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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)
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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
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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%
---- --- ---
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 catego