgeon. In the United
States, hospitals, physicians and other health care providers that purchase
medical devices generally rely on third-party payors, principally Medicare,
Medicaid, private health insurance plans, health maintenance organizations and
other sources of reimbursement for health care costs, to reimburse all or part
of the cost of the procedure in which the medical device is being used. Such
third-party payors have become increasingly sensitive to cost containment in
recent years and place a high degree of scrutiny on coverage and payment
decisions for new technologies and procedures.
Hearing aids, which do not involve surgery and, in certain cases, are exempt
from the requirement for 510(k) approval, are generally not reimbursed, although
a modest reimbursement is provided under certain insurance plans. Traditionally,
hearing aid users have paid for these devices directly. For cochlear implants,
however, that are technologically advanced and FDA-approved through the PMA
process for the treatment of profound hearing impairment, a reimbursement is
available for the device, the audiological testing, and the surgery. Similarly,
reimbursement is available for ossicular replacement prostheses that are FDA-
approved for the treatment of conductive hearing impairment. The Company
anticipates that, as surgically implanted devices that require FDA PMA approval,
the Company's products may also be the subject of reimbursement in the future.
During clinical trials, the Company does not anticipate that there will be any
reimbursement for the Vibrant soundbridge implant or procedure.
The Company's strategy is to pursue reimbursement for the Company's
soundbridges, once a PMA is approved by the FDA, based on surgeon endorsement
and demonstration of improved quality of life for specific patient groups.
Quality of life issues are included in the Company's clinical trial to provide
data in support of this reimbursement strategy. There can be no assurance that
the Company will be able to demonstrate improvement in quality of life or that
reimbursement will ever be available for the Company's products.
Certain third-party payors are moving toward a managed care system in which
they contract to provide comprehensive health care for a fixed cost per person.
The fixed cost per person established by these third-party payors may be
independent of the hospital's cost incurred for the specific case and the
specific devices used. Medicare and other third-party payors are increasingly
scrutinizing whether to cover new products and the level of reimbursement for
covered products. Because the Company's hearing prostheses are currently under
development and have not received FDA clearance or approval, uncertainty exists
regarding the availability of third-party reimbursement for procedures that
would use the Company's soundbridges. Failure by physicians, hospitals and other
potential users of the Company's soundbridges to obtain sufficient reimbursement
from third-party payors for the procedures in which the Company's soundbridges
are intended to be used could have a material adverse effect on the Company's
business, financial condition and results of operations.
Third-party payors that do not use prospectively fixed payments increasingly
use other cost-containment processes or require various outcomes data that may
pose administrative hurdles to the use
24
of the Company's soundbridges. In addition, third-party payors may deny
reimbursement if they determine that the device used in a procedure is
unnecessary, inappropriate, experimental, used for a non-approved indication or
is not cost-effective. Potential purchasers must determine that the clinical
benefits of the Company's products justify the additional cost or the additional
effort required to obtain prior authorization or coverage and the uncertainty of
actually obtaining such authorization or coverage.
Even after obtaining the necessary foreign regulatory approvals, market
acceptance of the Company's products and products currently under development in
international markets will be dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems. Reimbursement and
health care payment systems in international markets vary significantly by
country, and include both government sponsored health care and private
insurance. The Company believes that in Europe, the primary source of funding
for products such as the Company's soundbridges is the various government
sponsored healthcare programs. Requirements for the granting of reimbursement
in many countries are not clearly specified and may involve the collection of
additional clinical data in support of submissions to the appropriate health
care administrations. There can be no assurance that any required data would be
available on a timely basis or that any international reimbursement approvals
will be obtained in a timely manner, if at all. Failure to receive
international reimbursement approvals could have a material adverse effect on
market acceptance of the Company's products in the EU as well as in
international markets in which such approvals are sought.
The Company believes that in the future reimbursement will be subject to
increased restrictions both in the United States and in international markets.
The Company believes that the overall escalating cost of medical products and
services will continue to lead to increased pressures on the health care
industry, both foreign and domestic, to reduce the cost of products and
services, including the Company's products and products currently under
development. There can be no assurance in either United States or international
markets that third-party reimbursement and coverage will be available or
adequate, that future legislation, regulation or reimbursement policies of
third-party payors will not otherwise adversely affect the demand for the
Company's products or products currently under development or its ability to
sell its products on a profitable basis. The unavailability of third-party payor
coverage or the inadequacy of reimbursement could have a material adverse effect
on the Company's business, financial condition and results of operations.
Product Liability
The Company's business involves the inherent risk of product liability claims.
The Company maintains limited product liability insurance at coverage levels
which the Company believes to be commercially reasonable and adequate given the
Company's current operations. However, there can be no assurance that such
insurance will continue to be available on commercially reasonable terms, or at
all, or that such insurance will be adequate to cover liabilities that may
arise. Any claims that are brought against the Company could, if successful,
have an adverse effect on the Company's business, financial condition and
results of operations.
25
Employees
At December 31, 1998, the Company had 61 employees. Of these employees, 26
were in research and development, including regulatory and clinical affairs, 22
were in manufacturing and quality assurance and 13 were in administration, sales
and marketing. None of the Company's employees is covered by a collective
bargaining agreement and the Company believes that it maintains good relations
with its employees.
Scientific Advisory Board
The Company has established a Scientific Advisory Board consisting of five
leading professionals in the fields of otology, otolaryngology and audiology.
The Board meets periodically and reviews the Company's clinical progress and
product development plans. The Company has also established an Audiology
Advisory Board consisting of five leading audiologists. This board brings an
audiological perspective to clinical protocol issues, and audiological testing
and results. In addition to periodic meetings of the boards, members of the
boards are available on an individual basis to consult with the Company. Each
member of the Scientific Advisory Board has received options for stock, pursuant
to the 1994 Option Plan, for participation on the Board.
ITEM 2. PROPERTIES
The Company's principal administrative, manufacturing and research and
development facility occupies approximately 30,500 square feet in San Jose,
California, pursuant to a lease that expires in December 2002. The Company has
established an office in Basel, Switzerland for the headquarters of its European
sales and marketing organization. The Company believes that its facilities are
adequate for its business as presently operated.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "SMPX". The following table sets forth, for the periods indicated,
the range of the low and high sales prices for the Company's Common Stock as
reported on the Nasdaq National Market beginning February 13, 1998, the date the
Common Stock commenced trading.
26
High Low
Fiscal 1998:
First Quarter (from February 13, 1998).............................. $17 1/2 $12 7/16
Second Quarter...................................................... $16 7/8 $ 10 1/4
Third Quarter....................................................... $12 1/8 $ 3 1/8
Fourth Quarter...................................................... $ 7 $ 2 3/8
As of December 31, 1998, there were approximately 175 holders of record of
the Common Stock. On December 31, 1998, the last reported sale price on the
Nasdaq National Market for the Common Stock was $ 4 1/8.
The Company has not declared or paid any cash dividends on its Common
Stock. The Company presently intends to retain earnings for use in its business
and therefore does not anticipate paying cash dividends in the foreseeable
future.
On February 17, 1998, the Company completed the sale of 2,300,000 Common
Shares at a per share price of $12.00 in a firm commitment underwritten public
offering. The offering was effected pursuant to a Registration Statement on
Form S-1 (Registration No. 333-40339), which the United States Securities and
Exchange Commission declared effective on February 12, 1998. The offering was
underwritten by Cowen & Company and UBS Securities. On February 27, 1998 the
Company completed the sale of an additional 345,000 Common Shares at a per share
price of $12.00 pursuant to the exercise of the over-allotment option by the
underwriters. Of the $31,740,000 in aggregate proceeds raised by the Company in
connection with the February offering, (i) approximately $2,221,800 was paid to
the underwriters in connection with underwriting discounts and commissions and
(ii) approximately $1,120,000 was paid by the Company in connection with
offering expenses, including legal, printing and filing fees. From February 17,
1998 to December 31, 1998, the Company has used the remaining proceeds of the
offering in the following manner:
Use of Proceeds
- ---------------
Research & Development, including clinical trials $ 7,400,000
Development of sales and marketing organization $ 1,900,000
Leasehold improvements and capital expenditures $ 1,000,000
Working capital and general corporate $ 2,600,000
Temporary investments
- ---------------------
Short-term investments $15,500,000
All amounts represent estimates of direct or indirect payments of amounts to
third parties. No amounts were paid directly or indirectly for the above
purposes to directors or officers of the Company, to persons owning ten percent
or more of any class of equity securities of the Company, or to affiliates of
the Company.
27
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share amounts)
Period from May
17, 1994 (date of
inception) to
December 31, Years Ended December 31,
------------ ----------------------------------
1994 1995 1996 1997 1998
------------------- --------------- --------- --------- ----------
Revenues: - - - - $ 597
Costs and expenses:
Cost of goods sold.................................. - - - - 1,663
Research and development............................ $ 707 $ 3,307 $ 5,399 $ 6,401 8,322
Selling, general and administrative................. 141 625 1,047 2,065 5,633
------ ------- ------- ------- --------
Total costs and expenses.......................... 848 3,932 6,446 8,466 15,618
Loss from operations................................. (848) (3,932) (6,446) (8,466) (15,021)
Non-operating income:
Interest income, net................................ 96 280 337 475 1,375
------ ------- ------- ------- --------
Net loss............................................. $ (752) $(3,652) $(6,109) $(7,991) $(13,646)
====== ======= ======= ======= ========
Basic and diluted net loss per common share.......... $(0.42) $ (1.86) $ (2.79) $ (3.10) $ (1.24)
====== ======= ======= ======= ========
Shares used in computing basic and diluted net loss
per common share.................................... 1,771 1,962 2,190 2,579 10,987
====== ======= ======= ======= ========
December 31,
------------------------------------------------------------------
1994 1995 1996 1997 1998
------ ------- ------- ------- --------
Balance Sheet Data:
Total assets........................................ $4,910 $ 7,685 $11,951 $13,141 $ 28,695
Working capital..................................... $4,365 $ 6,188 $10,069 $ 9,554 $ 23,795
Long-term debt...................................... $ 99 $ 423 $ 596 $ 2,325 $ 2,098
Stockholders' equity................................ $4,568 $ 6,593 $10,238 $ 8,463 $ 23,875
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Statements in this Management's Discussion and Analysis of Financial Condition
and Results of Operations which express that the company "believes",
"anticipates" or "plans to..." as well as other statements which are not
historical fact, are forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Actual events or results may
differ materially as a result of the risks and uncertainties described herein
and elsewhere including, in particular, those factors described under "Business"
and "Additional Factors That Might Affect Future Results."
Symphonix is developing a family of proprietary semi-implantable and
implantable soundbridges for the management of moderate to severe hearing
impairment. The Company's family of Vibrant soundbridges is based on its
patented core FMT technology.
The Company received the authorization to affix the CE Mark to the first
generation Vibrant soundbridge and the second generation Vibrant P soundbridge
in March 1998 and the Vibrant HF soundbridge in July 1998. The Company began
selling activities for the Vibrant P soundbridge in the European Union in March
1998 and plans to commence selling activities for the Vibrant HF in Europe after
it has gathered clinical data on a limited number of patients.
The Company has established a European sales and marketing organization which,
as of December 31, 1998, is comprised of three marketing management and support
personnel located in Basel, Switzerland and three sales managers performing
direct sales activities in Germany, France, the United Kingdom, Switzerland and
Austria. In addition, the Company has hired a sales manager for South America.
The Company's initial selling efforts in Europe have been targeted primarily at
those ENT surgeons specializing in otology. While the Company intends to
continue to market its products to these specialists, it also plans to focus on
the referring physicians, audiologists and the general population of ENT
surgeons in an attempt to increase the number of patients that are referred to
specialist ear surgeons. The Company is also attempting to gather clinical and
other data which it believes will be helpful in obtaining reasonable
reimbursement levels for its products. There can be no assurance that the
Company will be successful in its efforts to increase the number of patients who
become candidates for the Company's soundbridges or in obtaining reimbursement
for its products.
In September 1996 the Company initiated clinical trials of the Vibrant
soundbridge in the United States. On December 11, 1997, the FDA approved a
multi-center pivotal study in 55 subjects at up to 12 sites with the second
generation Vibrant P soundbridge. As of January 31, 1999 the Company had
enrolled a total of 55 subjects in this pivotal study. During the year ending
December 31, 1998, the Company was selected by the FDA to participate in the
new, streamlined PMA process called the modular PMA. Under the modular PMA
process, modules reflecting the content requirements of a traditional PMA are
submitted as they are completed, allowing them to be reviewed and approved in a
sequential manner. To date, the Company has submitted four modules of its PMA
for the Vibrant P soundbridge. There can be no assurance that the Company's
participation in the modular PMA program
29
will lead to the timely approval of the Vibrant P soundbridge, if at all. In
November 1998, the FDA approved the inclusion of the Vibrant HF soundbridge in
the existing pivotal trial, and in January 1999 granted the Company permission
to enroll an additional 15 subjects for purposes of evaluating the Vibrant HF
soundbridge.
Symphonix has a limited operating history. Through December 31, 1998 the
Company had not generated significant revenue from product sales and had an
accumulated deficit of $32.2 million. The Company expects to incur substantial
losses through at least 2000. To date, the Company's principal sources of
funding have been net proceeds from its initial public offering completed in
February 1998, private equity financings, an equipment lease financing and bank
borrowings.
Results of Operations
Revenue. Revenue of $597,000 was recorded in the year ended December 31,
1998 for sales of the Vibrant P soundbridge in Europe. No revenue was recorded
in 1997 or 1996 because the Company had no product sales in those years.
Cost of goods sold. Cost of goods sold was $1.7 million in the year ended
December 31, 1998, and represents the direct cost of the products sold as well
as a portion of the manufacturing overhead. There was no cost of goods sold for
1997 or 1996 because the Company had no product sales in those years.
Research and Development Expenses. Research and development expenses were
$8.3 million, $6.4 million and $5.4 million, in the years ended December 31,
1998, 1997 and 1996, respectively. Research and development expenses consist
primarily of personnel costs, professional services, materials, supplies and
equipment in support of product development, clinical trials, regulatory
submissions, preparation and filing of patent applications and the start-up of
manufacturing. Research and development expenses increased from 1997 to 1998 in
part due to higher facility costs attributable to the commencement of a lease on
a new facility in January 1998. In addition, the Company increased the level of
spending on supplies, professional services and equipment and hired more
employees. During 1997, the Company increased its product development efforts,
developed clinical research and regulating functions, initiated clinical trials
and established a pilot manufacturing capability. To support these activities,
the Company hired more employees and increased the level of spending on
supplies, professional services and equipment. The Company expects its research
and development expenses to increase in 1999, primarily due to the development
of the Vibrant TI soundbridge.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $5.6 million, $2.1 million and $1.0 million in the
years ended December 31, 1998, 1997 and 1996, respectively. Selling, general
and administrative expenses consist primarily of personnel, marketing, legal and
consulting costs. Expenses increased from 1997 to 1998, due to the establishment
of a European sales and marketing organization, the initiation of selling and
marketing activities in Europe, amortization of deferred compensation and
increases in administrative costs associated with expanded operations and
becoming a public company. Expenses increased from 1996 to 1997 due to
increases in the level of staffing and spending on professional services as the
Company expanded the scope of its operations. The Company plans to expand its
European sales organization in 1999 and as a result expects
30
selling general and administrative expenses to increase in 1999.
Deferred compensation of $2.3 million was recorded in 1997, representing the
difference between the exercise prices of certain options granted and the deemed
fair value of the Company's Common Stock on the grant dates. Deferred
compensation expense of $191,000 and $556,000 attributed to such options was
amortized during the years ended December 31, 1997 and 1998, respectively. The
remaining deferred compensation will be amortized over the vesting period of the
options (generally four years).
Interest Income, net. Interest income, net was $1.4 million, $475,000 and
$337,000 in the years ended December 31, 1998, 1997 and 1996, respectively.
Most of the increase from 1997 to 1998 was generated from interest income on net
proceeds from the Company's February 1998 initial public offering.
Income Taxes. To date, the Company has not incurred any U.S. income tax
obligations. At December 31, 1998, the Company had net operating loss
carryforwards of approximately $25.0 million for federal and $19.3 million for
state income tax purposes, which will expire at various dates through 2013 and
2003, respectively, if not utilized. The principal differences between losses
for financial and tax reporting purposes are the result of the capitalization of
research and development and start-up expenses for tax purposes. United States
and state tax laws contain provisions that may limit the net operating loss
carryforwards that can be used in any given year, should certain changes in the
beneficial ownership of the Company's outstanding common stock occur. Such
events could limit the future utilization of the Company's net operating loss
carryforwards.
Liquidity and Capital Resources
Since its inception, the Company has funded its operations and its capital
expenditures from net proceeds of its initial public offering completed in
February 1998 totaling $28.4 million, from the private sale of equity securities
totaling $26.5 million, from an equipment lease financing totaling $1.3 million
and from bank borrowings totaling $2.0 million, net. At December 31, 1998, the
Company had $23.8 million in working capital, and its primary source of
liquidity was $25.3 million in cash, cash equivalents and short-term
investments.
Capital expenditures, related primarily to the Company's research and
development and manufacturing activities, were $1.6 million, $898,000 and
$409,000 in the years ended December 31, 1998, 1997 and 1996, respectively. The
increased capital expenditures in 1998 and 1997 relate primarily to the
Company's new facility. At December 31, 1998, the Company did not have any
material commitments for capital expenditures.
In October 1997 the Company entered into a lease agreement for a new facility
for a five year term commencing January 1998. During the quarter ended March
31, 1998 the Company relocated its research and development and administrative
functions to the new facility. The Company completed the relocation of its
manufacturing activities to the new facility in April 1998. Through December 31,
1998, the Company has made approximately $1.6 million in capital expenditures,
primarily attributable to leasehold improvements and furniture and fixtures
related to the new facility.
31
The Company has a loan agreement with a bank providing for borrowings of up to
$2.0 million and for the issuance of letters of credit up to $250,000. At
December 31, 1998, the Company had borrowings of $2.0 million and an outstanding
letter of credit in the amount of $195,000 under the loan agreement. Borrowings
under the loan agreement are repayable over four years commencing in January
2000.
Symphonix used $12.7 million in cash for operations in 1998, an increase of
$6.2 million from the $6.5 million used in 1997. The increase was primarily due
to an increase in net loss from 1997 to 1998.
The Company will expend substantial funds in the future for research and
development, preclinical and clinical testing, capital expenditures and the
manufacturing, marketing and sale of its products. The timing and amount of
spending of such capital resources cannot be accurately predicted and will
depend on several factors including the availability of third party
reimbursement, the progress of the Company's research and development efforts
and preclinical and clinical activities, competing technological and market
developments, the time and costs of obtaining regulatory approvals, the time and
costs involved in filing, prosecuting and enforcing patent claims, the progress
and cost of commercialization of products currently under development, market
acceptance and demand for the Company's products in the United States, if
approved for marketing, and internationally and other factors not within the
Company's control. While the Company believes that its existing capital will be
sufficient to fund its operations and its capital investments through 1999,
there can be no assurance that the Company will not require additional financing
prior to that time. In addition, there can be no assurance that such additional
financing will be available on a timely basis on terms acceptable to the
Company, or at all, or that such financing will not be dilutive to stockholders.
If adequate funds are not available, the Company could be required to delay
development or commercialization of certain of its products, license to third
parties the rights to commercialize certain products or technologies that the
Company would otherwise seek to commercialize for itself, or reduce the
marketing, customer support or other resources devoted to certain of its
products, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Year 2000 Compliance
The Company has initiated planning for issues related to the upcoming new
millennium. These issues derive from the use of software and hardware with
embedded chips or processors that use two digits to refer to a year and do not
properly recognize a year that begins with "20" instead of the familiar "19".
The use of such software and hardware occurs at many internal and external
points in the Company's development, supply, manufacturing and distribution
chain both within the Company's internal operations as well as at important
external partners, such as vendors and customers.
The Company has developed a plan to address these issues and to enhance the
Company's readiness for Year 2000. The Company's plan (the "Year 2000 Readiness
Program") focuses on five areas: (1) network and facility infrastructure, (2)
business applications software, (3) process control systems, (4) external
partners, and (5) the Company's products. Within each area, the Year 2000
Readiness Program will involve (a) the identification of systems that may be
susceptible to Year 2000
32
issues (the "identification phase"), (b) the assessment of the degree of
readiness of those systems for the Year 2000 and an assessment of the risks that
may be posed to the Company's business (the "assessment phase"), (c) the
remediation of problems that are identified (the "remediation phase"), and (d)
contingency planning.
Network and facility infrastructure: Included in this category are the
computer networks in the Company's San Jose, California headquarters and Basel,
Switzerland European headquarters (including servers, computers, other network
equipment and computer and network operating systems), together with general
facility systems such as telephone and security systems. The Company expects
that the identification and assessment phases will be completed during the first
quarter of 1999, at which time remediation and contingency planning will be
initiated as appropriate.
Business applications software: Included in this category are various
applications used in design, manufacturing, distribution and finance. The
Company's primary business application is a company-wide system used for
manufacturing planning, accounting, inventory management and sales transactions.
The Company expects that the identification and assessment phases will be
completed during the second quarter of 1999, at which time remediation and
contingency planning will be initiated as appropriate. For many software
applications, the Company will, in the assessment phase, rely on the software
developer's representations regarding Year 2000 compliance of their software.
There can be no assurance, however, that software applications represented by
developers as being Year 2000 compliant will be free from Year 2000 errors and
defects.
Process control systems: Included in this category are instrumentation and
systems used in design and manufacturing processes. The Company expects that
the identification and assessment phases will be completed during the second
quarter of 1999 at which time remediation and contingency planning will be
initiated as appropriate.
External partners: The Company intends to assess the possible effects on its
operations of the Year 2000 compliance of certain relevant third parties, such
as customers and service providers by using questionnaires and, in limited
cases, site visits and interviews to solicit information from these parties. In
the event the Company identifies a problem with respect to a particular vendor,
then the Company may be forced to identify alternative sources of supply.
However, the Company's ability to seek alternative sources of supply is subject
to FDA restrictions and may involve extensive validation processes. The failure
to timely identify and validate an alternative supplier could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company expects to complete the identification phase and
initiate the assessment phase by the first quarter of 1999.
Symphonix products: The Company's products are regulated by the FDA and the
FDA has advised manufacturers of medical devices to address readiness of their
products for year 2000 issues. The Company has completed a preliminary
assessment and has informed the FDA that the Company does not believe that any
of its existing products are susceptible to Year 2000 issues.
The Company does not expect to incur costs in its Year 2000 Readiness Program
that will be
33
material to its business, financial condition or results of operations. However,
until the Company completes the identification and assessment phases of its
program, the full extent of the remediation costs will not be known and there
can be no assurance that such costs will not be material. The Company will
utilize both internal and external resources, such as consultants and
professional advisors, in implementing the Year 2000 Readiness Program and the
Company currently estimates that the external resources required during the
identification and assessment phases of the Year 2000 Readiness Program will
cost approximately $50,000. Because the Year 2000 Readiness Program is an
ongoing process, all cost estimates are subject to change. Specific contingency
plans will be developed upon completion of the assessment phases and may include
additional procurement of inventory to assure continued supply from vendors.
Although the Company intends to complete all phases of its Year 2000 Readiness
Program by December 31, 1999, there can be no assurance, even if this program is
successfully completed on schedule, that disruptions in the Company's business
will be avoided. The Year 2000 issues are pervasive in nature and involve
highly technical issues, not all of which are under the Company's control.
Possible consequences of Year 2000 issues that the Company is unable to
adequately identify, assess or remediate include but are not limited to: delays
in supplies from vendors, delays in shipment to customers, errors in processing
transactions, deficiencies in management of inventory, delays in collection of
funds from customers, and diversion of management time and effort to addressing
difficulties that emerge. The goal of the Company's Year 2000 Readiness Program
is to plan for and reduce the risk of such difficulties. There can be no
assurance that the Year 2000 Readiness Program will be completed in a timely
manner or will be successful.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which establishes accounting and reporting standards for derivative instruments
and hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The Company, to date, has not engaged in
derivative and hedging activities. The Company will adopt SFAS No. 133 as
required for its first quarterly filing of 2000.
Additional Factors That Might Affect Future Results
History of Losses and Expectation of Future Losses.
At December 31, 1998, the Company had an accumulated deficit of $32.2
million. Since the Company's inception in 1994, substantially all of the
Company's resources have been dedicated to research and development,
establishment of a European sales and marketing organization and the initiation
of sales and marketing activities in Europe. In March 1998, the Company received
the authorization to affix the CE Mark to the Vibrant and Vibrant P
soundbridges, permitting the initiation of commercial sales in the European
Union ("EU"). Although the Company has commenced selling the Vibrant P
soundbridge in Europe, through December 31,1998 the Company has not generated
significant revenues from these sales. The Company received CE Mark approval for
the Vibrant HF soundbridge
34
in July 1998 and plans to commence selling the Vibrant HF soundbridge after it
has gathered clinical data on a limited number of patients. In the United
States, the Company's Vibrant P and Vibrant HF soundbridges will require
additional clinical testing prior to the submission of a regulatory application
for commercial use. All of the Company's other products will require additional
development, and preclinical and clinical testing prior to the submission of a
regulatory application for commercial use internationally and domestically.
Since the Vibrant P soundbridge only recently became available for sale in the
EU and is not currently available for sale in the United States, significant
product revenues will not be realized for at least several years, if ever. The
Company expects its operating losses to continue at least through the year 2000
as it continues to expend substantial funds for clinical trials in support of
regulatory approvals, expansion of research and development activities and
establishment of commercial-scale manufacturing and sales and marketing
capabilities. There can be no assurance that any of the Company's soundbridges
will be successfully commercialized internationally or in the United States or
that the Company will achieve significant revenues from product sales. In
addition, there can be no assurance that the Company will achieve or sustain
profitability in the future. The Company's results of operations may fluctuate
from quarter to quarter or year to year and will depend upon numerous factors,
including action relating to regulatory matters, progress of clinical trials,
the timing and scope of research and development efforts, the extent to which
the Company's products gain market acceptance or achieve reasonable
reimbursement levels, the timing of scale-up of manufacturing capabilities, the
timing of expansion of sales and marketing activities and competition.
Limited Clinical Testing Experience.
In the United States, the Company has conducted only limited clinical
trials of the Vibrant and Vibrant P soundbridges. The Company has received
approval of an IDE to conduct a clinical trial of the Vibrant, Vibrant P and
Vibrant HF soundbridges. In Europe, the Vibrant and Vibrant P soundbridges have
been the subject of limited clinical testing. The Company intends to conduct
clinical testing of the external components of the Vibrant HF soundbridge. The
implanted components of the Vibrant HF soundbridge are the same as the implanted
components of the Vibrant P soundbridge which was tested in clinical trials
previously conducted by the Company in Europe. None of the Company's other
soundbridges under development have been tested in human clinical trials and
these soundbridges will require additional development, clinical trials and
regulatory approval prior to commercialization. The results from preclinical
studies and early clinical trials may not be indicative of results obtained in
later clinical trials, and there can be no assurance that clinical trials
conducted by the Company will demonstrate sufficient safety and efficacy to
obtain requisite approvals.
The rate of completion of the Company's clinical trials may be delayed by
many factors, including slower than anticipated patient enrollment or adverse
events occurring during clinical trials. Completion of preclinical and clinical
activities may take several years, and the length of time for completion of the
required studies is unpredictable. In addition, data obtained from preclinical
and clinical activities are susceptible to varying interpretations, which could
delay, limit or prevent regulatory approval. No assurance can be given that any
of the Company's clinical trials will be successfully completed on a timely
basis, or at all, that additional clinical trials will be allowed by the FDA or
other regulatory authorities or that such clinical trials will commence as
planned. Any delays in the Company's clinical trials would have a material
adverse effect on the Company's business, financial condition and results of
operations. Success in preclinical studies or early stage clinical trials
35
does not assure success in later stage clinical trials.
Reliance on FMT Technology.
The Company has concentrated its efforts primarily on the development,
implementation and acceptance of the FMT, the patented core direct drive
technology upon which all of the Company's soundbridges are based. The
Company's soundbridges employ a direct drive approach to the management of
hearing impairment, which is a novel development. There can be no assurance that
the Company's soundbridges, based on the Company's FMT technology, will prove to
be safe and effective, or that if proven safe and effective, can be manufactured
at a reasonable cost or successfully commercialized.
No Assurance of Market Acceptance.
The market acceptance of the Company's soundbridges will depend upon their
acceptance by the medical community and patients as clinically useful, reliable
and cost-effective compared to other devices. Clinical acceptance will depend on
numerous factors, including the establishment of the safety and the
effectiveness of the soundbridge's ability to drive the ossicles directly and
improve hearing over currently available hearing aids. Clinical acceptance will
also depend on the receipt of regulatory approvals in the United States and the
Company's ability to adequately train ear surgeons on the techniques for
implanting the Company's soundbridges. There can be no assurance that the
Company's soundbridges will be preferable alternatives to existing devices, some
of which, such as the acoustic hearing aid, do not require surgery, or that the
Company's soundbridges will not be rendered obsolete or noncompetitive by
products under development by other companies. Patient acceptance of the
Company's soundbridges will depend in part upon physician, audiologist and
surgeon recommendations as well as other factors, including the effectiveness,
safety, reliability and invasiveness of the procedure as compared to established
approaches. Prior to undergoing surgery for the implantation of the Company's
soundbridge, a patient may speak with a number of medical professionals,
including the patient's primary care physician, an audiologist, an ENT
specialist, as well as surgeons who specialize in ear surgery. The failure by
any of these medical professionals to favorably recommend the Company's products
and the surgery required to implant the soundbridge could limit the number of
potential patients who are introduced to an ear surgeon as candidates for the
Company's soundbridges. Even if the Company's soundbridges are adopted by the
medical community, a significant market may not develop for the Company's
products unless acceptable reimbursement from health care payors is available.
There can be no assurance that the Company's soundbridges will be accepted by
the medical community or consumers, that acceptable reimbursement from third-
party payors will be available or that market demand for such products will be
sufficient to allow the Company to achieve profitable operations. Failure of the
Company's soundbridges, for whatever reason, to achieve significant adoption by
the medical community or consumers or failure of the Company's products to
achieve any significant market acceptance would have a material adverse effect
on the Company's business, financial condition and results of operations.
Future Capital Requirements; Uncertainty of Additional Funding.
The Company will expend substantial funds in the future for research and
development,
36
preclinical and clinical testing, capital expenditures and the manufacturing,
marketing and sale of its products. The timing and amount of spending of such
capital resources cannot be accurately predicted and will depend upon several
factors, including the progress of its research and development efforts and
preclinical and clinical activities, competing technological and market
developments, the time and costs of obtaining regulatory approvals, the time and
costs involved in filing, prosecuting and enforcing patent claims, the progress
and cost of commercialization of products currently under development, market
acceptance and demand for the Company's products in the United States, if
approved for marketing, and internationally and other factors not within the
Company's control. On February 17, 1998, the Company completed an initial public
offering of 2,300,000 shares of common stock. On February 27, 1998, the Company
completed the sale of an additional 345,000 shares of common stock pursuant to
the exercise by the underwriters of an over allotment option. Net proceeds to
the Company totaled approximately $28.4 million. While the Company believes that
the net proceeds of the offering, together with its previously existing capital
resources and projected interest income, will be sufficient to fund its
operations and its capital investments through 1999, there can be no assurance
that the Company will not require additional financing prior to that time. In
addition, there can be no assurance that such additional financing will be
available on a timely basis on terms acceptable to the Company, or at all, or
that such financing will not be dilutive to stockholders. If adequate funds are
not available, the Company could be required to delay development or
commercialization of certain of its products, to license to third parties the
rights to commercialize certain products or technologies that the Company would
otherwise seek to commercialize for itself, or to reduce the marketing, customer
support or other resources devoted to certain of its products, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence upon Key Personnel.
The Company's future success depends in significant part upon the continued
service of certain key scientific, technical and management personnel.
Competition for such personnel is intense and there can be no assurance that the
Company can retain its key scientific, technical and managerial personnel or
that it can attract, assimilate or retain other highly qualified scientific,
technical and managerial personnel in the future. The loss of key personnel,
especially if without advance notice, or the inability to hire or retain
qualified personnel could have a material adverse effect upon the Company's
business, financial condition and results of operations. The Company has not
entered into employment agreements with any of its key personnel. The Company
is the beneficiary under a $1.0 million key man insurance policy on Harry S.
Robbins, its President and Chief Executive Officer.
Volatility of Stock
The market prices for securities of medical device companies have historically
been highly volatile. Announcements of technological innovations or new products
by the Company or its competitors, developments concerning proprietary rights,
including patents and litigation matters, publicity regarding actual or
potential results with respect to products under development by the Company or
others, regulatory developments in both the United States and foreign countries
and public concern as to the safety of new technologies, changes in financial
estimates by securities analysts or failure of the Company to meet such
estimates and other factors may have a significant impact on the market price
37
of the common stock. In addition, the Company believes that fluctuations in its
operating results may cause the market price of its common stock to fluctuate,
perhaps substantially.
38
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company considered the provision of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments". The Company
had no holdings of derivative financial or commodity instruments at December 31,
1998. The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. The fair value of the
Company's investment portfolio or related income would not be significantly
impacted by either a 100 basis point increase or decrease in interest rates due
mainly to the short-term nature of the Company's investment portfolio. The
Company's fixed rate debt obligations are subject to interest rate risk with
minimal impact. An increase in interest rates would not significantly affect
the Company's net loss. Much of the Company's revenue and all of its capital
spending is transacted in U.S. dollars. However, the Company does enter into
these transactions in other currencies, primarily certain European currencies.
At December 31, 1998, the Company performed sensitivity analyses to assess the
potential effect of this risk and concluded that near-term changes in interest
rates and foreign currency exchange rates should not materially adversely affect
the Company's financial position, results of operations or cash flows.
39
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
San Jose, California
January 22, 1999
To the Board of Directors and
Stockholders of Symphonix Devices, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, comprehensive loss, stockholders' equity,
and of cash flows present fairly, in all material respects, the financial
position of Symphonix Devices, Inc. at December 31, 1998 and 1997, and the
results of operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. 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 of these financial
statements in accordance with generally accepted auditing standards, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
40
SYMPHONIX DEVICES, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data)
December 31,
-----------------------------
1998 1997
-----------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 3,401 $ 4,908
Short-term investments 21,916 6,549
Accounts receivable, net of allowance for doubtful
accounts of $3 in 1998 228 -
Inventories 761 -
Prepaid expenses and other current assets 211 451
-------- --------
Total current assets 26,517 11,908
Property and equipment, net 2,100 1,157
Other assets 78 76
-------- --------
Total assets $ 28,695 $ 13,141
-------- --------
LIABILITIES
Current liabilities:
Accounts payable $ 684 $ 366
Accrued compensation 1,060 888
Other accrued liabilities 751 778
Current portion of capital lease obligation 227 322
-------- --------
Total current liabilities 2,722 2,354
Capital lease obligation, less current portion 98 325
Bank borrowings, less current portion 2,000 2,000
-------- --------
Total liabilities 4,820 4,679
-------- --------
Commitments (Note 6).
STOCKHOLDERS' EQUITY
Convertible preferred stock, $.001 par value
Authorized: 50,000,000 shares
Issued and outstanding: no shares in 1998, 9,195,000 shares in 1997 - 9
Common stock, $.001 par value:
Authorized: 50,000,000 shares
Issued and outstanding: 12,201,000 in 1998 and 2,785,000 in 1997 12 3
Notes receivable from stockholders (484) (499)
Deferred compensation (1,517) (2,073)
Additional paid-in capital 58,040 29,526
Accumulated other comprehensive loss (26) -
Accumulated deficit (32,150) (18,504)
-------- --------
Total stockholders' equity 23,875 8,462
-------- --------
Total liabilities and stockholders' equity $ 28,695 $ 13,141
-------- --------
The accompanying notes are an integral part of these consolidated financial statements
41
SYMPHONIX DEVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
---------------------------------------------------------------
1998 1997 1996
---------------- ------------------ -------------------
Revenue $ 597 $ - $ -
Costs and expenses:
Costs of goods sold 1,663 - -
Research and development 8,322 6,401 5,399
Selling, general and administrative 5,633 2,065 1,047
-------- ------- -------
(15,618) (8,466) (6,446)
-------- ------- -------
Operating loss (15,021) (8,466) (6,446)
Interest income 1,486 581 423
Interest expense (111) (106) (86)
-------- ------- -------
Net loss $(13,646) $(7,991) $(6,109)
-------- ------- -------
Basic and diluted net loss per common share $ (1.24) $ (3.10) $ (2.79)
-------- ------- -------
Shares used in computing basic and diluted net loss
per common share 10,987 2,579 2,190
-------- ------- -------
The accompanying notes are an integral part of these consolidated financial statements
42
SYMPHONIX DEVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Cash flows from operating activities:
Net loss $(13,646) $ (7,991) $(6,109)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of deferred compensation 556 191 -
Depreciation and amortization 682 498 421
Changes in operating assets and liabilities:
Accounts receivable (228) - -
Inventory (761) - -
Prepaid expenses and other current assets 240 (374) (23)
Accounts payable 318 324 (26)
Accrued compensation 172 213 251
Other accrued liabilities (27) 661 100
-------- -------- -------
Net cash used in operating activities (12,694) (6,478) (5,386)
-------- -------- -------
Cash flows from investing activities:
Purchases of short-term investments (37,086) (10,009) (8,222)
Sales of short-term investments 21,704 8,028 7,890
Purchases of property and equipment (1,625) (898) (409)
Change in other assets (2) (68) 51
-------- -------- -------
Net cash used in investing activities (17,009) (2,947) (690)
-------- -------- -------
Cash flows from financing activities:
Proceeds from capital leases - 63 518
Payments on capital lease obligations (322) (296) (222)
Proceeds from bank borrowings - 2,000 -
Proceeds from issuance of preferred stock, net of issuance costs - 5,990 9,682
Proceeds from issuance of common stock, net of issuance costs 28,514 35 71
Payments received on notes receivable from stockholders 15 - -
-------- -------- -------
Net cash provided by financing activities 28,207 7,792 10,049
-------- -------- -------
Net increase (decrease) in cash and cash equivalents (1,496) (1,633) 3,973
Effect of exchange rates on cash and cash equivalents (11) 2 -
Cash and cash equivalents, beginning of year 4,908 6,539 2,566
------- --------- -------
Cash and cash equivalents, end of year $ 3,401 $ 4,908 $ 6,539
------- --------- -------
43
Supplemental disclosure of cash flow information and non-cash activities
Cash paid during the year for interest $ 111 $106 $ 86
----- ---- ----
Common stock issued in exchange for promissory note $ - $360 $124
----- ---- ----
Change in short-term investments $ (15) $ 2 $ -
----- ---- ----
The accompanying notes are an integral part of these consolidated financial statements
44
SYMPHONIX DEVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the three years ended December 31, 1998
(in thousands, except per share data)
Preferred Stock Common Stock Notes
Receivable
from
Stockholders
---------------- ----------------
Shares Amount Shares Amount
---------------- ----------------
Balances, December 31, 1995 6,842 $7 1,980 $2 $ (15)
Series C preferred stock issued at $5.35 per
share, net of issuance costs of $54 1,162 1
Series D preferred stock issued at $8.00 per
share, net of issuance costs of $9 441 -
Common stock issued in connection with stock
option exercise in exchange for $71 in cash
and $124 of notes, net of repurchase of 73
shares 404 - (124)
Net loss
----- -- ----- -- -----
Balances, December 31, 1996 8,445 8 2,384 2 (139)
Series D preferred stock issued at $8.00 per
share, net of issuance costs of $10 750 1
Common stock issued in connection with stock
option exercise in exchange for $34 in cash
and $360 in notes 401 1 (360)
Deferred compensation related to grant of
options
Amortization of deferred compensation
Unrealized losses on short-term investments
Translation adjustments
Net loss
----- -- ----- -- -----
Balances, December 31, 1997 9,195 9 2,785 3 (499)
Deferred Paid-In Comprehensive Accummulated Total
Compensation Capital Income Deficit Stockholders'
(Loss) Equity
------------ -------- ------------- ------------ --------------
Balances, December 31, 1995 $11,003 $ (4,404) $ 6,593
Series C preferred stock issued at $5.35 per share,
net of issuance costs of $54 6,162 6,163
Series D preferred stock issued at $8.00 per share,
net of issuance costs of $9 3,519 3,519
Common stock issued in connection with stock option
exercise in exchange for $71 in cash and $124 of
notes, net of repurchase of 73 shares 195 71
Net loss (6,109) (6,109)
------- -------- --------
Balances, December 31, 1996 20,879 (10,513) 10,237
Series D preferred stock issued at $8.00 per share,
net of issuance costs of $10 5,989 5,990
Common stock issued in connection with stock option
exercise in exchange for $34 in cash and $360 in
notes 394 35
Deferred compensation related to grant of options $(2,264) 2,264 -
Amortization of deferred compensation 191 191
Unrealized losses on short-term investments $(2) (2)
Translation adjustments 2 2
Net loss (7,991) (7,991)
------- ------- -- -------- --------
Balances, December 31, 1997 (2,073) 29,526 - (18,504) 8,462
45
Preferred Stock Common Stock Notes
Receivable
from
Stockholders
---------------- ----------------
Shares Amount Shares Amount
---------------- ----------------
Common stock issued in connection with the
Company's initial public offering at $12.00
per share, net of issuance costs of $1,119 2,645 2
Conversion of preferred stock to common stock
upon the closing of the Company's initial
public offering (9,195) (9) 6,682 7
Common stock issued in conncetion with stock
option exercises for cash 65 -
Common stock issued pursuant to the Company's
Stock Purchase Plan 24 -
Payment of promissory note 15
Amortization of deferred compensation
Unrealized losses on short-term investments
Translation adjustments
Net loss
------ -- ------ --- -----
Balances, December 31, 1998 - - 12,201 $12 $(484)
====== == ====== === =====
Deferred Paid-In Comprehensive Accummulated Total
Compensation Capital Income Deficit Stockholders'
(Loss) Equity
------------ -------- ------------- ------------ --------------
Common stock issued in connection with the Company's
initial public offering at $12.00 per share, net of
issuance costs of $1,119 28,397 28,399
Conversion of preferred stock to common stock upon
the closing of the Company's initial public offering 2 -
Common stock issued in conncetion with stock option
exercises for cash 40 40
Common stock issued pursuant to the Company's Stock
Purchase Plan 75 75
Payment of promissory note 15
Amortization of deferred compensation 556 556
Unrealized losses on short-
term investments (15) (15)
Translation adjustments (11) (11)
Net loss (13,646) (13,646)
------- ------- ---- -------- --------
Balances, December 31, 1998 $(1,517) $58,040 $(26) $(32,150) $ 23,875
======= ======= ==== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements
46
SYMPHONIX DEVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
Year Ended December 31,
---------------------------------------------------------------------
1998 1997 1996
---------------- ---------------- -----------------
Net loss $(13,646) $(7,991) $(6,109)
Unrealized losses on
short-term investments (15) (2) -
Translation adjustments (11) 2 -
-------- ------- -------
Comprehensive loss $(13,672) $(7,991) $(6,109)
-------- ------- -------
The accompanying notes are an integral part of these consolidated financial statements
47
SYMPHONIX DEVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY:
Symphonix Devices, Inc. (the "Company") was incorporated on May 17, 1994 to
develop and manufacture implantable and semi-implantable hearing devices. The
Company sells products in Europe and South America through its direct sales
force and distributors.
The Company's commercial operations commenced during 1998 at which time it
emerged from the development stage. In the course of its development
activities, the Company has sustained operating losses and expects such losses
to continue at least through 2000. The Company will finance its operations
primarily through its cash, cash equivalents and short-term investments,
together with existing credit facilities and future revenues. There can be no
assurance that the Company will not require additional funding and should this
prove necessary, the Company may sell additional shares of its common or
preferred stock through private placement or further public offerings.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
Short-Term Investments:
All short-term investments are classified as available-for-sale and therefore
are carried at fair market value. Unrealized gains and losses on such
securities, when material, are reported as a separate component of stockholders'
equity. Interest income is recorded using an effective interest rate, with
associated premium or discount amortized to "investment income." Realized gains
and losses on sales of all such securities are reported in earnings and computed
using the specific identification cost method.
Property and Equipment:
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally three to five years.
Amortization of leasehold improvements and property and equipment under capital
lease
48
obligations is computed using the straightline method over the shorter of the
remaining lease term or the estimated useful life of the related assets,
typically five years. Upon retirement or disposal of the asset, the cost and
related accumulated depreciation are removed from the balance sheet and any gain
or loss is reflected in Other Income.
Research and Development:
Research and development costs are charged to operations as incurred.
Concentration of Credit Risk and Other Risks and Uncertainties:
The Company's cash and cash equivalents are primarily maintained at two
financial institutions in the United States. Deposits held with banks may
exceed the amount of insurance provided on such deposits. Generally these
deposits may be redeemed upon demand and therefore, bear minimal risk.
The Company performs ongoing credit evaluations of its customers and maintains
allowances for doubtful accounts. Historically the Company has not experienced
significant losses related to individual customers. At December 31, 1998, three
customers accounted for approximately 22.7%, 19.1% and 18.4% of accounts
receivable, respectively.
The Company's products require approvals from the Food and Drug Administration
and international regulatory agencies prior to commercialized sales. During
1998, the Company received approvals to market its Vibrant P and Vibrant HF
soundbridges in the European Union. There can be no assurance that the
Company's products will receive additional required approvals. If the Company
was denied such approvals or such approvals were delayed, it would have a
materially adverse impact on the Company.
Fair value of Financial Instruments:
Carrying amounts of the Company's financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities
approximate fair values due to their short maturities. Based on the borrowing
rates currently available to the Company for loans with similar terms, the
carrying values of the equipment line of credit and bank loan approximate fair
values. Estimated fair values for short-term investments, which are separately
disclosed elsewhere, are based on quoted market prices for the same or similar
instruments.
Income Taxes:
The Company accounts for income taxes under the liability method, whereby
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to affect taxable income. Valuation allowances are established when necessary to
reduce deferred tax assets to the amounts expected to be realized.
49
Use of Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Foreign Currency Translation:
The Company's international subsidiaries use their local currency as their
functional currency. Assets and liabilities are translated at exchange rates in
effect at the balance sheet date and income and expense accounts at average
exchange rates during the year. Resulting translation adjustments are recorded
directly to a separate component of stockholders' equity.
Computation of Basic and Diluted Net Loss per Common Share:
The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128
"Earnings Per Share" and the provisions of the Securities and Exchange
Commission Staff Accounting Bulletin (SAB) No. 98, and accordingly all prior
periods have been restated. Basic and diluted net loss per common share are
computed using the weighted average number of shares of common stock
outstanding. Common equivalent shares from stock options, warrants, and
preferred stock are excluded from the computation of diluted net loss per share,
as their effect is antidilutive. The Company has determined that no incremental
shares should be included in the computation of net loss per share in accordance
with SAB No. 98.
Stock options, preferred stock, and warrants to purchase 694,000, 600,000 and
618,000 shares of common stock at prices ranging from $0.14 to $4.13 per share
were outstanding at December 31, 1998, 1997, and 1996, respectively, but were
not included in the computation of diluted net loss per common share because
they were antidilutive. The aforementioned stock options, preferred stock and
warrants could potentially dilute earnings per share in the future.
Revenue Recognition:
Revenue is generally recognized upon shipment of product to the customer.
Inventories:
Inventories are stated at the lower of cost or market. Cost is determined on a
standard cost basis that approximates the first-in, first-out (FIFO) method.
Appropriate consideration is given to obsolescence, excessive levels,
deterioration and other factors in evaluating lower of cost or market.
50
Recent Accounting Pronouncement:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The Company, to date, has not engaged in
derivative and hedging activities. The Company will adopt SFAS No. 133 as
required for its first quarterly filing of 2000.
3. BALANCE SHEET DETAIL:
Short-Term Investments:
Marketable securities are deemed by management to be available-for-sale and at
December 31, 1998 and 1997 comprise (in thousands):
December 31, 1998 December 31, 1997
-------------------------------- -----------------------------------
Estimated Estimated
Cost Accrued Fair Cost Accrued Fair
Basis Interest Value Basis Interest Value
------- -------- --------- --------- -------- ---------
Municipal bonds $ - $ - $ - $ 500 $ 8 $ 508
Certificate of Deposit 11,504 405 11,909 - - -
Commercial paper 3,500 26 3,526 2,000 16 2,016
Medium term notes 4,426 45 4,471 3,006 21 3,026
U.S. Government agencies 2,019 6 2,010 996 4 999
------- -------- --------- --------- ------- ---------
$21,449 $ 482 $ 21,916 $ 6,502 $ 49 $ 6,549
------- -------- --------- --------- ------- ---------
At December 31, 1998 and 1997, scheduled maturities for all of the available-
for-sale securities were less than one year. There were no realized gains or
losses recognized in 1998 and 1997.
Property and Equipment:
Property and equipment include amounts for assets acquired under capital leases
of $1,187,000 and $1,202,000, with related accumulated amortization of
$1,107,000 and $882,000 at December 31, 1998 and 1997, respectively. Property
and equipment consist of the following (in thousands):
December 31,
----------------------
1998 1997
--------- --------
Furniture and Fixtures $ 471 $ 151
Machinery and equipment 2,006 1,407
Leasehold improvements 1,067 626
Software 170 108
--------- --------
3,714 2,292
Less accumulated depreciation and amortization (1,614) (1,135)
--------- --------
$ 2,100 $ 1,157
--------- --------
51
Accrued Liabilities
Accrued liabilities comprise (in thousands):
December 31,
---------------------------
1998 1997
----------- -----------
Professional fees $ 146 $ 116
Clinical trials 396 170
Other 209 492
----- -----
$ 751 $ 778
----- -----
Inventories
Inventories are comprised of the following (in thousands):
December 31,
---------------------------
1998 1997
----------- -----------
Raw Materials $ 418 $ -
Work-in-Process 182 -
Finished Goods 161 -
----------- -----------
$ 761 $ -
----------- -----------
4. CAPITAL LEASE OBLIGATIONS:
The Company has capital lease obligations under seven lease lines that expire
between 1998 and 2001. Under the terms of these lease lines, the Company is
responsible for property taxes and insurance. At December 31, 1998, the future
minimum payments under capital leases are as follows (in thousands):
1999 $ 256
2000 97
2001 8
-----
Minimum lease payments 361
Less amount representing interest 36
-----
Principal amount of minimum lease payments 325
Less current portion 227
-----
$ 98
-----
5. BANK BORROWINGS
The Company has a Loan Agreement with a bank providing for borrowings of up to
$2,000,000 and the issuance of letters of credit up to $250,000. The agreement
provides a revolving line of credit through December 31, 1999 after which the
principal amount is repayable over four years. Borrowings under the agreement
bear interest at the bank's prime rate plus 0.75% (8.5% at December 31, 1998)
and are secured by substantially all of the Company's assets. The Company is
required to maintain certain levels of cash and stockholders' equity and to
comply with certain other financial covenants.
52
At December 31, 1998, the Company had borrowings of $2,000,000 and an
outstanding letter of credit in the amount of $195,000 under the Loan Agreement.
Future payments of principal under the Loan Agreement are as follows (in
thousands):
1999 $ -
2000 500
2001 500
2002 500
2003 500
------
$2,000
------
6. COMMITMENTS:
The Company rents its facilities under an operating lease that expires in
December 2002. Under the terms of the lease, the Company is responsible for
certain taxes, insurance and maintenance expenses. Future minimum rental
payments under all operating leases as of December 31,1998 are as follows (in
thousands):
1999 $ 656
2000 665
2001 635
2002 666
------
$2,622
------
Rent expense for the periods ended December 31, 1998, 1997, 1996 was $750,000,
$162,000, and $118,000, respectively.
7. STOCKHOLDERS' EQUITY:
Initial Public Offering
On February 17, 1998, the Company completed the sale of 2,300,000 shares of its
common stock at a price of $12 per share in a firm commitment underwritten
public offering. On February 27, 1998 the Company completed the sale of an
additional 345,000 shares at a price of $12 per share pursuant to an exercise of
an over-allotment option by the underwriters. Aggregate proceeds of these sales
of common stock, net of issuance costs were $28.4 million.
In connection with the initial public offering, the Company filed an Amended and
Restated Certificate of Incorporation which eliminated the existing convertible
preferred stock, changed the number of authorized preferred stock to 5,000,000
shares, $0.001 par value, and increased the shares of common stock authorized to
50,000,000 shares.
53
Reincorporation in Delaware
In January 1998, the Company reincorporated in Delaware. Under the
reincorporation, each class and series of shares of the predecessor company were
exchanged for one share of identical class and series of stock of the Delaware
successor company having a par value of $0.001 per share for both common stock
and preferred stock. The accompanying consolidated financial statements have
been adjusted retroactively to give effect to the reincorporation.
Reverse Stock Split:
Share and per share data presented reflect a one-for-1.376 reverse stock split
of the Company's common stock and a corresponding change in the preferred stock
conversion ratios effective in February 1998. All common stock and per share
amounts in these financial statements have been adjusted retroactively to give
effect to the split.
Convertible Preferred Stock:
Under the Company's Certificate of Incorporation, the Company's preferred stock
is issuable in series and the Company's Board of Directors is authorized to
Shares Issued determine the rights, preferences and terms of each series. Upon
the closing of the Company's initial public offering, all outstanding preferred
stock was automatically converted into common stock.
At December 31, 1997, the amounts, terms and liquidation value of Series A,
Series B, Series C and Series D convertible preferred stock were (in thousands):
Shares of
Common
Shares Stock Preferential
Shares Issued and Reserved for Liquidation
Series Amount Authorized Outstanding Conversion Value
----- -------- ----------- ------------- ------------ --------------
A $ 5,436 5,500 5,463 5,500 $ 5,463
B 5,498 1,500 1,379 1,500 5,516
C 6,163 1,500 1,162 1,500 6,217
D 9,509 1,250 1,191 1,250 9,528
-------- -------- -------- -------- --------
Balances, December 31, 1997 $ 26,606 9,750 9,195 9,750 $ 26,724
-------- -------- -------- -------- --------
Warrants:
The Company has issued warrants in connection with obtaining its equipment lease
line of credit to purchase up to 26,889 shares of common stock at $1.38 per
share and up to 6,722 shares of common stock at $5.50 per share. The warrants
are exercisable until October 2004.
54
Notes Receivable:
In 1997, 1996 and 1994, the Company issued 338,000, 207,000, 1,076,000 shares,
respectively, of its common stock to one of the founders and other key persons
in exchange for promissory notes of $360,000, $124,000 and $30,000,
respectively. The 1997 and 1996 promissory notes bear annual interest ranging
from 6.36% to 6.84%, payable in the years 2001 and 2002. The 1994 promissory
notes bore annual interest of 5.36%, payable in the year 1999, but were repaid
by two principal payments of $15,000 made in each of 1994 and 1998. The related
shares are pledged as collateral for the notes.
1997 Employee Stock Purchase Plan:
The Company adopted the 1997 Employee Stock Purchase Plan (the "Purchase Plan")
under which 75,000 shares of common stock have been reserved for issuance.
Eligible employees may purchase a limited number of common stock at 85% of the
market value at certain plan-defined dates. During 1998, 24,459 shares were
purchased under the Purchase Plan.
1994 Stock Option Plan:
The 1994 Stock Option Plan (the "1994 Plan") provides for grants of incentive
stock options to employees (including officers and employee directors) and
nonstatutory stock options to employees (including officers and employee
directors) and consultants of the Company. The 1994 Plan is administered by a
committee appointed by the Board of Directors which identifies optionees and
determines the terms of options granted, including the exercise price, number of
shares subject to the option and the exercisability thereof.
The terms of options granted under the 1994 Plan generally may not exceed ten
years. The term of all incentive stock options granted to an optionee who, at
the time of grant, owns stock representing more than 10% of the voting power of
all classes of stock of the Company or a parent or subsidiary of the Company (a
"Ten Percent Stockholder"), may not exceed five years, however. Generally,
options granted under the 1994 Plan vest and become exercisable starting one
year after the date of grant, with 25% of the shares subject to the option
becoming exercisable at that time and an additional 1/48th of such shares
becoming exercisable each month thereafter. Certain holders of options granted
under the 1994 Plan may exercise their unvested options prior to complete
vesting of shares, subject to such holder's entering a restricted stock purchase
agreement granting the Company an option to repurchase, in the event of a
termination of the optionee's employment or consulting relationship, any
unvested shares at a price per share equal to the original exercise price per
share for the option. The exercise price of incentive stock options granted
under the 1994 Plan must be at least equal to the fair market value of the
shares on the date of grant. The exercise price of nonstatutory stock options
granted under the 1994 Plan is determined by the Board of Directors. The
exercise price of any incentive stock option granted to a Ten Percent
Stockholder must equal at least 110% of the fair market value of the common
stock on the date of grant.
55
Activity under the 1994 Plan is as follows (in thousands, except per share
data):
Options Outanding
-------------------------------
Shares
Available for Number of Exercise Aggregate
Grant Shares Price Price
-------------- ---------- ---------------- ---------------
C>
Balance, December 31, 1995 44 701 $ 0.14 - $ 0.55 $ 175
Additional options reserved 654
Options granted (572) 572 $ 0.14 - $ 0.83 420
Options exercised (477) $ 0.14 - $ 0.83 (196)
Options canceled 211 (211) $ 0.14 - $ 0.55 (60)
Repurchase of common shares 73
------ ------ ------
Balance, December 31, 1996 410 585 $ 0.14 - $ 0.83 339
Additional options reserved 375
Options granted (396) 396 $ 1.10 - $ 8.81 803
Options exercised (401) $ 0.14 - $ 2.20 (394)
Options canceled 13 (13) $ 0.14 - $ 1.10 (7)
------ ------ ------
Balance, December 31, 1997 402 567 $ 0.14 - $ 8.81 741
Options granted (281) 281 $ 3.13 - $ 10.50 1,145
Options exercised (65) $ 0.14 - $ 3.13 (40)
Options canceled 123 (123) $ 0.14 - $ 10.50 (648)
------ ------ ------
Balance, December 31, 1998 244 660 $ 0.14 - $ 4.13 $1,198
------ ------ ------
The difference between the exercise price and the deemed fair market value of
the Company's common stock at the date of issue of certain stock options,
totaling $2,264,000 has been recorded as deferred compensation as a component of
stockholders' equity. Of this amount, $747,000 has been recognized as an
expense through December 31, 1998. The remaining $1,517,000 will be recognized
as an expense as the shares and options vest over periods of up to four years.
The options outstanding and currently exercisable by exercise price at December
31, 1998 are as follows:
Options outstanding Options currently exercisable
- -------------------------------------------------------------------------- ----------------------------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Life Exercise Number Exercise
Price Outstanding (years) Price Exercisable Price
- --------- --------------- ---------------------- ---------------- --------------- ---------------------------
$0.14 94 5.96 $ 0.14 92 $0.14
$0.55 29 6.94 $ 0.55 19 $0.55
$0.73 77 7.59 $ 0.73 32 $0.73
$0.83 11 7.73 $ 0.83 6 $0.83
$1.10 128 8.41 $ 1.10 41 $1.10
$2.20 86 8.76 $ 2.20 17 $2.20
$3.13 196 9.67 $ 3.13 7 $3.13
$4.13 39 9.88 $ 4.13 0 $4.13
------------ ------------
660 8.37 $1.820 214 $0.73
------------ ------------
56
At December 31, 1997 and 1996, outstanding options to purchase 215,000 and
267,000 shares were exercisable at weighted average exercise prices of $0.59 and
$0.62 per share, respectively.
The Company has adopted the disclosure only provision of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, the Company applies
Accounting Principles Board's Opinion No. 25 and related Interpretations in
accounting for its stock option plans. If the Company had elected, beginning
1996, to recognize compensation cost based on the fair value of the options
granted at grant date as prescribed by SFAS No. 123, net loss and basic and
diluted net loss per common share would have been increased to the proforma
amounts shown below (thousands except per share data):
Year Ended December 31,
----------------------------------------------------
1998 1997 1996
-------------- -------------- ----------------
Net loss-as reported $13,646 $7,991 $6,109
Net loss-pro forma $13,828 $8,032 $6,127
Basic and diluted net loss per common share - as reported $ 1.24 $ 3.10 $ 2.79
Basic and diluted net loss per common - proforma $ 1.26 $ 3.11 $ 2.80
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
1998 1997 1996
-------------- -------------- ----------------
Expected dividend yield 0.0% 0.0% 0.0%
Risk-free interest rate 5.2% 6.0% 5.8%
Expected volatility 73.0% 0.0% 0.0%
Expected life (in years) 5.0 5.0 5.4
The weighted average estimated fair values of employee stock options granted
during 1998, 1997, and 1996 were $2.59, $2.03, and $0.70, respectively. The
weighted average estimated fair value of the Purchase Plan options issued during
1998 was $3.38.
The above proforma disclosures are not likely to be representative of the
effects on net income (loss) and basic and diluted net income (loss) per share
in future years, because they do not take into consideration pro forma
compensation expense related to grants made prior to 1996.
8. INCOME TAXES:
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at December 31, 1998 and 1997 are presented below (in
thousands):
1998 1997
------------ ------------
Depreciation $ 44 $ 153
Capitalized start-up costs 1,604 1,402
Net operating loss carryforward 9,631 5,241
Research and development credits 1,648 1,017
Other 332 51
Valuation allowance (13,259) (7,864)
-------- -------
$ - $ -
-------- -------
57
Due to the uncertainties surrounding the realization of deferred tax assets, the
Company has provided a full valuation allowance and, therefore, no benefit has
been recognized for the net operating loss and other deferred tax assets.
At December 31, 1998, the Company has $25,019,000 for federal and $19,302,000
for state net operating loss carryforwards which expire from 2009 through 2013
and 1999 through 2003, respectively, if not utilized.
The Tax Reform Act of 1986 limits the use of net operating loss and tax credit
carryforwards in certain situations where changes occur in the stock ownership
of a company. In the event the Company has had a change in ownership,
utilization of the carryforwards could be restricted.
9. EMPLOYEE BENEFIT PLAN:
During 1996, the Company established a Retirement Savings and Investment Plan
(the "Plan") under which employees may defer a portion of their salary up to the
maximum allowed under IRS rules. The Company has the discretion to make
contributions to the Plan. As of December 31, 1998, no Company contributions
have been made to the Plan.
10. RELATED PARTY TRANSACTIONS:
In 1998, the Company purchased furniture and fixtures totaling $242,000 from an
entity where the Company's President and Chief Executive Officer is a member of
the board of directors. There were no outstanding payables relating to these
transactions at December 31, 1998.
In February 1997, the stockholders approved the assignment of technology
relating to and including two patent applications to VibRx in consideration for
repayment of approximately $10,000 of related patent expenses and issuance of
common stock equal to 20% of all VibRx's outstanding shares at such time as
VibRx completes an initial financing with aggregate proceeds of at least
$500,000. VibRx was formed and is controlled by the Company's President and
Chief Executive Officer.
11. GEOGRAPHIC INFORMATION AND MAJOR CUTOMERS
The Company operates in one business segment; namely, the design, manufacture,
and sale of implantable and semi-implantable hearing devices. During 1998, the
Company received regulatory approvals and began to market certain products in
the European Union and South America.
Two customers individually accounted for 18.9% and 14.7%, respectively of the
Company's revenue.
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements with the independent public accountants on
accounting and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information regarding Directors appearing under
the heading "Election of Directors" in the Registrant's proxy statement to be
filed with the Commission in connection with the annual meeting of stockholders
to be held on May 6, 1999, which information is hereby incorporated by
reference. The executive officers of the Registrant, and their ages as of
January 31, 1999, are as follows:
Name Age Position
----- --- --------
Harry S. Robbins.............................. 51 Chairman of the Board of Directors, President
and Chief Executive Officer
Geoffrey R. Ball.............................. 35 Vice President, Chief Technical Officer and
Director
Alfred G. Merriweather........................ 45 Vice President of Finance, Chief Financial
Officer and Assistant Secretary
Deborah A. Arthur............................. 48 Vice President of Clinical Affairs
R. Michael Crompton........................... 40 Vice President of Regulatory Affairs and Quality
Assurance
Bob H. Katz................................... 38 Vice President of Research and Development
Patrick J. Rimroth............................ 44 Vice President of Operations
Harry S. Robbins co-founded the Company and has served as Chairman of the
Board of Directors, President and Chief Executive Officer of the Company since
its founding in May 1994. From January 1991 to December 1993, Mr. Robbins was
President and Chief Executive Officer of CardioRhythm, Inc., a medical device
company that, from May 1992, was a subsidiary of Medtronic, Inc. Previously, Mr.
Robbins held executive sales and marketing positions with Laserscope and
Diasonics, Inc., medical device companies. Mr. Robbins is a director of Business
Resource Group, a distributor of office furniture and systems. Mr. Robbins holds
a B.A. degree in arts and sciences from Pennsylvania State University.
Geoffrey R. Ball invented the FMT, co-founded the Company and has served as
Vice President and Chief Technical Officer and a director since May 1994. From
1987 to March 1994, Mr. Ball was a biomedical engineer in the hearing research
laboratory at the Veterans Hospital in Palo Alto, California, affiliated with
Stanford University. Mr. Ball holds an M.S. degree in systems management from
the University of Southern California and a B.S. degree in human development
and performance from the University of Oregon.
59
Alfred G. Merriweather has been Vice President of Finance and Chief
Financial Officer of the Company since March 1996. From September 1993 to March
1996, Mr. Merriweather was Senior Vice President of Finance and Administration
and Chief Financial Officer of LipoMatrix Inc., a medical device company. From
1983 to August 1993, Mr. Merriweather held executive management positions with
Laserscope, including serving as Vice President of Finance and Chief Financial
Officer from 1988. Mr. Merriweather holds a B.A. degree in economics from the
University of Cambridge, England.
Deborah A. Arthur has been Vice President of Clinical Affairs of the
Company since August 1998. From 1990 to August 1998, Ms. Arthur was employed by
the Ear Nose and Throat Division of Smith & Nephew, Inc., a leading supplier of
ear, nose and throat medical devices. At Smith & Nephew, Ms. Arthur served in a
variety of management positions in clinical affairs, regulatory affairs and
quality assurtance, including from June 1993 to July 1996 as Group Manager of
Regulatory and Clinical Affairs, from July 1996 to January 1998 as Group Manager
of Regulatory and Clinical Affairs and Quality Assurance, and from January 1998
to August 1998, as Director of Regulatory and Clinical Affairs and Quality
Assurance. Ms. Arthur holds a B.S. degree in speech and hearing science from
East Tennessee State University and an M.A. degree in audiology from the
University of Tennessee.
R. Michael Crompton has been Vice President of Regulatory Affairs and Quality
Assurance of the Company since June 1996 and Vice President of Regulatory and
Clinical Affairs and Quality Assurance since January 1998. From June 1995 to May
1996, from October 1993 to January 1994 and from February 1992 to August 1992,
Mr. Crompton was employed by Advanced Bioresearch Associates, a medical device
consulting company, where he specialized in regulatory consultation for FDA-
regulated products. From February 1994 to May 1995, Mr. Crompton was an attorney
with Hyman, Phelps & McNamara, a Washington, D.C. law firm specializing in FDA
matters. From September 1992 to September 1993, Mr. Crompton was Manager of
Regulatory Affairs at Tosoh Medics, Inc., a medical device company. Mr. Crompton
has a J.D. degree from the University of San Francisco, and a B.A. degree in
biochemistry and an M.P.H. degree in biomedical sciences from the University of
California at Berkeley.
Bob H. Katz has been Vice President of Research and Development of the Company
since October 1994. From April 1990 to October 1994, Mr. Katz was employed by
Telectronics Pacing Systems, a manufacturer of implantable medical devices. At
Telectronics Pacing Systems, he served as Program Manager, Bradycardia Product
Development, from 1990 to September 1993 and as Director of Strategic Planning,
Instrument Systems, from September 1993 to October 1994. Mr. Katz holds a B.A.
degree in business administration and a B.S. degree in electrical engineering
from Rutgers University, an M.S. degree in biomedical engineering from Boston
University and an M.B.A. from Nova Southeastern University.
Patrick J. Rimroth has served as Vice President of Operations of the Company
since March 1996 and as Vice President of Manufacturing, from November 1995 to
March 1996. From June 1994 to October 1995, Mr. Rimroth was Vice President of
Research and Development for Camino Neurocare, a medical device company. From
December 1988 to June 1994, Mr. Rimroth held multiple research and development
management positions with divisions of C.R. Bard, Inc., a
60
medical device company. Mr. Rimroth has a B.S. degree in biology and a B.S.E.E.
degree in electronic engineering from Purdue University.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to the information regarding executive compensation
appearing under the heading "Executive Compensation and Other Matters" in the
Registrant's proxy statement to be filed with the Commission in connection with
the annual meeting of stockholders to be held on May 6, 1999, which information
is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the information regarding security ownership appearing
under the heading "Record Date and Principal Share Ownership" in the
Registrant's proxy statement to be filed with the Commission in connection with
the annual meeting of stockholders to be held on May 6, 1999, which information
is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information regarding appearing under the heading
"Certain Transactions" in the Registrant's proxy statement to be filed with the
Commission in connection with the annual meeting of stockholders to be held on
May 6, 1999, which information is hereby incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K -
(a) FINANCIAL STATEMENTS AND SCHEDULES
1. The financial statements as set forth under Item 8 of this report
on Form 10-K are included.
2. FINANCIAL STATEMENT SCHEDULES. The following consolidated
financial statement schedule of Symphonix Devices, Inc. for the year ended
December 31, 1998 is filed as part of this Report and should be read in
conjunction with the consolidated financial statements:
Description Page No.
Schedule II Valuation and Qualifying Accounts............... 64
61
Schedules not listed above have been omitted because they are not
applicable or are not required to be set forth therein is included in the
consolidated financial statements or notes thereto.
(b) REPORTS ON FORM 8-K
None.
62
INDEPENDENT ACCOUNTANTS' REPORT ON SCHEDULE
To the Board of Directors and
Stockholders of Symphonix Devices, Inc.
Our audits of the consolidated financial statements referred to in our report
dated January 22, 1999, appearing on page 42 of this Form 10-K also included an
audit of the financial statement schedule listed in Item 14(a)(2) of this Form
10-K. In our opinion, this financial statement schedule presents farily, in all
material respects, the information set forth therein when read in conjunction
with the related financial statements.
San Jose, California
January 22, 1999 PricewaterhouseCoopers LLP
63
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Thousands)
Balance at
beginning of Balance at
period Additions Deductions end of period
Allowance for doubtful accounts:
Year ended December 31, 1998 - $3 - $3
Year ended December 31, 1997 - - - -
Year ended December 31, 1996 - - - -
64
(c) EXHIBITS.
Exhibit Description
1.1* Form of Underwriting Agreement.
3.1* Certificate of Incorporation of Symphonix Devices, Inc.,
a Delaware corporation, as currently in effect.
3.2* Bylaws of the Registrant, as currently in effect.
3.3* Certificate of Amendment of the Certificate of
Incorporation of the Registrant, amending Exhibit 3.1.
4.1* Specimen Common Stock Certificate.
10.1* Form of Indemnification Agreement between the Registrant
and each of its directors and officers.
10.2* 1994 Stock Option Plan and forms of Stock Option
Agreements thereunder.
10.3* 1998 Employee Stock Purchase Plan.
10.4* Restated Investors Rights Agreement dated June 11, 1997
between the Registrant and certain holders of the
Registrant's securities.
10.5* Master Equipment Lease Agreement between the Registrant
and Lighthouse Capital Partners dated December 2, 1994.
10.6* Assignment by the Registrant to VibRx, Inc. dated March
14, 1997.
10.7* Registrant's Series D Preferred Stock Purchase Agreement
dated June 11, 1997.
10.8* Net Lease Agreement between Realtec Properties I, L.P., a
California limited partnership, and the Registrant dated
July 28, 1994; letter agreements dated July 28, 1994 and
August 17, 1994 and First Amendment dated April 17, 1997.
10.9* Lease between Silicon Valley Properties, L.L.C., a
Delaware limited liability partnership, and the
Registrant dated October 27, 1997.
10.10* Form of Option Vesting Agreement between the Registrant
and its officers.
10.11* License Agreement dated June 1, 1995 between Baptist
Medical Center of Oklahoma, Inc. and the Registrant.
10.12* Loan and Security Agreement dated December 30, 1997
between the Registrant and Silicon Valley Bank.
10.13 Loan Modification Agreement dated December 24, 1998
between the Registrant and Silicon Valley Bank.
10.14 Premium Contribution Plan Effective November 1, 1998, as
Amended and Restated on January 1, 1999.
10.15 Form of Distribution Agreement.
21.2 List of Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
24.1 Power of Attorney (see page 66).
27.1 Financial Data Schedule.
* Filed as an Exhibit to the Company's Registration Statement on Form
S-1 (File No. 333-40339) and incorporated herein by reference.
65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized, in the City of San
Jose, State of California, on the 23rd day of February, 1999.
SYMPHONIX DEVICES, INC.
By: /S/ Harry S. Robbins
---------------------------------
Harry S. Robbins
President, Chief Executive Officer
and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Harry S. Robbins and Alfred G.
Merriweather, and each of them, his attorneys-in-fact, and agents, each with the
power of substitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments to this Report on Form 10-K, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and conforming all
that said attorneys-in-fact and agents of any of them, or his or their
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
Signature Title Date
/s/ Harry S. Robbins President, Chief Executive Officer and February 23, 1999
- -------------------------------- Director
Harry S. Robbins
/s/ Alfred G. Merriweather Vice President and Chief Financial February 23, 1999
- -------------------------------- Officer
Alfred G. Merriweather
/s/ Geoffrey R. Ball
- -------------------------------- Director February 23, 1999
Geoffrey R. Ball
66
Signature Title Date
/s/ B.J. Cassin
- -------------------------------- Director February 23, 1999
B. J. Cassin
/S/ Terry Gould
- -------------------------------- Director February 23, 1999
Terry Gould
/s/ Michael J. Levinthal
- -------------------------------- Director February 23, 1999
Michael J. Levinthal
/S/ Petri T. Vainio
- -------------------------------- Director February 23, 1999
Petri T. Vainio
67