-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CXj8gQdlfkQ7YHXz2OfiLVYsDpFrg41M2lEdnTNG5w5rSqw405HIR0IB5kvgs2Fv +o+JaYnV1SUFXQ2ZkUcQhg== 0000891618-97-001533.txt : 19970401 0000891618-97-001533.hdr.sgml : 19970401 ACCESSION NUMBER: 0000891618-97-001533 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: RESOUND CORP CENTRAL INDEX KEY: 0000846463 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 770019588 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20046 FILM NUMBER: 97570984 BUSINESS ADDRESS: STREET 1: 220 SAGINAW DR STREET 2: SEAPORT CENTRE CITY: REDWOOD CITY STATE: CA ZIP: 94063 BUSINESS PHONE: 4157807800 MAIL ADDRESS: STREET 1: 220 SAGINAW DRIVE STREET 2: SEAPORT CENTRE CITY: REDWOOD CITY STATE: CA ZIP: 94063 10-K 1 FORM 10-K FOR THE PERIOD ENDED 12/31/96 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1996, 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: 0-20046 RESOUND CORPORATION (Exact name of Registrant as specified in its charter) California 77-0019588 (State or other jurisdiction of incorporation or (I.R.S. Employer organization) Identification No.)
220 Saginaw Drive, Seaport Centre, Redwood City, California 94063 (Address of principal executive offices) Registrant's telephone number, including area code: (415) 780-7800 ---------------------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value per share Preferred Share Purchase Rights ---------------------------------- 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 the voting stock held by non-affiliates of the registrant was approximately $120,791,540 as of February 28, 1997, based upon the closing sale price on the Nasdaq National Market reported for such date. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. There were 19,428,416 shares of Registrant's Common Stock issued and outstanding as of February 28, 1997. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates information by reference from the definitive proxy statement for the Annual Meeting of Shareholders to be held on May 22, 1997. 2 INTRODUCTORY STATEMENT Except for the historical information contained in this Annual Report on Form 10-K, the matters discussed herein are forward-looking statements that are subject to certain risks and uncertainties that could cause the actual results to differ materially from those projected. Factors that could cause actual results to differ materially include, but are not limited to, the timing of orders and shipments, the timely development and market acceptance of new products, the impact of competitive products and pricing, the Company's ability to expand further into international markets, public policy relating to health care reform in the United States and other countries, approval of its products by government agencies such as the United States Food and Drug Administration, and other risks detailed below and included from time to time in the Company's other SEC reports and press releases, copies of which are available from the Company upon request. The Company assumes no obligation to update any forward-looking statements contained herein. The Company's future results of operations may be adversely affected by or fluctuate significantly due to various factors, including those factors discussed below. These factors include the success and timing of new product introductions by the Company or its competitors. Announcements of new products that the Company may develop from time to time may cause hearing care professionals or hearing impaired persons to defer purchases of existing products or return previously purchased products, thereby adversely affecting the Company's results of operations. In addition, there can be no assurance that any of the Company's products under development can be commercialized on a timely basis or at all, that they can be manufactured on a cost-effective basis, that regulatory approvals, where necessary, can be obtained to permit the sale and use of such products, that such products will not experience design or manufacturing problems, or that there will be any significant degree of market acceptance of these new products. While the Company believes that the price/performance characteristics of its products are competitive, increased competition or announcement of leading edge products by other companies could create pricing pressures and cause possible delays or reductions in the number of sales, which could adversely affect the Company's results of operations. Increased competition with these products could also adversely impact the Company's revenues and results of operations. In the past, the Company has been involved in a number of lawsuits. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements--Litigation." The Company has incurred significant expenses in defending and settling such litigation. From time to time the Company has been contacted by various other parties who have alleged that certain of the Company's products infringe or may infringe patents that such parties claim to hold. Management believes the Company has not infringed any such patents and does not believe such claims, if pursued, will result in a material adverse effect on the financial position or results of operations of the Company. However, senior management and other employees of the Company may be required to devote substantial amounts of time in connection with such defenses, which may impact their ability to manage the Company's business operations. During the last fiscal year, the Company experienced various changes in its management and technical staff. Competition for employees with technical, management and other skills is intense in the hearing device industry. The Company's failure to retain the services of key personnel or to attract additional qualified employees could materially and adversely affect the Company's business. 2 3 Certain key components used in the Company's products are currently available only from single or limited sources. Although the Company believes that with adequate notice it can secure, if necessary, alternate sources for such components, its inability to obtain sufficient sole source or limited source components or subassemblies as required, or to develop alternative sources if and as required, would have a material adverse effect on the Company's business, financial condition and results of operations. Other factors which could impact the Company's revenues and results of operations include a significant reduction in product sales to certain customers, economic downturns in certain geographic or vertical markets, and the costs incurred to expand distribution in Europe and Asia. In connection with the Company's increased international sales, a number of risks are inherent in international transactions. Fluctuations in the exchange rates between the U.S. dollar and other currencies could increase the sales price of the Company's products in international markets where the prices of the Company's products are denominated in U.S. dollars or lead to currency exchange losses where the prices of the Company's products are denominated in local currencies. International sales and operations may also be limited or disrupted by the imposition of governmental controls, regulation of medical devices, export license requirements, political instability, trade restrictions, changes in tariffs, and difficulties in staffing and managing international operations. The market price of the Company's common stock may be subject to significant fluctuations. These fluctuations may be due to factors specific to the Company, such as quarterly fluctuations in the Company's financial results, changes in analysts' estimates of future results, litigation and regulatory developments, changes in investors' perceptions of the Company or the announcement of new or enhanced products by the Company or its competitors. In addition, such fluctuations may be due to or exacerbated by general conditions in the medical device industry or conditions in the financial markets generally. References made in this Annual Report on Form 10-K to "ReSound," the "Company" or the "Registrant" refer to ReSound Corporation and its subsidiaries. The following ReSound trademarks are mentioned in this Annual Report: P(3) System, Advanced ReSound Processing, Cochlea Dynamics, Portable Prescriptive Programming System, Real Zoom Technology, ReSound, Sonar, Sonar Hearing Health and Viennatone. PART I ITEM 1. BUSINESS OVERVIEW Founded in 1984, ReSound Corporation is a hearing health care company that designs, develops, manufactures and sells technologically advanced hearing devices for the hearing impaired. The Company's hearing device products utilize proprietary sound processing technology originally developed by AT&T Bell Laboratories and subsequently enhanced and refined by ReSound. ReSound's Multiband Full Dynamic Range Compression ("MFDRC") sound processing technology enables ReSound(R) hearing devices to be individually programmed to adjust the amplification of sound continuously in response to the acoustic environment and each patient's residual range of hearing. ReSound's current products with MFDRC sound processing technology are offered in In-the-Ear ("ITE"), Behind-the-Ear ("BTE") and In-the-Canal ("ITC") versions. 3 4 In December 1994, the Company acquired 100% of the shares of Viennatone AG ("Viennatone"), a hearing instrument manufacturer based in Vienna, Austria. Viennatone is an established company which had total 1994 revenues of approximately $31 million. Viennatone designs, manufactures and distributes approximately 100,000 hearing devices per year and employed approximately 360 people as of December 31, 1996. Viennatone primarily distributes through ReSound subsidiaries in Germany, France and the United Kingdom and additionally sells through approximately 30 distributors located throughout the world. In Austria, Viennatone sells its hearing devices directly to consumers through 22 retail outlets. Viennatone also produces hearing device components such as hearing device cases, high reliability switches and telecoils. In June 1996, the Company completed the purchase of certain assets of the hearing health business activity of Minnesota Mining and Manufacturing Company ("3M"). The Company has established a subsidiary in the United States, Sonar Hearing Health Corporation, to manage this activity on an ongoing basis. International distribution of former 3M products is undertaken through the Company's international subsidiaries. Hearing health constituted a small business activity in 3M's worldwide operations which was neither a division nor subject to the maintenance of discrete accounting records such that financial statements could be or are determinable. However, the Company believes that this business activity generated revenues for 3M of approximately $9.3 million and $16.6 million for the six months ended June 30, 1996, and for the year ended December 31, 1995, respectively. The Company believes that profits, if any, generated from the hearing health activity of 3M for the above-mentioned periods were minimal, and that historically, such business activity may not have been profitable. The Sonar product line incorporates non-proprietary, nonlinear sound processing technologies into ITC and ITE custom hearing devices. In addition, the Sonar line now incorporates the proprietary programmable technology formerly owned by 3M. Such products are now sold under the label "Sonar - with 3M technology." The Viennatone product line spans all segments of the market, from BTE products to high power instruments with a large number of options. Viennatone is also a worldwide leader in bone conduction hearing instruments markets. Through December 31, 1996, the Company sold over 623,000 hearing devices worldwide. ReSound currently distributes its products through more than 4,300 authorized dispensers worldwide. The Company sells its products to retail chains and hearing device dispensers through wholly-owned subsidiaries in Germany, the Netherlands, the United Kingdom, France, Austria, Sweden and Australia and has non-exclusive distribution agreements with retail chains and single stores in Canada, Spain, Belgium, Denmark and Switzerland. The Company also operates a joint venture, ReSound Asia Ltd., which operates a retail store in Hong Kong and manages sales to Taiwan, Singapore and the People's Republic of China. The Company has an exclusive distribution agreement for Japan with Hoya Medical Corporation. It is estimated that between 8% and 10% of the population in developed countries is hearing impaired. However, only about 10% to 25% of this hearing impaired group (depending on the country) currently wear a hearing device. It is estimated that the majority of the hearing impaired group experiences mild to moderate impairment, and that relatively low market penetration has occurred in this segment because of the failure of most hearing devices to provide adequate sound quality, adequate speech intelligibility in noisy environments, the stigma associated with wearing a hearing device, acoustic feedback, discomfort, occlusion, mechanical problems and general lack of physician endorsement. 4 5 The Company has chosen audiologists (hearing care professionals with advanced degrees), acousticians and other qualified hearing device dispensers to distribute its products. To assist in proper measurement of each patient's hearing impairment, ReSound also sells a proprietary device programming system that enables dispensers to assess each patient's hearing impairment through computerized measurement, to select an appropriate individualized prescription and to program each patient's hearing device appropriately. The Company has developed a PC-based competitive fitting software module for NOAH (the standardized industry platform that provides dispensers with an integrated hearing care software system) called ReSource. This software module can either be used in conjunction with ReSound's proprietary P(3) fitting system, or with HI-PRO, an industry standard programming interface. Viennatone offers both programmable and non-programmable devices. The Viennatone fitting system consists of PC-based software and an inexpensive interface. Although the older Viennatone products incorporate linear sound processing or a traditional type of audio compression, Viennatone's newer products incorporate a proprietary, patented, non-linear type of sound processing designed to improve performance in situations involving background noise and avoid the need for manual volume control. Sonar Hearing Health ("SHH") offers a full line of both programmable and non-programmable instruments in both BTE and custom models. The programmable instruments all use patented, technically advanced sound processing developed by the former hearing health business activity of 3M. PC-based fitting systems are used to adjust the programmable instruments at either point-of-sale or point-of-manufacture. ReSound's technology operates across the full dynamic range of speech, separating incoming sounds into two frequency bands and amplifying low and high intensity sounds differently within each band. Low intensity, high frequency consonant sounds that are critical to speech intelligibility can be amplified more than sounds that are already loud, such as background noise. Consequently, since most sounds are amplified to an appropriate loudness and overamplification is avoided, speech intelligibility and listening comfort may be greatly improved for many hearing impaired patients. SHH's sound processing technology uses proprietary integrated circuits to separate incoming sounds into two frequency bands and provide independent processing in the two bands. Thus, low intensity, high frequency sounds can be processed differently than high level, low frequency sound such as background noise. Viennatone's most recent technology relies on a custom integrated circuit connected to two microphones and capable of adjusting the directional sensitivity to the level of background noise. In quiet environments, the hearing device is equally sensitive to sounds from all directions. As the level of low frequency background increases, the hearing device becomes progressively and automatically more sensitive to sounds from a frontal direction, the most likely direction for the desired speech signals. ReSound has prototyped a system which combines the advantages of the two patented technologies, the omni/directional microphone and the dynamic range compression sound processing. ReSound launched its latest programmable sound processing, called "Cochlea Dynamics" in an ITC hearing device in North America, Europe and Japan in 1996. The device's sound processing circuit is 40% smaller, consumes about 40% less power, and has equivalent or improved performance compared to the Company's ITE version. PRODUCTS ReSound's strategy is to create innovative, proprietary, technologically superior products that address the shortcomings of traditional hearing devices. ReSound's hearing device products address inadequate speech intelligibility by incorporating sound processing technology originally developed by AT&T Bell Laboratories and subsequently enhanced and refined at ReSound. This technology 5 6 features multiband compression across a patient's full dynamic range of hearing. Multiband compression offers patients the following benefits: - Proper Levels of Amplification. Amplified sounds can be heard at their normal loudness level. - Soft Consonants Become Audible. The full range of soft sounds becomes audible, so that soft consonants such as "f," "s" and "t," which are critical for speech intelligibility, can be heard without overamplifying normal sounds. - Increased Speech Intelligibility. The ability of patients to understand speech in noisy listening environments is enhanced. The ReSound strategy is also supported by Sonar Hearing Health which provides a full line of proprietary products incorporating technically advanced sound processing developed at the former hearing health business activity of 3M. These products use state-of-the-art PC-based fitting systems for instrument adjustment at point-of-sale or point-of-manufacture. Although the older Viennatone products incorporate linear sound processing or a traditional type of audio compression, the new products incorporate a proprietary, patented, non-linear type of sound processing designed to improve performance in the presence of noise and avoid the need for manual volume control. ReSound's Current Products ReSound currently offers the Personal Hearing System line of products, which are marketed in several configurations and incorporate the ReSound proprietary sound processing technology. These products continuously adjust the amplification of sounds according to the acoustic environment and the patient's range of hearing. This process is accomplished using two circuits known as dynamic range compressors, as well as a compressor/limiter circuit that controls the maximum power output of the device. Incoming sound signals are divided into two frequency bands, passed through the dynamic range compressors, where differential amplification occurs for sounds of different intensities, and then recombined. As a result, low intensity, high frequency consonant sounds that are critical to speech intelligibility can be amplified more than sounds that are already loud, such as background noise. Consequently, since most sounds are amplified to an appropriate loudness and overamplification is avoided, speech intelligibility and listening comfort may be greatly improved for many hearing impaired patients. To operate the Company's Personal Hearing System products, the patient may use a remote control, similar in size to a large fountain pen, to control ultrasonically the output volume of the device and to switch between two programs prescribed for different listening environments. The two listening environment programs are stored in the remote control. Hearing care professionals program the hearing devices most frequently to perform in either a quiet or noisy setting, but they may change the program should the patient's hearing change or another prescription be found more desirable. In addition, the Company has developed an innovative, Portable Prescriptive Programming System, the P3 System(TM), that enables the hearing care professional to program the operating parameters of the patient's Personal Hearing System. In 1996, the Company launched a new software package, "ReSource," designed to enable hearing professionals with a personal computer to fit and program all 6 7 of ReSound's programmable products. ReSource is designed to operate in conjunction with an industry standard software platform called NOAH. There are approximately 6,000 NOAH users worldwide as of January 1997. The ReSource software can be operated without the P(3) fitting system, if desired. Personal Hearing System The Company's Personal Hearing System is available in ITE, BTE and ITC versions. ITE Version. The ITE version of the Personal Hearing System incorporates programmable, multiband compression sound processing and was first shipped in December 1989. ITE versions of hearing devices are the most popular design in the hearing impaired market in the United States. The system consists of a custom earmold shell containing a microphone, a speaker, an industry-standard battery and sound processing electronics that store the patient's personal hearing prescription in the hearing device. The ITE version of the Personal Hearing System also includes a remote control that can be programmed to contain an additional prescription; however, the ITE can also be operated without the remote control, if desired. The hearing care professional fitting the patient can program the system to address a wide range of mild to severe hearing impairments. During 1995, ReSound added a new ITE to its product line called Encore. This new product provides the same ReSound sound processing circuit, but does not have a remote control and is limited to one hearing program. The Encore product line is offered at a price approximately 1/3 lower than ReSound's original ITE. The new Encore ITE has proven to be very successful since its introduction and today it is the most popular ITE model. Retail prices for the Company's ITE products typically range from $1,500 to $2,650 for one ear (monaural) and $3,000 to $4,000 for both ears (binaural). A majority of hearing device patients purchasing ReSound's ITE devices have selected binaural systems. Because of the custom packaging required for the ITE product, it is sold to international distributors at the sub-assembly level for assembly into ITE custom shells provided by the local distributor. BTE Version. The BTE version of the Personal Hearing System was introduced by ReSound in January 1992. The BTE version does not require a custom earmold shell, and is packaged in a standard miniature case worn above and behind the ear. The Company's BTE version incorporates the ReSound proprietary sound processing technology and, because it is worn behind the ear, reduces feedback and occlusion. Feedback is a high-pitched squeal that occurs when too much of the sound output from the hearing device speaker is picked up by the hearing device microphone. Occlusion occurs when the ear canal is sealed by a hearing device to prevent feedback and results in the person perceiving that his or her voice is distorted and much louder than it is when the ear canal is not obstructed. During 1995, ReSound introduced an Encore BTE which provides the same ReSound sound processing circuit, but does not have a remote control and is limited to one hearing program. U.S. retail prices for the Company's BTE devices typically range from $1,400 to $2,600 for a monaural version and $2,800 to $4,000 for a binaural version. The BTE versions of hearing devices are the most popular design in the hearing impaired markets in most of Europe. In September 1994, the Company introduced a power BTE product which provides an increased degree of amplification for patients with severe hearing loss. A new BTE product was launched during the fourth quarter of 1996. This product can be pre-programmed at the factory and the final stages of fine-tuning require less training than had previously been required to set up each patient's device appropriately. The device can also be programmed 7 8 using proprietary, easy to use, PC software. This BTE product is designed to expand further the distribution base of ReSound sound processing technology. A similar ITE product was launched during the first quarter of 1997. ITC Version. ReSound launched its latest programmable sound processing, called "Cochlea Dynamics" in an ITC hearing device in North America in April, 1996. U.S. retail prices for the Company's ITC devices typically range from $2,800 to $3,200 for a monaural version and $3,600 to $4,200 for a binaural version. In May and November 1996, this product was launched in Europe and Japan, respectively. The device's sound processing circuit is 40% smaller, consumes about 40% less power, and has equivalent or improved performance compared to the Company's ITE version. Portable Prescriptive Programming System The Company offers a proprietary programming system designed to enable a hearing care professional to assess a patient's hearing impairment through computerized measurement, to select an appropriate, individualized prescription and to program the Personal Hearing System. The Viennatone programmable products can be programmed using a personal computer and a low-cost interface. Both Viennatone and ReSound are participating in the new PC-based industry standard software platform, NOAH, and are developing the compatible software. The Company shipped its first programming system, the DHS, in December 1989. In January 1992, the Company began shipping its P(3) System, a programming system that offers enhanced software and ease of use and that can program both the remote control and the Company's ITE, BTE and ITC hearing devices. The P(3) System programs the ReSound hearing devices and an optional remote control which can be used to switch between prescriptions adapted to different listening environments or to adjust volume, if desired. The ReSource software can be operated without the P(3) fitting system, if desired. The ReSound P(3) System is a hand-held computer that performs a proprietary, interactive, audiologic test developed by ReSound and the Acoustics Research Laboratory of AT&T Bell Laboratories to determine the patient's dynamic range and hearing impairment at various frequencies and intensities. The software for the P(3) System is based on extensive clinical data compiled by ReSound. Using the test results from its proprietary test or standard audiometric data, the P(3) System calculates appropriate fitting parameters for the ReSound hearing device, and programs the patient's hearing device and remote control with these parameters. The P(3) System is also designed to accommodate future ReSound products and enhancements and is priced to the U.S. hearing care professional at approximately $3,000. Current Viennatone Products The Viennatone product line is comprised of a full range of hearing devices, both in terms of price and type. The Viennatone products span many technologies, both traditional and new, ranging from low-cost BTE products to higher-priced BTE products, newly-developed programmable ITE and BTE products, and from devices worn on the body to eyeglass hearing devices. The Viennatone fitting system consists of PC-based software and an inexpensive interface. The Viennatone software can run on a stand-alone basis or under NOAH, the emerging industry standard for fitting systems. 8 9 New Products In April 1996, the Company launched its newest sound processing, incorporated first into an ITC hearing device. This new sound processing labeled Cochlea Dynamics(TM) technology, has been under development since 1992, and is protected by newly-issued U.S. patents (and corresponding foreign patents and patent applications). This new sound processing consists of digitally programmed multichannel listening range expansion. When properly programmed for a hearing impaired patient, this sound processing enables the patient, in most situations, to listen to and understand comfortably a wider dynamic range of both bass and treble sounds. In addition, the new electronic module, which incorporates two new integrated circuits, is over 40% smaller than the previous generation and consumes about 40% less power, allowing for the use of smaller hearing device batteries. In the first half of 1996, ReSound began shipping an improved version of the Power BTE, a product sold to the more severely hearing impaired. The improved version is believed to be more reliable, more cosmetically acceptable and easier to manufacture and service. In 1996, the Company launched a new software package, "ReSource," designed to enable hearing professionals with a personal computer to fit and program all of ReSound's programmable products. ReSource is designed to operate in conjunction with an industry standard software platform called NOAH. There are approximately 6,000 NOAH users worldwide as of January 1997. The ReSource software can be operated without the P(3) fitting system, if desired. During 1996, the Company upgraded most of its installed base of P(3) fitting systems, so as to allow improved performance in programming of its newest generation of hearing devices. ReSound currently is developing a BTE combining two proprietary and unique technologies: the digitally programmed Multiband Full Dynamic Range Compression sound processing technology and Real Zoom Technology(TM). The latter was patented in 1995 by Viennatone (both in Europe and in the U.S.) and consists of two miniature microphones connected to a custom-designed integrated circuit. Under the direct manual control of the patient, the signal from each microphone is added in such a way that the combined signal depends on the direction of incoming sounds. Thus, the patient can adjust the directional sensitivity to increase the detection of sounds from the frontal direction. To further the patient's benefits, the combined signal is then processed by ReSound sound processing. Thus, the first technology allows increased signal to noise amplification ratio, while the combination with the second ensures that the signal is perceived at the proper loudness by the patient. In connection with the June 1996 acquisition of certain assets of the hearing health business activity of 3M, the Company obtained a full line of both programmable and non-programmable instruments in both BTE and custom models. The programmable instruments all use patented, technically advanced sound processing developed by the former hearing health business activity of 3M. SHH also has a PC-based competitive fitting software module for NOAH. In 1996, ReSound entered into a joint venture with AudioLogic Hearing Systems (Boulder, Colorado) and GN Danavox a/s (Denmark), to develop a new generation of digital signal processing ("DSP") integrated circuit and software. In contrast with early DSP products recently introduced by 9 10 competitors, this new technology is designed to allow all of the signal processing functions to be programmed in software rather than embedded into the circuitry of the DSP chip. As a result, the number of new sound processing functions, and the speed of their implementation, should be dramatically increased. MANUFACTURING The Company manufactures its hearing devices according to specifications received from the hearing care professionals. In the case of an ITE or ITC device, after receiving an impression of the patient's ear canal and the programming requirements of the device, the Company manufactures the custom earmold shell and assembles the electronic circuitry of the device. In the case of a BTE device, the Company assembles the electronic circuitry into a case the Company produces or purchases. ReSound's manufacturing operations consist of coordination of integrated circuit production, assembly and testing of electronic subsystems, fabrication of custom earmolds, integration of the electronic components into the device shell, and final testing of the complete system. Electronic assembly operations include the attachment of three integrated circuits onto a printed circuit board along with other components by an outside vendor. A microphone and speaker are wired and attached to this circuit board which is then attached to a faceplate and tested. The faceplates are stored in inventory until, in the case of an ITE or ITC, an impression of the patient's ear canal and audiological information are received from a hearing device dispenser. The Company then produces the custom ITE or ITC shell and assembles the product. In the case of a BTE device, the Company purchases a standard case from a supplier, or makes use of a Viennatone case, and assembles the electronic circuitry into the case. The Company subcontracts manufacture of its proprietary P(3) System(TM) and remote control used with its hearing devices. The Company has manufacturing facilities in Redwood City, California; Eagan, Minnesota; Cork, Ireland; Munster, Germany; Grafenschachen, Austria; and Vienna, Austria. The Company subcontracts for the manufacture of the P(3) System from a single supplier. The P(3) System is purchased under a supply contract, while other components are purchased pursuant to purchase orders on an as-needed basis. In connection with the Company's acquisition of Sonar Design & Hortechnik GmbH in January 1994, the Company has established an ITE manufacturing capability in Germany. See "Sales and Marketing." Viennatone manufactures its hearing devices in Vienna and Grafenschachen, Austria. SHH manufactures its custom hearing devices in Eagan, Minnesota. Viennatone and SHH manufacture the custom hearing instruments in accordance with specifications received from the respective hearing care professional. In the case of an ITE device, after receiving an impression of the patient's ear canal and the programming requirements of the device, the custom earmold shell is manufactured and the electronic circuitry of the device is assembled. In the case of a BTE device, a standard case is manufactured and the electronic circuitry is assembled into the device. Viennatone and SHH's manufacturing operations consist of coordination of integrated circuit production, assembly and testing of electronic subsystems, fabrication of custom earmolds, integration of the electronic components into the device shell and final testing of the complete system. In the U.S., the Company is subject to inspection on a routine basis by both the United States Food and Drug Administration ("FDA") and the states of California and Minnesota to ensure compliance with the FDA's Good Manufacturing Practice ("GMP") regulations and comparable state 10 11 regulations that impose certain procedural and documentation requirements upon the Company with respect to manufacturing and quality assurance activities. Manufacturing sites outside of the United States which are supplying the U.S. market are also subject to compliance with the FDA's GMP regulations and inspections. Viennatone's, Sonar's and ReSound's U.S. ISO 9001 and Cork, Ireland's ISO 9002 certifications will require periodic audits by a registrar to maintain the certification. See "Government Regulation." PRODUCT RETURNS, REPAIRS AND REMAKES The Company believes that the hearing device industry in the United States is characterized by a relatively high rate of product returns (approximately 16 to 32 percent) and that these returns are due to a number of factors. Many states have laws that require hearing device dispensers to allow purchasers a minimum period of time for return of their hearing devices, typically 30 days. In addition, the relatively poor performance of many existing hearing devices may cause patients to return them. Further, patients may not be able to judge the performance of a new hearing device at the dispenser's office. Finally, the Company believes that many dispensers encourage potential purchasers to try a variety of hearing devices on a trial basis, in part because of the industry's liberal return policy. ReSound allows its hearing devices sold in the U.S. and Canada to be returned without charge for a period of 90 days after delivery to the dispenser. In Europe and Asia, the Company sells primarily to chains of hearing device dispensers, and all returns from the end user are the responsibility of these chains. In addition, in the U.S. and Canada, ReSound currently offers warranties of one to three years to the dispenser on the electronic components of its hearing devices and a 12-month warranty against defects in the manufacture of the custom shell. The Company offers a 12-month warranty to the distributor on the P(3) System in the U.S. Internationally, the Company offers a 12-month warranty to the distributor on the components of its hearing devices. In Austria, the retail business is characterized by an average trial period of up to 60 days. Austrian dealers typically offer a 12-month warranty commencing on the date of invoice. However, Viennatone does not typically issue an invoice for a hearing device until the patient has accepted the device. The Company believes that its product returns are primarily the result of the advanced sound processing of its products, which provides greater amplification than other products and therefore requires a more precise fit of the hearing device in order to reduce feedback. Other factors include the relatively high price of the Company's products and inadequate training of some of its dispensers. In addition, many repairs have been required on the Company's ITE and ITC hearing devices due to blockage of the speaker by accumulated ear wax. The natural production of ear wax in the ear canal can clog hearing devices periodically. The Company reintroduced an ear wax guard system in May 1994 to reduce the occurrence of this blockage. The Company has also experienced a high rate of repair and remake requests related to imperfect fitting of the ITE and ITC shell. The Company is attempting to reduce these occurrences by continuing to improve fitting procedures, by improving the software used in the P(3) System(TM), by teaching hearing care professionals more effective techniques for screening patients, and by offering a standard trial unit that hearing care professionals may utilize to demonstrate the ReSound(R) Personal Hearing System for the patient. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 11 12 SALES AND MARKETING In the United States and Canada, hearing devices typically have been sold by hearing device dispensers and audiologists. There are approximately 6,000 hearing device dispensing specialists and 5,000 dispensing audiologists in the United States. ReSound's products are positioned as premium- priced, premium-performance devices. Because the Company's programmable product lines are more technically advanced than many competitors' conventional hearing products, the Company has targeted audiologists and qualified hearing device specialists to distribute its Personal Hearing System products. The Company's sales staff, consisting of fourteen people, six of whom are audiologists, supports over 2,200 authorized dispensers in the United States, the majority of whom are audiologists. As part of its sales and marketing efforts, ReSound seeks to differentiate itself to the hearing care professional by offering a comprehensive training program to its network of dispensers. The Company's training program is designed to educate the hearing device dispenser about ReSound's products and to train the hearing device dispenser in the proper fitting of patients. In addition, the Company's sales and marketing force provides ongoing support and service to audiologists and hearing device dispensers. In July 1996, ReSound acquired the hearing health business activity of 3M. It was renamed Sonar Hearing Health Corporation ("SHH") and currently operates as a separate business unit selling its line of programmable hearing devices to audiologists and qualified hearing aid specialists. SHH's products are sold through its own professional sales force of eight people who service a customer base of over 800 dispensing sites throughout the United States. In Europe, SHH has been integrated into ReSound's existing distribution structure. ReSound employs several distribution channels to market and sell its products internationally. The Company is a party to an exclusive distribution agreement covering the Japanese market that expires in December 1997 with Hoya Medical Corporation, a large Japanese company with substantial experience in the contact and intraocular lens markets. During 1992, the Company expanded distribution of its products into Germany, Belgium and Spain by entering into non-exclusive distributor arrangements with leading retailers of hearing devices in those countries. During 1993, an exclusive distributor arrangement with France's leading hearing device retail chain was converted into a non-exclusive distributor arrangement. In 1992, ReSound established a German subsidiary, ReSound GmbH Hortechnologie ("ReSound GmbH"), for marketing and distribution of its current and future products, primarily in Germany, Austria and Switzerland. In 1994, this subsidiary, located in Munich, became the Company's European headquarters. ReSound GmbH has captured a significant share of Germany's BTE hearing device market. On January 1, 1994, ReSound completed the acquisition of all of the outstanding ownership interest in Sonar Design & Hortechnik GmbH ("Sonar") located in Muenster, Germany. Coupling Sonar's significant ITE market share and expertise in ITE design and manufacturing with ReSound's BTE devices has given ReSound a complete line of high technology hearing devices in Germany. Through this subsidiary, which was renamed ReSound Deutschland GmbH during 1996, ReSound sells services and manufactures custom hearing devices for the German market. In 1993, ReSound established a Dutch subsidiary, ReSound b.v., for distribution of the Company's products in the Netherlands. In 1994, ReSound established ReSound Asia Ltd., ("RSND Limited"), a British Virgin Islands company which is a joint venture with a large Hong Kong group. Headquartered in Hong Kong, RSND Limited commenced selling ReSound products in Hong Kong, Taiwan and Singapore in 1994 and has exclusive rights to 12 13 distribute the Company's products in Hong Kong, Taiwan, Singapore and the People's Republic of China, with the potential to expand its distribution rights into Thailand and Malaysia. Viennatone sells to distributors in numerous countries, to a majority-owned retail chain of stores in Austria and to subsidiaries in the United Kingdom, France and Germany. It also sells to a minority-owned Mexican subsidiary. In 1995, ReSound established subsidiaries in Australia and Sweden. The Company also has branch operations in Canada and Switzerland. International sales accounted for 55% of the Company's total sales in 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company intends to expand into other international markets through appropriate distribution arrangements. THIRD-PARTY REIMBURSEMENT In the United States, third-party reimbursement generally is not available for the purchase of hearing devices. As a result, the price of a hearing device may be a key factor in the patient's decision to purchase such a device. In international markets, reimbursement levels vary and are generally provided. In 1996, however, the level of reimbursement in Austria decreased substantially and, as a result, revenues were negatively affected in that market. Changes or anticipated changes in reimbursement levels can affect the Company's sales in the relevant geographic markets significantly. There can be no assurance that such changes or anticipated changes would not have an adverse effect on the Company's business in the future. GOVERNMENT REGULATION The development, production and marketing of the Company's current products and products under development are subject to regulation by numerous governmental authorities in the United States (including the FDA, the California Department of Health Services and the state of Minnesota) and other countries. In the United States, medical device products are subject to rigorous FDA review. The United States Federal Food, Drug, and Cosmetic Act (the "FDC Act") and other federal statutes and regulations govern or influence the design, testing, manufacture, labeling, sale, storage, record keeping, approval, advertising and promotion of such products. Noncompliance with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production, refusal of the government to approve product license applications or withdrawal of approvals, injunctions, civil fines and criminal prosecution. In order to obtain FDA permission to market a new medical device, the Company must submit proof of substantial equivalence in a 510(k) pre-market notification submission or proof of safety and efficacy in a Pre-Market Approval Application ("PMAA"). In many cases, such proof entails extensive clinical tests. The testing, preparation of necessary applications and processing of those applications by the FDA is expensive, time-consuming, lengthy and uncertain. Applicants seeking a 510(k) clearance must show that the device is substantially equivalent to another legally marketed predicate device. The 510(k) process can require clinical testing of the applicable device under an Investigational Device Exemption ("IDE"), while the pre-market approval process always requires clinical data. The review of a PMAA generally takes one to two years from the date the application is accepted for filing, but may take significantly longer. It generally takes from four to twelve months from submission to obtain clearance of a 510(k) notification, but may take longer. Recently, the FDA has been requiring more rigorous demonstration of substantial equivalence in 510(k) notifications than in the past. There is no assurance that the FDA will act favorably or quickly in making such reviews, and significant difficulties or costs may be encountered by the Company in its efforts to 13 14 obtain FDA approvals that could delay or preclude the Company from marketing any product it may develop. The FDA may also require post-marketing testing and surveillance to monitor the effects of products or place conditions on any approvals that could restrict commercial applications of such products. Marketing permission may be withdrawn if compliance with regulatory requirements is not maintained or if problems occur following initial marketing. In addition, delays imposed by the governmental approval process may materially reduce the period during which the Company may have the exclusive right to exploit patented products or technologies unless the Company is successful in obtaining patent term restoration. The Company's clinical research programs for uncleared or unapproved devices are subject to the IDE regulations of the FDA and California and Minnesota state regulations. These regulations govern many important aspects of the clinical investigation of medical products, including obtaining informed consent from clinical subjects, securing the approval of an Institutional Review Board and maintaining required documentation relating to the conduct of the investigational study. In addition, for some devices, these regulations may require the Company to obtain approval from the FDA prior to the commencement of clinical investigations of new products or of expanded applications for any commercially available product. If the PMAA procedure is being utilized, the results of the pre-clinical and clinical studies and other information such as the device description, GMP regulation compliance, bio-compatibility and labeling materials regarding the medical device under study are submitted to the FDA in the form of a PMAA for approval to commence commercial sales. In responding to the PMAA, the FDA may grant marketing approval, with or without conditions, require additional testing or information, or deny the application. Regardless of whether a 510(k) notification or PMAA is required, the Company also must register as a medical device manufacturer with the FDA and be licensed by the Food and Drug Branch of the California Department of Health Services and the state of Minnesota. The Company is subject to inspection on a routine basis by both the FDA and the states of California and Minnesota for compliance with the FDA's GMP and medical device reporting ("MDR") regulations and comparable state regulations. Those regulations impose certain procedural and documentation requirements upon the Company with respect to manufacturing and quality assurance activities. Additionally, the Company must comply with various FDA requirements for design, safety, advertising, labeling, record keeping and reporting of negative experiences in the use of regulated products. The FDA actively enforces regulations prohibiting marketing of products for non-indicated uses as well as products that violate design, safety and the other FDA regulations mentioned above. Failure to comply with applicable regulatory requirements can result in, among other things, fines, suspensions or loss of permission to market products, seizures or recalls of products, operating restrictions, injunctions, civil fines and criminal prosecution. The FDA has proposed changes to the GMP regulations and has promulgated new MDR regulations, both of which will likely increase the cost of compliance with GMP requirements. The Company also is subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. Changes in existing requirements or adoption of new requirements, such as design control and postmarket surveillance, could have a material adverse effect on the Company's business, financial condition, and results of operations. Although the Company believes that it is in compliance with all applicable regulations of the FDA and the states of California and Minnesota, current regulations depend heavily on administrative interpretation, and there can be no assurance that the 14 15 Company will not incur significant costs to comply with laws and regulations in the future or that laws and regulations will not have a material adverse effect upon the Company's business, financial condition or results of operations. Sales of medical device products outside the United States are subject to international regulatory requirements that vary widely from country to country. The time required to obtain approvals required by other countries may be longer or shorter than that required for FDA approval, and requirements for licensing may differ from FDA requirements. Some countries have historically permitted human studies earlier in the product development cycle than the United States. Other countries, such as Japan, have standards similar to those of the FDA. This disparity in the regulation of medical devices may result in more rapid product approvals in certain countries than in the United States, while approvals in countries such as Japan or France may require longer than in the United States. The European Union has completed the Medical Device Directive for obtaining CE-Marking for medical devices to be sold within the Union. The Company has obtained the required certifications of quality and regulatory systems and is now applying the CE Marking on its products for Europe. Viennatone, Sonar and the Redwood City facility have obtained and are maintaining the ISO 9001 and EN 46001 quality system certifications. ReSound Ireland has achieved and is maintaining ISO 9002 certification. Individual country requirements regarding third party reimbursements, advertising, professional training, language of labeling materials and other areas continue to apply and may make certain markets more difficult to penetrate. Certain of the Company's products also may be subject to U.S. Federal Communications Commission ("FCC") regulation, which establishes radio frequency emission standards for certain electronic equipment. Products that fail to comply with these regulations may not be sold in the United States until appropriate modifications are made. Various countries in which the Company markets its products, or in which the Company may do so in the future, also have regulatory agencies or standards authorities that perform functions comparable to the FCC, and the Company will need to comply with these requirements to the extent that it markets covered products in such countries. RESEARCH AND DEVELOPMENT ReSound's research and development staff consisted of 83 people at December 31, 1996. Its responsibilities include integrated circuit development, software development, mechanical and electroacoustic engineering, clinical research, regulatory affairs, magnetic transduction design and development and biomaterials (including polymers) engineering. The Company also retains consultants with special expertise to augment internal product development. ReSound's research and development is primarily focused on the enhancement of its current hearing device products, development of new BTE, ITE, ITC and Completely-in-the-Canal ("CIC") acoustic products, fitting systems and transducers. Some acoustic and magnetic clinical investigations are conducted at the California Ear Institute at Stanford in Palo Alto, California which has an affiliation with the faculty at the Stanford University School of Medicine. Dr. Rodney Perkins, Chairman of the Company's Board of Directors, is the President of the California Ear Institute at Stanford and a professor at the Stanford University School of Medicine. 15 16 Over the last few years, Viennatone has increased its research and development investment, resulting in several new patents and new technologies. These new technologies include the development of a custom IC for providing automatic, gradual mixing between an omni and a directional microphone. Furthermore, Viennatone has developed a unique parametric filter IC. With the acquisition of SHH, the Company obtained a large portfolio of patents and intellectual property for programmable devices. SHH also provides ReSound with technology related to materials, electronic packaging, manufacturing engineering of custom shells as well as analog signal processing. Certain programmable and DSP patents obtained from the SHH acquisition, were made available to the industry through a partnership formed in 1996 comprised of six hearing device manufacturers, including ReSound, at December 31, 1996. In consideration, ReSound received cash payments from the initial partnership members valued at $7.3 million (net), as of December 31, 1996, and has rights to an additional $3.6 million as future partnership interests or licenses are sold. If and when such funds are received, the related intangible assets will be reduced accordingly. Thereafter, any amounts paid to the partnership will be divided equally among the partners and recognized as license income. COMPETITION The hearing device industry is intensely competitive. Many of the Company's competitors, including Siemens Corporation, Oticon, Phonak, Philips, Starkey Laboratories, Bausch & Lomb, Beltone Electronics, Widex and Danavox may have substantially greater financial, manufacturing, marketing or technical resources than those of the Company. In addition, the Company is aware that several of its competitors have advanced programs for the development of technologically advanced hearing devices. Oticon and Widex have recently introduced digital signal processing ("DSP") hearing devices. The Company, through its joint venture with AudioLogic Hearing Systems (Boulder, Colorado) and GN Danavox a/s (Denmark) is developing a new generation of DSP integrated circuit and software. There can, however, be no assurance that the Company's competitors will not develop products that may be more effective in treating hearing loss than the Company's products, or that the Company's technologies and products may not be rendered obsolete or uncompetitive by such developments. Principal competitive factors in the market for the Company's existing BTE, ITE and ITC hearing device products include price, product quality and reliability, technical support and service, marketing and distribution channels. PATENTS, TRADE SECRETS, LICENSES AND RELATED LITIGATION The Company's policy is to protect its proprietary position by, among other methods, filing United States and international patent applications to protect technology, inventions and improvements that are important to the development of its business and, in this regard, the Company owns and has filed applications for a number of patents and patent applications in the United States and elsewhere in the world. No assurance can be given that pending patent applications will be approved or that any patents will provide competitive advantages for the Company's products or will not be challenged or circumvented. The Company also relies upon trade secrets and technical know-how and continuing technological innovation to develop and maintain its competitive position. The Company typically 16 17 requires its employees, consultants and advisors to execute a confidentiality agreement upon the commencement of an employment, consulting or advisory relationship with the Company. There can be no assurance, however, that these agreements will not be breached or that the Company will have adequate remedies for any breach. Furthermore, no assurance can be given that competitors will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's proprietary technology or disclose such technology or that the Company can meaningfully protect its rights in such unpatented proprietary technology. In February 1987, ReSound obtained a worldwide, royalty-bearing license from AT&T to certain AT&T technical information, including electronics schematics and software, for use in hearing assistance applications. The license required the Company to pay a royalty based on net sales of products utilizing the licensed technology until the completion of the Company's initial public offering in March 1993. AT&T may terminate the license if the Company is in breach of the license agreement. The Company believes that it is presently in compliance with the terms of the license agreement. Under an amendment to the license agreement effective as of January 1988, AT&T assigned to the Company three patents related to the Company's sound processing technology that had been developed through use of the licensed AT&T technical information. Under this amendment, AT&T was granted back an exclusive license to these three patents for use in applications other than in hearing assistance applications. AT&T also received a right to grant sublicenses to the patents to third parties where required under its pre-existing agreements with such parties. On April 28, 1995, the Company settled its then pending patent infringement lawsuit with Dr. Paul Yanick. In exchange for a one-time lump-sum royalty payment, the lawsuit was dismissed and the Company received a fully-paid license to use all of Dr. Yanick's trade secrets and patent technology, including the four patents involved in the lawsuit. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements - Litigation." On October 19, 1995, the Company announced that it had reached agreement to settle the then pending patent lawsuit with A&L Technology. As a result of the settlement, the lawsuit was dismissed and the Company received a fully-paid license to use A&L's United States Letters Patent No. 4,396,806 in its hearing device products both in the United States and overseas. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements - Litigation." The Company was the defendant in a lawsuit filed in September 1993 in the United States District Court, District of Minnesota, by 3M alleging that the Company's hearing devices and programming systems infringed the claims of three patents owned by the plaintiff. This lawsuit was dismissed in June 1996 upon the Company's purchase of certain assets, including the related patents, of the hearing health business activity of 3M. From time to time, the Company has been contacted by various other parties who have alleged that certain of the Company's products infringe or may infringe patents that such parties claim to hold. Management believes the Company has not infringed on any such patents and does not believe such claims, if pursued, will result in a material adverse effect on the financial position or results of operations of the Company. 17 18 A substantial number of patents have been issued that relate to, or could relate to, the design and manufacture of hearing devices. As a result, the Company may in the future be contacted by parties claiming that the Company's products infringe their patent or other proprietary rights. Any future litigation could result in substantial costs and the diversion of effort by management of the Company. The Company may also find it necessary to institute litigation to enforce patents issued to it, to protect trade secrets or know-how owned by it or to determine the scope and validity of the patents or other proprietary rights of others. Resolution of these claims generally involves complex legal and factual questions and is highly uncertain. Adverse determinations in any litigation could subject the Company to significant liabilities to third parties and require the Company to seek licenses from other parties or prevent the Company from manufacturing and selling its products or require the Company to redesign its products, all of which could have a materially adverse effect on the Company's business, financial condition and results of operations. PRODUCT LIABILITY AND INSURANCE Medical device companies are subject to an inherent risk of product liability and other liability claims in the event that the use of their products or a medical procedure associated with prescribing and fitting their products results in personal injury claims. Although the Company has not experienced any product liability claims to date, any such claims could have an adverse effect on the Company. The Company currently maintains liability insurance with coverage of $21 million per occurrence and an annual aggregate maximum of $21 million. There can be no assurance that product liability or other claims will not exceed such insurance coverage limits or that such insurance will continue to be available on commercially acceptable terms, or at all. EMPLOYEES As of December 31, 1996, the Company had 1,024 employees, including 83 in research and development, 569 in manufacturing, 257 in sales and marketing and 115 in administration. The Company believes it maintains competitive compensation, benefits, equity participation and work environment policies to assist in attracting and retaining qualified personnel. Viennatone's employees are compulsorily covered by a collective bargaining agreement with respect to the electronics industry and are compulsorily members of the Austrian Chamber of Workers. The Company believes that the success of its business will depend, in part, on its ability to attract and retain qualified personnel. The Company believes its relationship with its employees is good. ADVISORY BOARDS The Company has a Scientific Advisory Board and a Medical Advisory Board comprised of leading scientists and physicians in the acoustic, auditory and electrical engineering fields. Both Boards meet and consult with the Company's management and technical staff on an as-needed basis. The Company estimates that members of the Advisory Boards spend on average one day per quarter on Company matters. Some members of the Boards may also receive compensation for consulting or clinical work performed for the Company under consulting contracts. The aggregate compensation paid by the Company under these consulting arrangements was approximately $9,000 during fiscal 1996, excluding amounts paid to Dr. Richard Goode and Dr. Rodney Perkins, who are also members of the Company's Board of Directors. 18 19 The current members of the Scientific Advisory Board are: Jont Allen, Ph.D., a member of the technical staff of AT&T Bell Laboratories in the acoustics research department. Dr. Allen was involved in the development of AT&T's internal hearing device venture, with particular emphasis on the fitting system, and has experience in acoustics, cochlear modeling and related electrical engineering fields. Dr. Allen holds a Ph.D. from the University of Pennsylvania. Harry Levitt, Ph.D., Distinguished Professor at City University of New York for the Center of Research in Speech and Hearing Science. Dr. Levitt is one of the world's leading scientists in the hearing aid field. He regularly presents, often as an invited speaker, at the most important hearing aid conferences. Dr. Levitt has over 200 publications in major audiology journals and textbooks. Brian Moore, Ph.D., Professor of Auditory Perception at Cambridge University in England. Dr. Moore has performed extensive basic and applied research in the fields of hearing, hearing impairment, hearing device design, and signal processing, with long-term Program Grant support from the Medical Research Council (U.K.). He has authored or edited more than eight books and has published over 220 book chapters and research articles. Dr. Moore holds a Ph.D. from Cambridge University. Edgar Villchur, President and Director of Research of the Foundation for Hearing Aid Research. Mr. Villchur was the founder of Acoustics Research, a manufacturer of stereophonic equipment, and has been a visiting scientist at the Massachusetts Institute of Technology and the Albert Einstein School of Medicine. Mr. Villchur has authored many books and papers on the reproduction of sound and signal processing for the hearing impaired. Mr. Villchur holds an M.S.Ed. from the City College of New York. The current members of the Medical Advisory Board are: Derald E. Brackmann, M.D., senior otologic surgeon at the House Ear Institute in Los Angeles. Dr. Brackmann is past President of the Academy of Otolaryngology--Head and Neck Surgery and past President of the American Neurotologic Society. He has published extensively on clinical topics in otologic surgery (ear surgery). Dr. Brackmann is Clinical Professor of Otolaryngology at the University of Southern California School of Medicine. Dr. Brackmann holds an M.D. from the University of Illinois School of Medicine. Professor Doctor Ugo Fisch, Professor and Chairman of the Department of Otolaryngology at the University Hospital in Zurich. Dr. Fisch is a leading surgeon in the fields of otologic surgery and neurotologic surgery (surgery of the neural components of the ear and related structures) and has over 30 years of research and teaching experience. Dr. Fisch is an Honorary Fellow of the Royal College of Surgeons of England. Dr. Fisch holds an M.D. from the University of Zurich. Bruce J. Gantz, M.D., Professor of Otolaryngology--Head and Neck Surgery at the University of Iowa College of Medicine. Dr. Gantz has received extensive funding from the National Institutes of Health for research on advanced hearing devices and cochlear implants. Dr. Gantz holds an M.D. from the University of Iowa. 19 20 William House, M.D., widely recognized as the founder of the field of neurotologic surgery. Dr. House did his pioneering work in cochlear implants and the development of advanced neurotologic surgical procedures at the House Ear Institute in Los Angeles. He has over 35 years experience in research and development of implantable hearing devices. Dr. House holds a D.D.S. from the University of California at Berkeley and an M.D. from the University of Southern California School of Medicine. Richard L. Goode, M.D. and Rodney Perkins, M.D., members of the Board of Directors, also serve on the Medical Advisory Board. ITEM 2. DESCRIPTION OF PROPERTIES The Company leases 47,600 square feet of office, research and development and manufacturing space in Redwood City, California under a non-cancelable operating lease and sublease through June 2000. Additionally, the Company leases 6,600 square feet in Redwood City under a lease which expires in December 2000. Sonar Hearing Health, in Eagan, Minnesota, leases 14,000 square feet under a non-cancelable operating lease which expires in December 1999. The Company's German subsidiary, ReSound GmbH Hortechnologie, leases approximately 3,500 square feet of space in Munich; and the Company's Dutch subsidiary, ReSound b.v., leases approximately 2,500 square feet of space in Oosterhout. During the first quarter of 1994, Sonar increased its leased manufacturing and administrative space in Munster from approximately 3,400 square feet to approximately 12,000 square feet. ReSound Ireland Limited leases a total of approximately 15,200 square feet in Cork, Ireland. ReSound acquired Viennatone AG in early December 1994. Viennatone's leased headquarters building, located in Vienna, Austria, consists of approximately 32,500 square feet. Viennatone also has a leased manufacturing facility in Grafenschachen, Austria, which consists of approximately 8,200 square feet. Viennatone operates 22 leased retail stores which total approximately 19,000 square feet. Viennatone owns two additional retail locations in Vienna which total approximately 1,600 square feet. Subsidiaries of Viennatone operating in France, Germany, the United Kingdom and Mexico lease approximately 11,000 square feet of building space. The Company expects that it may require additional space in the future and that such space will be available on acceptable terms if required. ITEM 3. LEGAL PROCEEDINGS See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements -- Litigation." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. 20 21 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the Nasdaq National Market under the symbol RSND. The prices per share reflected in the table below represents the range of low and high closing sale prices for the Company's Common Stock as reported in the Nasdaq National Market for the quarters indicated.
FISCAL 1995..............................................HIGH LOW ---- --- First Quarter ended April 2, 1995 ................... 10 5/8 6 3/4 Second Quarter ended July 2, 1995 ................... 9 3/8 7 3/8 Third Quarter ended October 1, 1995 ................. 9 1/4 7 5/8 Fourth Quarter ended December 31, 1995 .............. 9 3/8 6 3/4 FISCAL 1996..............................................HIGH LOW ---- --- First Quarter ended March 31, 1996................... 12 1/2 6 7/8 Second Quarter ended June 30, 1996 .................. 13 1/2 10 1/4 Third Quarter ended September 30, 1996 .............. 12 5/8 7 1/4 Fourth Quarter ended December 31, 1996 .............. 9 1/2 6 7/8
The Company had approximately 7,624 shareholders as of December 31, 1996, including beneficial owners included in securities position listings as described in Rule 17Ad-8. The Company has never paid cash dividends on its capital stock. The Company currently anticipates that it will retain all available funds for use in the operation and expansion of its business, and does not anticipate paying any cash dividends in the foreseeable future. 21 22 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31, ------------------------ (in thousands, except per share data) 1996 (1) 1995 1994 (2) 1993 1992 ------- ---- ---- ---- ----- CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net sales $ 125,646 $ 107,330 $ 62,253 $35,686 $ 16,686 Cost of sales 57,241 53,626 26,461 15,025 9,075 --------- --------- -------- ------- -------- Gross profit 68,405 53,704 35,792 20,661 7,611 Operating expenses: Research and development 14,898 11,181 8,862 5,179 3,526 Selling, general and administrative 50,899 45,606 21,403 10,872 5,124 --------- --------- -------- ------- -------- Total operating expenses 65,797 56,787 30,265 16,051 8,650 --------- --------- -------- ------- -------- Income (loss) from operations 2,608 (3,083) 5,527 4,610 (1,039) Interest income (expense), net (1,819) (1,860) 553 748 (5) Other income (expense), net (359) (368) 496 -- -- Provision for litigation and related costs -- -- (19,230) -- -- --------- --------- -------- ------- -------- Income (loss) before income taxes 430 (5,311) (12,654) 5,358 (1,044) Provision for income taxes 1,397 591 1,635 536 -- ---------- --------- -------- ------- -------- Net income (loss) $ (967) $ (5,902) $(14,289) $ 4,822 $ (1,044) ========= ========= ======== ======= ======== Net income (loss) applicable to common shareholders $ (1,192) $ (5,902) $(14,289) $ 4,822 $ (1,044) ========= ========= ======== ======= ======== Net income (loss) per common share $ (0.07) $ (0.38) $ (0.95) $ 0.35 $ (0.19) ========= ========= ======== ======= ======== Shares used in net income (loss) per share calculation 17,591 15,439 15,089 13,973 5,502 ========= ========= ======== ======= ========
AS OF DECEMBER 31, ------------------ (in thousands) 1996 1995 1994 1993 1992 ---- ---- ---- ---- ----- CONSOLIDATED BALANCE SHEET DATA: Working capital $ 25,377 $ 9,324 $ 5,995 $ 29,248 $ 4,932 Total assets 114,752 83,370 95,116 40,846 9,157 Long-term obligations, net of current portion 25,985 30,729 23,146 -- 109 Accumulated deficit (39,202) (38,010) (32,108) (17,819) (22,641) Shareholders' equity 57,596 18,221 21,169 32,793 5,958
(1) Includes the operating results of Sonar Hearing Health Corporation, established from the purchase of certain assets of the hearing health business activity of 3M in June 1996. See Note 2 in Notes to Consolidated Financial Statements. (2) Includes the operating results of Sonar Design & Hortechnik GmbH and Viennatone AG from their purchase dates of January and December 1994, respectively. See Note 2 in Notes to Consolidated Financial Statements. 22 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company was primarily engaged in research and development from its inception in February 1984 through December 1989, when it commenced shipments of its first In-the-Ear ("ITE") hearing devices and its Digital Hearing System ("DHS"), a hearing testing and programming system. Through December 31, 1996, the Company has sold over 623,000 hearing devices worldwide including over 229,000 in 1996, to over 4,300 audiologists and hearing device dispensers. In general, the Company's net sales have increased primarily from higher volumes of product shipments and a broader product line (due to both internal growth and acquisitions) rather than from increases in product prices. Increases in the number of audiologists and hearing device dispensers selling the Company's hearing instruments have contributed to the higher volume of shipments. In the last several years, the Company has established significant operations outside the United States. In 1994, the Company significantly expanded its business by acquiring two existing hearing health care companies in Europe, established a manufacturing facility in Ireland and entered into an Asian distribution joint venture. In 1995, the Company formed wholly owned subsidiaries in Australia and Sweden. The Company currently derives over 55% of its revenues outside the United States. ACQUISITIONS AND STRATEGIC ALLIANCES In 1994, the Company completed two acquisitions. On January 1, 1994, the Company acquired all the outstanding ownership interests in Sonar Design & Hortechnik GmbH ("Sonar") for approximately $3.5 million and 100,000 shares of ReSound Common Stock. Sonar, located in Munster, Germany, is a leading German manufacturer and distributor of custom ITE hearing devices. The acquisition of Sonar allows the Company to market custom ITE hearing devices in Europe, containing ReSound technology, as well as devices containing Sonar technology. During 1996, Sonar was renamed ReSound Deutschland. On August 9, 1994, the Company entered into a joint venture agreement establishing ReSound Asia Limited ("ReSound Limited") with a group of companies based in Hong Kong. ReSound Limited has been granted exclusive distribution of ReSound hearing health care products in Hong Kong, Taiwan, Singapore and the People's Republic of China with the potential to expand its distribution rights into Thailand and Malaysia. ReSound holds a majority equity position in the partnership and provides technical and clinical expertise to the joint venture. On December 9, 1994, a newly-formed Austrian subsidiary of the Company acquired 100% of the shares of Viennatone AG, an Austrian company, for approximately $27.7 million, and the Company's German subsidiary acquired the net assets of a related business for approximately $0.6 million, or a total of approximately $28.3 million (Viennatone AG owns an 80% interest in its Austrian distribution company, Viennatone BVG). Viennatone, based in Vienna, Austria, designs, manufactures and distributes BTE, ITE and other hearing devices and components worldwide. The acquisition of Viennatone provided the Company with Viennatone's electroacoustic and electromechanical technologies; expanded distribution of ReSound products through Viennatone's established subsidiaries in the United Kingdom, France, and Germany, as well as a retail chain in 23 24 Austria consisting of 22 stores; and access to high quality hearing device cases and components. In 1996, the Company purchased the remaining minority interest in Viennatone Hannover for $1.9 million in cash. In June 1996, the Company completed the purchase of certain assets of the hearing health business activity of Minnesota Mining and Manufacturing Company ("3M") for $25.4 million and has established a subsidiary in the United States, Sonar Hearing Health Corporation, to manage this activity on an ongoing basis. International distribution of former 3M products is undertaken through the Company's international subsidiaries. To finance this purchase and provide working capital, the Company raised approximately $32.9 million (net proceeds) through the private sale of 3,212,176 shares of common stock. Hearing health constituted a small business activity in 3M's worldwide operations which was neither a division nor subject to the maintenance of discrete accounting records such that financial statements could be or are determinable. However, the Company believes that this business activity generated revenues for 3M of approximately $9.3 million and $16.6 million for the six months ended June 30, 1996, and for the year ended December 31, 1995, respectively. The total purchase price of $25.4 million included a cash payment of $24.9 million and $500,000 for related acquisition expenses. Together with patents acquired from 3M valued at $7.5 million, patents valued at $2.5 million were acquired in July 1996 in connection with the above acquisition. These patents were contributed to a recently formed partnership comprised of six hearing device manufacturers, including ReSound, at December 31, 1996. In consideration, ReSound received cash payments from the initial partnership members of $7.3 million (net) as of December 31, 1996, and has rights to an additional $3.6 million as future partnership interests or licenses are sold. Thereafter, any amounts paid to the partnership will be divided equally among the partners. Cash receipts from the sale of partnership interests has lowered the net purchase price of the hearing health business activity of 3M to $18.1 million at December 31, 1996. SALES The Company recognizes revenue upon shipment of products. Net sales consist of gross sales less discounts and allowances for estimated returns. In general, the Company has a 90-day return policy for sales in the United States. The Company believes that the hearing device industry in the U.S. is characterized by a relatively high rate of returns due to a number of factors, including liberal return policies required by law in many states. However, the Company's return rates in the U.S. are within the range it believes are experienced by other hearing device manufacturers. In 1996, 1995, and 1994 the provision for estimated sales returns in the U.S., expressed as a percentage of domestic sales, has been 27%, 28%, and 23%, respectively. Because of the need to provide a return policy competitive with industry practice in the U.S. and because of the importance of the initial fitting process, the Company expects sales returns will continue at a relatively high rate. In Europe and Asia, returns are not material. COSTS & EXPENSES Cost of sales consists of manufacturing costs, royalty expenses, quality assurance costs and costs and accruals associated with warranty repairs and product remakes. In 1996, cost of sales as a percentage of net sales decreased to 46% from 50% in 1995. The 1995 cost of sales included $2.8 million in royalties to A&L Technology stemming from a disputed patent and higher manufacturing costs of approximately $2.3 million necessitated by a temporary re-design of all affected products pending settlement of the A&L Technology patent suit. 24 25 The Company provides for estimated warranty cost at the time of sale and adjusts these estimates based on subsequent experience. The period over which warranty claims may be made in the U.S. is one to three years for electronic components and 12 months for the custom shell used for ITE and ITC devices. In 1996, 1995 and 1994, the approximate provisions for estimated warranty cost (and as a percentage of net sales domestically) were $4.4 million (8%), $4.2 million (11%), and $3.0 million (10%), respectively. The period over which warranty claims may be made in Europe and Asia is 12 months, and the amount of these claims has been of lesser significance. The Company experiences a high rate of warranty claims related to damage and blockage of the speaker caused by moisture and accumulated ear wax. The Company expects such claims to continue to be significant and expects warranty costs to continue to represent a significant component of cost of sales. The 1996 increase in selling, general and administrative expenses was primarily the result of the acquisition of certain assets of the hearing health business activity of 3M. The 1995 increase in selling, general and administrative expenses was primarily related to acquisitions and the establishment of wholly owned subsidiaries in Australia and Sweden. In 1994, the Company established distribution in Asia through a joint venture located in Hong Kong and initiated sales in the United Kingdom, Denmark, and Sweden. International sales as a percentage of net sales in 1996, 1995 and 1994 were 55%, 65% and 51%, respectively. PATENT AND OTHER LITIGATION On April 28, 1995, the Company settled its then-pending patent infringement lawsuit with Dr. Paul Yanick. In exchange for a one-time lump-sum royalty payment, the lawsuit was dismissed and the Company received a fully-paid license to use all of Dr. Yanick's trade secrets and patent technology, including the four patents involved in the lawsuit. On October 19, 1995, the Company announced that it had reached agreement to settle both the patent lawsuit with A&L Technology and the shareholder class action lawsuit previously filed on behalf of certain shareholders. The patent infringement lawsuit brought against the Company by A&L Technology was dismissed and the Company received a fully-paid license to use A&L's United States Letters Patent No. 4,396,806 in its hearing device products both in the United States and overseas. In addition, A&L Technology relinquished its claims to receive approximately $13.5 million in damages, attorneys' fees, royalties and interest previously awarded by the court in the action. In exchange, the Company on October 19, 1995, the Company made a cash payment to A&L Technology of $7.0 million and released all claims to a $2.8 million royalty paid to A&L Technology in 1995. The shareholder class action suit, filed against the Company, its directors and certain of its officers, and against the underwriters of its initial public offering on behalf of purchasers of ReSound's common stock between March 4, 1993 and March 13, 1995, was settled on October 19, 1995 and resulted in a settlement fund of $8.0 million from which plaintiff's attorneys' fees and expenses will be deducted. Fifty percent of the fund was paid by the Company on October 30, 1995, and the balance was paid by the Company's insurance carriers. The Court approved the settlement on June 12, 1996. At the settlement hearing relating to the final distribution of the shareholder settlement fund, an objection was raised to the provisions of the settlement agreement relating to attorney's fees and certain other matters. The judge rejected the objector's claim and approved the proposed terms of the distribution. Notice of appeal was filed by the objector on July 10, 1996, and the appeal is currently pending before the Ninth Circuit Court of Appeals. 25 26 The Company was the defendant in a lawsuit filed in September 1993 in the United States District Court, District of Minnesota, by 3M alleging that the Company's hearing devices and programming systems infringed the claims of three patents owned by the plaintiff. This lawsuit was dismissed in June 1996 upon the Company's purchase of certain assets, including the related patents, of the hearing health business activity of 3M. From time to time, the Company has been contacted by various other parties who have alleged that certain of the Company's products infringe or may infringe patents that such parties claim to hold. Management believes the Company has not infringed on any such patents and does not believe such claims, if pursued, will result in a material adverse effect on the financial position or results of operations of the Company. A substantial number of patents have been issued that relate to or could relate to the design and manufacture of hearing devices. As a result, the Company may in the future be contacted by parties claiming that the Company's products infringe their patent or other proprietary rights. Any future litigation could result in substantial costs and the diversion of effort by management of the Company. The Company may also find it necessary to institute litigation to enforce patents issued to it, to protect trade secrets or know-how owned by it or to determine the scope and validity of the patents or other proprietary rights of others. Resolution of these claims generally involves complex legal and factual questions and is highly uncertain. Adverse determinations in any litigation could subject the Company to significant liabilities to third parties and require the Company to seek licenses from other parties or prevent the Company from manufacturing and selling its products or require the Company to redesign its products, all of which could have a materially adverse effect on the Company's business, financial condition and results of operations. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain statements of operations data as a percentage of net sales:
YEARS ENDED DECEMBER 31, ------------------------ 1996 1995 1994 ---- ---- ---- Net sales 100% 100% 100% Cost of sales 46 50 42 ---- ---- ---- Gross profit 54 50 58 Operating expenses: Research and development 12 10 14 Selling, general and administrative 41 43 35 ---- ---- ---- Total operating expenses 53 53 49 ---- ---- ---- Income (loss) from operations 1 (3) 9 Interest income (expense), net (1) (2) 1 Other income (expense), net -- -- 1 ---- ---- ---- Income (loss) before income taxes -- (5) 11 Provision for litigation and related costs -- -- (31) ---- ---- ---- Income (loss) before income taxes -- (5) (20) Provision for income taxes 1 1 3 ---- ---- ---- Net loss (1)% (6)% (23)% ==== ==== ====
26 27 Years Ended December 31, 1996 and 1995 Net sales increased by 17% to $125.6 million in 1996 compared to $107.3 million in 1995 due to the introduction of the ITC hearing device, continued strong sales of the Encore product line, the inclusion of sales relating to products acquired from 3M Hearing Health, increased sales of the Company's ITE and BTE hearing devices, and an increase in the number of audiologists (hearing care professionals with advanced degrees), acousticians, and hearing device dispensers selling the Company's products. The total number of audiologists and hearing device retailers increased in the U.S. from 1,392 at the end of 1995 to 2,200 at the end of 1996. The number of acousticians and hearing device dispensers selling the Company's products internationally increased from 2,050 at the end of 1995 to 2,120 at the end of 1996. International sales for the twelve months ended December 31, 1996, were level with the comparable period last year due to unfavorable changes in governmental reimbursement policies in Europe, an increasingly competitive marketplace, and weaker European currencies compared to the U.S. dollar. International sales as a percentage of net sales in 1996 and 1995 were 55% and 65%, respectively. Cost of sales increased to $57.2 million in 1996 from $53.6 million in 1995. Gross profit increased to $68.4 million in 1996 from $53.7 million in 1995, and as a percentage of net sales increased to 54% in 1996 from 50% in 1995. The year-to-year increase in gross profit was largely attributable to the $2.8 million in royalty payments and the higher manufacturing costs of approximately $2.3 million incurred in 1995 due to the A&L Technology patent litigation. In addition, the Company has benefited from improved efficiencies at its Ireland manufacturing facility which supplies all ReSound BTE hearing devices and faceplate assemblies worldwide. Research and development expenses increased by 33% to $14.9 million (12% of net sales) for 1996 from $11.2 million (10% of net sales) for 1995. The Company increased spending during the twelve months ended December 31, 1996 relative to the prior year for the continued development of new products being introduced throughout 1996 and for products planned for future years. In May 1996, the Company introduced its Advanced ReSound Processing(TM) chip incorporating ReSound's Cochlea Dynamics technology into an In-the-Canal hearing device, a ReSound software fitting system, ReSource, based on the industry standard NOAH PC system platform and an improved Behind-the-Ear Power hearing device. In 1996 the Company also upgraded its installed base of Portable Prescriptive Programming fitting systems. In addition, expenses were incurred for the development of a standard hardware platform for Digital Signal Processing technology as part of an alliance with AudioLogic Hearing Systems and GN Danavox a/s which was announced in April 1996 and finalized on September 30, 1996. Selling, general and administrative expenses increased by 12% to $50.9 million (41% of net sales) in 1996 from $45.6 million (43% of net sales) in 1995. This year-to-year increase in expenditures resulted from the acquisition of the 3M Hearing Health business activity and increased expenses related to increased sales volume. These increases were offset by a labor agreement reached in Austria which reduced SG&A expenses on a one-time basis by approximately $1.3 million in 1996. The Company expects expenses generally to continue at high levels, but to fluctuate as a percentage of sales. The Company is undertaking a program to reduce expenses, but no assurance can be given that reductions will be obtained, especially on a percentage of sales basis which may vary substantially on a quarter to quarter basis. 27 28 Interest income was $184,000 in 1996, compared to $326,000 in 1995. This year-to-year decrease is primarily due to a reduction in the average cash and short-term investment balances resulting from cash payments made to settle litigation in the fourth quarter of 1995. Interest expense was $2.0 million in 1996, compared to $2.2 million in 1995. This decrease is primarily due to the Company paying down debt in 1996. Other expense was $359,000 in 1996 compared to $368,000 in 1995. Both amounts consisted primarily of realized losses on foreign currency transactions. Income tax provisions were $1.4 million in 1996 and $591,000 in 1995. Income taxes primarily represent taxes on profits earned at the Company's European subsidiaries in Ireland, Austria, the United Kingdom and Holland. The Company had net operating loss carryforwards of approximately $31.0 million for United States' federal purposes and $8.6 million for United States' state purposes as of December 31, 1996. Each international subsidiary is subject to income taxes in the countries in which it operates. The income of these subsidiaries is not included in the Company's U.S. federal and state income tax returns. The Company had foreign net operating loss carryforwards of approximately $7.0 million at December 31, 1996, which will expire at various dates beginning in 1997 through 2002, if not utilized. Years Ended December 31, 1995 and 1994 Net sales increased by 72% to $107.3 million in 1995 compared to $62.3 million in 1994 due primarily to higher sales of the Company's ITE and BTE hearing devices, an increase in the number of audiologists (hearing care professionals with advanced degrees), acousticians, and hearing device dispensers selling the Company's products and the inclusion of a full year's sales of Viennatone, acquired in December 1994. The total number of audiologists and hearing device retailers increased in the U.S. from 1,118 at the end of 1994 to 1,392 at the end of 1995. The Company experienced increased international sales in Austria, Belgium, Canada, Denmark, France, Germany, Hong Kong, Japan, the Netherlands, Portugal, Spain, Switzerland, Taiwan, and the United Kingdom. The number of acousticians and hearing device dispensers selling the Company's products internationally increased from 1,630 at the end of 1994 to 2,050 at the end of 1995. Cost of sales increased to $53.6 million in 1995 from $26.5 million in 1994. Gross profit increased to $53.7 million in 1995 from $35.8 million in 1994, and as a percentage of net sales declined to 50% in 1995 from 58% in 1994. This decline in gross profit as a percentage of net sales in 1995 was primarily attributable to payment of $2.8 million in royalties to A&L Technology stemming from a disputed patent and higher manufacturing costs of approximately $2.3 million necessitated by a temporary re-design of all affected products. In September 1994, ReSound established a new manufacturing facility in Cork, Ireland which has supplied the majority of ReSound standard BTE and faceplates for custom ITE hearing devices since mid-year 1995. Research and development expenses increased by 26% to $11.2 million (10% of net sales) for 1995 from $8.9 million (14% of net sales) for 1994. This increase was attributable to the hiring of additional engineering personnel, payments to outside consultants and contractors for new product development associated with acoustic products and the engineering costs of Viennatone. In 1994, the Company introduced a Sculptured ITE hearing device in the U.S. market, and a Power BTE hearing device in worldwide markets. The Company continued to incur research and development expenses 28 29 at a substantial level for the development of additional new products, such as an In-the-Canal ("ITC") hearing device, the incorporation of a directional microphone with ReSound sound processing technology into the Company's BTE hearing device products, the development of the Advanced ReSound Processing(TM) chip, and the development of new software and fitting systems. The expenses relating to designing around the A&L Technology patent represented approximately $500,000 of 1995 research and development costs. Selling, general and administrative expenses increased by 113% to $45.6 million (43% of net sales) in 1995 from $21.4 million (35% of net sales) in 1994. This increase was attributable to additional staffing due to higher sales volumes, the expansion of distribution of the Company's products into several additional countries, and the inclusion of Viennatone for a full year. In 1995, $15.1 million of selling, general and administrative expenses related to Viennatone. During 1995, ReSound established wholly owned subsidiaries in Australia and Sweden. Interest income was $326,000 in 1995, compared to $680,000 in 1994. This decrease was attributable to the reduction and eventual elimination of investing activity by ReSound in 1995. There was less cash on hand during the course of the year due to $16.6 million paid to settle the A&L Technology, shareholder class action and Yanick lawsuits. Interest expense was $2.2 million in 1995, compared to $127,000 in 1994. This increase was due, principally, to $17.3 million in bank borrowings established in December 1994 and to the issuance of $10 million of convertible notes in February 1995 related to the acquisition of Viennatone AG. Other expense of $368,000 in 1995 was related to the operating losses incurred by the Company's joint venture in Hong Kong and the minority interest expenses incurred at the Viennatone subsidiary, partially offset by approximately $175,000 of realized gains on foreign currency transactions. Other income was $496,000 in 1994 and consisted primarily of realized gains on foreign currency transactions. Income tax provisions were $591,000 in 1995 and $1.6 million in 1994. Income taxes primarily represent taxes on profits earned at the Company's European subsidiaries in Ireland, Austria, the United Kingdom and Holland. The Company had net operating loss carryforwards of approximately $30.0 million for federal purposes and $12.6 million for state purposes as of December 31, 1995. Each international subsidiary is subject to income taxes in the countries in which it operates. The income of these subsidiaries is not included in the Company's U.S. federal and state income tax returns. LIQUIDITY AND CAPITAL RESOURCES Operating Activities During 1996, the Company used $1.6 million of cash in operations primarily to fund the Company's net current asset position. During 1995, the Company used $17.5 million of cash in operations, of which $16.6 million was paid in litigation and related costs. 29 30 Investing Activities Net cash used in investing activities in 1996 was $27.0 million and resulted primarily from the acquisition of certain assets of the 3M hearing health business activity for $25.4 million, additions to property and equipment of $7.5 million and the purchase of a minority shareholder's interest in a subsidiary of Viennatone for $1.9 million. These amounts were primarily offset by net proceeds from the licensing of patent rights for $7.3 million. Financing Activities Net cash provided by financing activities in 1996 was $31.5 million. This amount resulted primarily from the issuance of Common and Preferred Stock for $34.3 million and $5.0 million, respectively. These amount were offset by reductions of long-term debt and loans payable of $4.2 million and $3.6 million, respectively. At December 31, 1996, the Company had available cash and cash equivalents of $8.0 million. While the Company believes that available cash will be sufficient to meet the Company's short-term operating and capital requirements through at least December 31, 1997, the Company may be required to raise additional capital for its currently envisaged long-term needs and in connection with any future acquisitions. 30 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE Report of Ernst & Young LLP, Independent Auditors 32 Consolidated Financial Statements: Consolidated Balance Sheets 33 Consolidated Statements of Operations 34 Consolidated Statement of Shareholders' Equity 35 Consolidated Statements of Cash Flows 36 Notes to Consolidated Financial Statements 37
31 32 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors ReSound Corporation We have audited the accompanying consolidated balance sheets of ReSound Corporation as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at item 14(a)(2). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ReSound Corporation at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Ernst & Young LLP Palo Alto, California January 28, 1997 32 33 RESOUND CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS DECEMBER 31, 1996 1995 ---- ---- Current assets: Cash and cash equivalents $ 7,980 $ 5,091 Accounts receivable, net of allowances for estimated returns and doubtful accounts of $4,774 and $4,123 at December 31, 1996 and 1995, respectively 20,497 17,746 Inventories 23,853 18,466 Other current assets 4,218 2,441 ---------- ----------- Total current assets 56,548 43,744 Property and equipment, net 13,494 9,300 Other assets 4,899 2,634 Goodwill, net of accumulated amortization of $3,379 and $1,779 39,811 27,692 ----------- ---------- $ 114,752 $ 83,370 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Bank loans and short-term notes payable $ 2,504 $ 8,134 Accounts payable 8,478 10,189 Accrued liabilities 17,976 12,643 Provision for litigation and related costs --- 492 Long-term debt, current portion 2,213 2,962 ------- ----------- Total current liabilities 31,171 34,420 Long-term liabilities: Long-term debt, non-current portion 19,515 22,988 Employee benefits 5,110 6,216 Other accrued liabilities 1,360 1,525 ------- ------- Total long-term liabilities 25,985 30,729 Commitments and contingencies Shareholders' equity: Preferred stock, $0.01 par value, 2,000,000 shares authorized; Series B: 54,055 issued and outstanding at December 31, 1996 5,225 --- Common stock, $0.01 par value, 50,000,000 shares authorized; 19,384,000 and 15,610,000 shares issued and outstanding at December 31, 1996 and 1995, respectively 90,680 54,292 Accumulated deficit (39,202) (38,010) Cumulative translation adjustment 893 1,939 ----------- --------- Total shareholders' equity 57,596 18,221 ----------- --------- $ 114,752 $ 83,370 ========= ========
See accompanying notes. 33 34 RESOUND CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, ------------------------ 1996 1995 1994 ---- ---- ---- Net sales $ 125,646 $ 107,330 $ 62,253 Cost of sales 57,241 53,626 26,461 -------- -------- -------- Gross profit 68,405 53,704 35,792 Operating expenses: Research and development 14,898 11,181 8,862 Selling, general and administrative 50,899 45,606 21,403 -------- -------- -------- Total operating expenses 65,797 56,787 30,265 -------- -------- -------- Income (loss) from operations 2,608 (3,083) 5,527 Other income (expense): Interest income 184 326 680 Interest expense (2,003) (2,186) (127) Other income (expense), net (359) (368) 496 Provision for litigation and related costs --- --- (19,230) -------- ----------- ----------- Total other income (expense) (2,178) (2,228) (18,181) --------- --------- ---------- Income (loss) before income taxes 430 (5,311) (12,654) Provision for income taxes 1,397 591 1,635 --------- --------- ---------- Net loss $ (967) $ (5,902) $(14,289) ========== ========= ========= Net loss applicable to common shareholders $ (1,192) $ (5,902) $(14,289) ========== ========= ========= Net loss per share $ (0.07) $ (0.38) $ (0.95) ========= ======== ========== Shares used in net loss per share calculation 17,591 15,439 15,089 ========= ======== ==========
See accompanying notes. 34 35 RESOUND CORPORATION CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
Unrealized Gain (Loss) on Securities Cumulative Total Preferred Common Accumulated Available for Translation Shareholders' Stock Stock Deficit Sale Adjustment Equity --------- ------ ----------- ---------------- ------------- ------------- Balance at December 31, 1993 $ -- $50,846 $(17,819) $ -- $ (234) $ 32,793 Exercise of stock options for 229 shares of common stock -- 227 -- -- -- 227 Issuance of 38 shares of common stock for employee stock purchase plan -- 291 -- -- -- 291 Issuance of 100 shares of common stock in connection with acquisition -- 1,987 -- -- -- 1,987 Net loss -- -- (14,289) -- -- (14,289) Unrealized loss on securities available-for-sale -- -- -- (675) -- (675) Translation adjustment -- -- -- -- 835 835 ------- -------- -------- ------ ------- --------- Balance at December 31, 1994 -- 53,351 (32,108) (675) 601 21,169 Exercise of stock options for 341 shares of common stock -- 570 -- -- -- 570 Issuance of 51 shares of common stock for employee stock purchase plan -- 333 -- -- -- 333 Exercise of stock options for 15 shares for directors' option plan -- 38 -- -- -- 38 Net loss -- -- (5,902) -- -- (5,902) Change in unrealized loss on securities available-for-sale -- -- -- 675 -- 675 Translation adjustment -- -- -- -- 1,338 1,338 ------- -------- -------- ------ ------- --------- Balance at December 31, 1995 -- 54,292 (38,010) -- 1,939 18,221 Issuance of 54 shares of 6% convertible redeemable preferred stock 5,000 -- -- -- -- 5,000 Issuance of 71 shares of common stock for employee stock purchase plan -- 385 -- -- -- 385 Exercise of stock options for 225 shares of common stock -- 1,055 -- -- -- 1,055 Issuance of 3,212 shares of common stock under private placement (net proceeds) -- 32,900 -- -- -- 32,900 Issuance of 266 shares of common stock upon conversion of Company's promissory note and related interest -- 2,048 -- -- -- 2,048 Net loss -- -- (967) -- -- (967) Accrued dividends on preferred stock 225 -- (225) -- -- -- Translation adjustment -- -- -- -- (1,046) (1,046) ------ ------- -------- ----- ------- -------- Balance at December 31, 1996 $5,225 $90,680 $(39,202) $ -- $ 893 $ 57,596 ====== ======= ======== ===== ======= ========
See accompanying notes. 35 36 RESOUND CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, ------------------------ 1996 1995 1994 ---- ---- ---- Cash flows from operating activities: Net loss $ (967) $ (5,902) $(14,289) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 6,066 5,830 2,828 Loss on disposal of property and equipment --- --- 30 Changes in assets and liabilities: Accounts receivable (982) (3,335) (1,457) Inventories (1,732) (2,495) (2,301) Other assets (3,435) (259) (1,144) Accounts payable (1,711) 3,087 1,610 Accrued liabilities 1,663 2,134 (28) Provision for litigation and related costs (492) (16,604) 17,096 ------ ------- -------- Net cash provided by (used in) operating activities (1,590) (17,544) 2,345 ------- -------- ------- Cash flows from investing activities: Acquisitions: Sonar --- --- (4,118) Viennatone --- --- (26,155) Sonar Hearing Health (25,443) --- --- Purchase of minority shareholder's interest in a subsidiary of Viennatone (1,857) --- --- Proceeds from patent contributions to partnership (net) 7,300 --- --- Purchase of short-term investments --- (5,582) (41,693) Sales and maturities of short-term investments --- 13,780 52,595 Change in translation adjustment 538 (745) 835 Additions of property and equipment (7,547) (4,168) (5,849) ------ ------ -------- Net cash provided by (used in) investing activities (27,009) 3,285 (24,385) -------- ------ --------- Cash flows from financing activities: Loans payable (3,630) (5,709) 13,532 Borrowings under long-term debt --- 10,000 17,374 Payments on long-term debt (4,222) (1,706) --- Proceeds from issuance of preferred stock 5,000 --- --- Proceeds from issuance of common stock 34,340 941 518 ------ ------- ------ Net cash provided by financing activities 31,488 3,526 31,424 ------ ------- ------ Net increase (decrease) in cash and cash equivalents 2,889 (10,733) 9,384 Cash and cash equivalents at the beginning of the year 5,091 15,824 6,440 ------ ------- -------- Cash and cash equivalents at the end of the year $7,980 $ 5,091 $ 15,824 ====== ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $2,104 $ 2,767 $ 127 ====== ======== ========= Income taxes $1,102 $ 1,360 $ 142 ====== ======== ========= Supplemental schedule of non-cash investing and financing activities: Issuance of common stock on acquisition of Sonar $ --- $ --- $ 1,987 Issuance of common stock on conversion of promissory notes $2,048 $ --- $ --- Accrual of preferred stock dividend $ 225 $ --- $ ---
s See accompanying notes. 36 37 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business ReSound Corporation (the "Company") was incorporated in the State of California on February 3, 1984. The Company is a hearing health care company which is involved in the research, development, manufacturing and distribution of technologically advanced hearing devices and diagnostic fitting systems. Shipments of products commenced in December 1989. The Company formed one European subsidiary in late 1992, and a second European subsidiary in 1993. In 1994, the Company significantly expanded its business by acquiring two existing hearing health care companies in Europe, Sonar Design & Hortechnik GmbH and Viennatone AG (see Note 2. "Acquisitions"). The Company also established a European manufacturing facility and an Asian distribution joint venture in 1994. In 1995, the Company formed subsidiaries in Australia and Sweden. In 1996, the Company completed the purchase of certain assets of the hearing health business activity of 3M and established a subsidiary, Sonar Hearing Health Corporation, to manage this activity on an ongoing basis (see Note 2. "Acquisitions"). Principles of Consolidation The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries. All significant intercompany accounts have been eliminated. Except for the Company's European manufacturing subsidiary located in Ireland, for which the U.S. dollar is the functional currency, the functional currency for each international subsidiary generally is its respective local currency. Accordingly, all assets and liabilities related to these subsidiaries are translated at the current exchange rates at the end of each quarter. The resulting translation adjustments are recorded directly to the foreign currency translation adjustment account included in shareholders' equity. Sales and expenses are translated at average exchange rates in effect during the period. Foreign currency transaction gains and losses are included in results of operations. Sales and Credit Risk The Company sells its products to audiologists, acousticians, hearing device chains and hearing device dispensers primarily in North America, Europe, and Asia. The Company performs on-going credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, and such losses have been within management's expectations. The Company's sales to customers outside of the United States accounted for approximately 55%, 65% and 51% of net sales for the years ended December 31, 1996, 1995 and 1994, respectively. A number of risks are inherent in international transactions. Fluctuations in the exchange rates between the U.S. dollar and other currencies could increase the sales price of the Company's products in international markets where the prices of the Company's products are denominated in U.S. dollars 37 38 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 or lead to currency exchange losses where the prices of the Company's products are denominated in local currencies. International sales and operations may also be limited or disrupted by the imposition of governmental controls, regulation of medical devices, export license requirements, political instability, trade restrictions, changes in tariffs and difficulties in staffing and managing international operations. Sales are recognized when products are shipped. Net sales consist of product sales less discounts and estimated returns. Estimated U.S. returns are provided for at time of shipment. Company policy allows for a 90-day return period on U.S. sales. The provisions for expected returns, expressed as a percentage of gross U.S. sales, were as follows: 1996--27%, 1995--28%, and 1994--23%. Most returns are resolved or settled within several months of the initial sale. In Europe and Asia, returns are not material. Cost of Sales Cost of sales consists of costs associated with products sold, which include estimated warranty costs. The Company provides at the time of sale for the estimated cost of remaking and repairing products under warranty. In the U.S., the warranty period is one year for the custom hearing device shell and one to three years for electronic components. Because of the length of the warranty period, adjustments to the originally recorded provisions, both increases and decreases, may be necessary from time to time. In 1996, 1995 and 1994, the approximate U.S. provisions for estimated warranty cost (and as a percentage of U.S. net sales) were $4.4 million (8%), $4.2 million (11%) and $3.0 million (10%), respectively. The period over which warranty claims may be made in Europe and Asia is one year. The amount of these claims has not been material. Advertising Expenses The Company accounts for advertising costs as expense in the period in which the costs are incurred. Advertising expense for 1996, 1995 and 1994 was approximately $2.8 million, $2.3 million and $1.5 million, respectively. Income Taxes The Company accounts for income taxes under the liability method. The Company's net operating loss carryforwards for U.S. purposes have not been given benefit in the financial statements. Per Share Data Net loss per share is computed using the loss attributable to common stock shareholders and the weighted average number of common shares outstanding. 38 39 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Cash Equivalents and Short-term Investments The Company considers all highly liquid investments with original maturities from the date of purchase of 90 days or less to be cash equivalents. Short-term investments are considered as available-for-sale and are carried at fair value with the unrealized gains and losses recorded as a separate component of shareholders' equity. Inventories Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories at December 31, 1996 and 1995 consist of the following (in thousands):
1996 1995 ---- Raw materials $ 9,934 $ 8,879 Work in progress 6,838 4,431 Finished goods 7,081 5,156 ------- ------- Total $23,853 $18,466 ======= =======
Property and Equipment Property and equipment are recorded at cost and are depreciated on a straight-line basis. Assets under capitalized leases are amortized over the shorter of the term of the lease or their useful lives, and such amortization is included with depreciation expense. Property and equipment at December 31, 1996 and 1995 is as follows (in thousands):
1996 1995 ---- ---- Machinery and equipment $21,160 $14,320 Furniture, fixtures and improvements 7,513 4,527 ------- -------- 28,673 18,847 Accumulated depreciation and amortization (15,179) (9,547) ------- --------- Total property and equipment, net $13,494 $ 9,300 ======= ========
Goodwill The unallocated excess purchase costs (goodwill) related to business acquisitions in 1994 (Sonar Design & Hortechnik GmbH and Viennatone AG) and the 1996 purchase of certain assets of the hearing health business activity of 3M, are being amortized over 20 years. 39 40 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Accrued Liabilities Accrued liabilities at December 31, 1996 and 1995 consist of the following (in thousands):
1996 1995 ---- ---- Accrued compensation $ 4,279 $ 2,397 Accrued warranty 5,100 3,759 Income taxes payable 1,415 1,691 Other 7,182 4,796 -------- ------- Total $17,976 $12,643 ======= =======
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. NOTE 2. ACQUISITIONS The Company acquired all the outstanding stock of two European-based companies in 1994 and certain assets of 3M's hearing health business activity in 1996. In each instance, the acquisitions were accounted for as purchase transactions. The acquired assets and liabilities were recorded at their estimated fair values at the date of acquisition, and the unallocated excess purchase price amounts (goodwill) are being amortized on a straight line basis over 20 year periods. The operating results of each subsidiary have been included in the consolidated statements of operations from the respective acquisition dates. Sonar On January 1, 1994, the Company's existing German subsidiary acquired all the shares of Sonar Design & Hortechnik GmbH ("Sonar"), a German company, for approximately $3.5 million in cash and 100,000 shares of the Company's common stock. Sonar is a manufacturer and distributor of both Sonar branded and ReSound branded hearing devices. In 1996, this Company was renamed ReSound Deutschland. Viennatone On December 9, 1994, a newly-formed Austrian subsidiary of the Company acquired 100% of the shares of Viennatone AG, an Austrian company, for approximately $27.7 million, and the 40 41 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Company's German subsidiary acquired the net assets of a related business for approximately $0.6 million, or a total of approximately $28.3 million (Viennatone AG owns an 80% interest in its Austrian distribution company, Viennatone BVG). To finance the acquisition, the Austrian subsidiary borrowed approximately $17.3 million from an Austrian bank. The balance of the purchase price was provided by available cash funds of the Company and $6.85 million in loans against the Company's short-term investment securities. Viennatone manufactures and markets hearing devices through subsidiaries in Germany, France and the United Kingdom. It uses both independent distributors and, in Austria, its own retail chain. In 1996, the Company purchased the remaining minority interest in Viennatone Hannover for $1.9 million in cash. The effects of these acquisitions on the 1994 consolidated statement of cash flows were as follows (in thousands):
Sonar Viennatone ----- ---------- Working capital acquired (excluding cash) $ 848 $ 9,318 Property and equipment, net 177 2,795 Goodwill 5,673 21,683 Long-term obligations (excluding financing for acquisition) (593) (7,641) ---------- --------- Less common stock issued for Sonar 6,105 26,155 Effect on cash flows - net cash used (1,987) --- ---------- -------- $ 4,118 $ 26,155 ========== ========
The following unaudited pro forma consolidated results for 1994 as if both acquisitions had been consummated on January 1, 1994 (in thousands, except per share amounts):
1994 ------- Net sales $91,295 Income before provisions for litigation and income taxes 9,487 Loss before income taxes (9,743) Net loss (12,626) Net loss per share $ (0.84) Average shares outstanding 15,089
The pro forma results, which were based upon certain assumptions and estimates which the Company believes are reasonable, do not purport to be indicative of the results that actually would have occurred had the acquisitions occurred on January 1, 1994. 41 42 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Sonar Hearing Health In June 1996, the Company completed the purchase of certain assets of the hearing health business activity of 3M and established a subsidiary, Sonar Hearing Health Corporation, to manage this activity on an ongoing basis. The total purchase price of $25.4 million consisted of a cash payment of $24.9 million and $500,000 for related acquisition expenses. To finance this purchase and provide working capital, the Company raised approximately $32.9 million (net proceeds) through the private sale of 3,212,176 shares of common stock. Hearing health constituted a small business activity in 3M's worldwide operations which was neither a division nor subject to the maintenance of discrete accounting records such that financial statements could be or are determinable. However, the Company believes that this business activity generated revenues for 3M of approximately $9.3 million (unaudited) and $16.6 million (unaudited) for the six months ended June 30, 1996, and for the year ended December 31, 1995, respectively. The Company believes that profits, if any, generated from the hearing health activity of 3M for the above-mentioned periods were minimal, and it may not have been profitable as a historical activity. In addition to patents acquired from 3M valued at $7.5 million, patents valued at $2.5 million were acquired in July 1996 in connection with the above acquisition. These patents were contributed to a partnership formed in 1996 comprised of six hearing device manufacturers, including ReSound, at December 31, 1996. In consideration, ReSound received cash payments from the initial partnership members of $7.3 million (net) as of December 31, 1996 and has rights to an additional $3.6 million as future partnership interests or licenses are sold. If and when such funds are received, the related intangible assets will be reduced accordingly. Thereafter, any amounts paid to the partnership will be divided equally among the partners and recognized as license income. The annual amortization resulting from the recognition of the intangible assets acquired from 3M on the Company's balance sheet (net of patents contributed to a partnership, as described above) will be approximately $188,500 and $655,000 for the patents and goodwill, respectively, and are being amortized over useful lives from 10 to 20 years. The effects of the purchase of certain assets of the hearing health business activity of 3M on the 1996 consolidated statement of cash flows were as follows (in thousands):
Net tangible assets acquired, $ 4,132 principally receivables and inventories Patents 7,500 Goodwill 13,811 -------- Total purchase price $ 25,443 ========
42 43 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NOTE 3. LITIGATION On April 28, 1995 the Company settled its then pending patent infringement lawsuit with Dr. Paul Yanick. In exchange for a one-time lump-sum royalty payment, the lawsuit was dismissed and the Company received a fully-paid license to use all of Dr. Yanick's trade secrets and patent technology, including the four patents involved in the lawsuit. On October 19, 1995 the Company announced that it had reached agreement to settle both the patent lawsuit with A&L Technology ("A&L") and the shareholder class action lawsuit previously filed on behalf of certain shareholders. The patent infringement lawsuit brought against the Company by A&L was dismissed and the Company received a fully-paid license to use A&L's United States Letters Patent No. 4,396,806 in its hearing device products both in the United States and overseas. In addition, A&L relinquished its claims to receive approximately $13.5 million in damages, attorneys' fees, royalties and interest previously awarded by the court in the action. In exchange, on October 19, 1995, the Company made a cash payment to A&L of $7.0 million and released all claims to a $2.8 million royalty paid to A&L in 1995. The shareholder class action suit, filed against the Company, its directors and certain of its officers, and against the underwriters of its initial public offering on behalf of purchasers of ReSound's common stock between March 4, 1993 and March 13, 1995, was settled on October 19, 1995 and resulted in a settlement fund of $8.0 million from which plaintiff's attorneys' fees and expenses will be deducted. Fifty percent of the fund was paid by the Company on October 30, 1995, and the balance was paid by the Company's insurance carriers. The Court approved the settlement on June 12, 1996. At the settlement hearing relating to the final distribution of the shareholder settlement fund, an objection was raised to the provisions of the settlement agreement relating to attorney's fees and certain other matters. The judge rejected the objector's claim and approved the proposed terms of the distribution. Notice of appeal was filed by the objector on July 10, 1996, and the appeal is currently pending before the Ninth Circuit Court of Appeals. The Company was the defendant in a lawsuit filed in September 1993 in the United States District Court, District of Minnesota, by 3M alleging that the Company's hearing devices and programming systems infringed the claims of three patents owned by the plaintiff. This lawsuit was dismissed in June 1996 upon the Company's purchase of certain assets, including the related patents, of the hearing health business activity of 3M. From time to time, the Company has been contacted by various other parties who have alleged that certain of the Company's products infringe or may infringe patents that such parties claim to hold. Management believes the Company has not infringed any such patents and does not believe such claims, if pursued, will result in a material adverse effect on the financial position or results of operations of the Company. 43 44 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 In 1994 the Company provided a total of $19.2 million as the estimated cost of resolving the above-described patent infringement suits and the shareholder class action suit brought against it. In 1995 the provision remaining amounted to $492,000. The Company had no provision for litigation and related cost at December 31, 1996. NOTE 4. BANK LOANS (CURRENT) AND SHORT-TERM NOTES PAYABLE Following are the individual loans and notes comprising bank loans (current) and short-term notes payable at December 31, 1996 and 1995 (in thousands):
1996 1995 ---- ---- Convertible promissory note $ --- $2,000 Bank term loan --- 1,667 Bank guaranteed loan --- 1,714 International bank loans 2,504 2,753 ------ ------ Total $2,504 $8,134 ------ ------
The Company's convertible promissory note was issued in November 1995, was due July 1, 1996 and bore interest at prime plus two percent. In connection with this note, the Company issued two warrants to purchase 38,897 shares each, of common stock, at an initial exercise price of $7.7125 per share, exercisable immediately and expiring October 30, 2000. As of December 31, 1996, these warrants had not been exercised. In June 1996, the principal and accrued interest on this note was converted into 265,506 shares of common stock (at $7.7125 per share). In October 1995, the Company borrowed $2 million under a bank term loan at an interest rate of prime plus 2%. This term loan was repayable in 12 monthly installments beginning November 1995. This loan was fully repaid in September 1996. In October 1995, the Company borrowed $1.7 million under a guaranteed loan from a bank at an interest rate of prime plus one percent. This loan was fully repaid in July 1996. This loan was guaranteed by certain directors of the Company. In connection with this loan, the Company issued a warrant to purchase 49,230 shares of common stock to the bank at an initial exercise price of $8.13 per share, exercisable immediately, expiring October 29, 2000. In addition, in connection with agreements to execute and deliver personal guarantees to the bank with respect to this loan, the Company issued warrants to purchase an aggregate of 105,492 shares of common stock to the six directors who executed such guarantees at an initial exercise price of $8.13 per share, exercisable immediately, expiring December 1, 2000. The international bank loans at December 31, 1996 and 1995 include loans and credit lines, primarily to Viennatone, from Austrian banks. 44 45 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NOTE 5. LONG-TERM DEBT Long-term debt consists of the following at December 31, 1996 and 1995 (in thousands):
1996 1995 ---- ---- 8% convertible promissory note to shareholder due in February 2000. $10,000 $10,000 Bank Austria loans to ReSound Horgerate GmbH: 8.25% term loan, due in quarterly installments over 7 years beginning June 30, 1995 11,728 15,602 8% revolving credit line of $1,836 through June 30, 1995 and $987 thereafter until November 30, 1999 --- 348 ------- ------- 21,728 25,950 Less current portion 2,213 2,962 -------- ------- Non-current portion $19,515 $22,988 ======= =======
The 8% note is convertible into 1,000,000 shares of common stock at $10 per share, beginning in February 1996. The Bank Austria loans are denominated in Austrian schillings and secured by the capital stock of Viennatone. The maturities of long-term debt are as follows (in thousands): 1997 - $2,213; 1998 - $2,198; 1999 - $2,198; 2000 - $12,198; 2001 - $2,198; thereafter - - $723. NOTE 6. VIENNATONE ACCRUED EMPLOYEE BENEFITS Viennatone's accrued employee benefits by category are as follows (in thousands):
1996 1995 ---- ---- Pensions $1,011 $1,072 Termination indemnities 2,875 2,935 Employees' long service premium 596 2,209 ------ ------- Total $4,482 $6,216 ====== ======
Pensions Viennatone has an unfunded defined benefit pension plan under which a number of senior management employees in Austria have pension entitlements. Viennatone's liability under this pension plan is funded partially by contributions to an insurance company and partially by fixed interest marketable securities held by Viennatone in accordance with Austrian tax requirements. 45 46 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 The status of the defined benefit plan as of year end is as follows (in thousands):
1996 1995 ---- ---- Accumulated benefit obligation (ABO) $ 957 $1,042 Projected benefit obligation (PBO) 1,011 1,092 Service cost 91 90 Net periodic pension cost --- (96) Interest 68 74
The interest rate used was 7%. The expected projected benefit obligation ("PBO") for 1997 has been estimated as $1.1 million. Differences between expected and projected benefit obligations are not material. The pension accrual has been recorded with the amount of projected benefit obligation. The weighted average discount rate used to evaluate the increase in rate of compensation was 4%. Termination Indemnities Viennatone provides for termination benefits as earned in accordance with Austrian law. Indemnities range from two to twelve months salary based on length of service. Employees are entitled to indemnities after three years of employment or according to contract. Payments are made upon normal retirement or other cause of termination, except voluntary departures or terminations for cause. The amount accrued at the year end represents the projected benefit obligation. This calculation has been made under the assumption that the majority of expected payments will be upon normal retirement. The liability is also partially funded by fixed interest marketable securities held by Viennatone in accordance with Austrian tax requirements. The status of the accrual for termination indemnities as of year end is as follows (in thousands):
1996 1995 ---- ---- Accumulated benefit obligation (ABO) $1,942 $1,877 Projected benefit obligation (PBO) 2,875 2,935 Service cost 217 202 Net periodic pension cost --- 285 Interest 202 196
The interest rate used was 7%. The expected projected benefit obligation for 1997 has been estimated as $3.2 million. Differences between expected and projected benefit obligations are not material. 46 47 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Employees' Long Service Premium According to the Viennatone work agreement, employees are entitled to a premium after ten years of service. Such a premium is also paid out after 15, 25, 35 and 45 years of service. A calculation of the total liability as of the balance sheet date is made on a discounted cash-flow basis, using an interest rate of 5.5%. The liability was $596,000 at December 31, 1996 and $2.2 million at December 31, 1995. This year to year decrease is due to a 1996 renegotiation of the agreement between Viennatone and its union workers. NOTE 7. COMMITMENTS Leases The Company leases 47,600 square feet of office, research and development and manufacturing space in Redwood City, California under a non-cancelable operating lease and sublease through June 2000. Additionally, the Company leases 6,600 square feet in Redwood City under a lease which expires in December 2000. Sonar Hearing Health, in Eagan, Minnesota, leases 14,000 square feet under a non-cancelable operating lease which expires in December 1999. Rent expense was $1.0 million, $520,000 and $522,000 in 1996, 1995 and 1994, respectively. The following is a schedule by year of future minimum lease payments at December 31, 1996 (in thousands):
YEAR ENDING OPERATING DECEMBER 31, LEASES ----------- --------- 1997 $1,323 1998 1,296 1999 1,236 2000 642 2001 214 Thereafter 214 ------ Total minimum payments required $4,925 ======
401(k) Plan Under the Company's retirement savings plan (the "401(k) Plan"), an employee may defer and invest up to 19% of his or her annual compensation, subject to an annual dollar limitation. The Company has elected to make matching contributions in the amount of 25% of the employee's contributions, up to a potential maximum of $2,250 per employee. The Company contributed $138,000, $83,000 and $72,000 to the 401(k) Plan in 1996, 1995 and 1994, respectively. 47 48 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NOTE 8. SHAREHOLDERS' EQUITY Preferred Stock In March 1996, the Company issued 54,055 shares of Series B Preferred Stock for an aggregate purchase price of $5.0 million in a private placement to an existing shareholder. These shares are convertible at the option of the holder into 540,550 shares of common stock at an effective conversion price of $9.25 per share. Automatic conversion will occur on the earliest of a) the approval of holders of a majority of the outstanding shares of all series of the Company's Preferred Stock, b) immediately prior to the closing of a sale of the Company, or c) March 31, 1999. The Series B Preferred Stock has a cumulative dividend rate of six percent, payable in shares of the Company's common stock on the date of any conversion. At December 31, 1996 approximately $225,000 has been recorded to reflect such dividends. Common Stock In June 1996, the Company raised approximately $32.9 million (net proceeds) through the private sale of 3,212,176 shares of common stock. The proceeds from this sale were used in connection with the purchase of certain assets of the hearing health business activity of 3M and to provide working capital. These proceeds reflect most of the proceeds shown as issuance of common stock on the Company's consolidated statements of cash flows for the year ended December 31, 1996. Fixed Stock Option Plans At December 31, 1996, the Company had two stock-based compensation plans (described below). ReSound uses the intrinsic method in accordance with APB 25 to account for its plans. Accordingly, no compensation cost has been recognized for its stock purchase plan. Compensation cost applicable to ReSound's fixed stock plans was immaterial for each of the three years presented. Pro forma information regarding net income (loss) and net income (loss) per share is required by Statement of Financial Accounting Standard No. 123 ("FAS 123"), which requires that the information be determined as if ReSound had used the fair value method to account for its stock- based compensation awards granted subsequent to December 31, 1994. Had compensation cost for the Company stock-based compensation awards (including 1988 Stock Option Plan and 1992 Employee Stock Purchase Plan) been determined at the grant date (subsequent to December 31, 1994) using the fair value method in accordance with FAS 123, the Company's net loss applicable to common shareholders and net loss per share would have been increased to the pro forma amounts indicated below: The fair value of each option grant is estimated on the date of grant using the Black-Scholes multiple option-pricing model. The following weighted average assumptions were used for grants in 1996 and 1995: risk-free interest rates of 6.3 percent, an expected option life of 0.81 years beyond each respective vesting period, expected volatility of 0.57 and dividend yield of zero. 48 49 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 The Black-Scholes model used by the Company to calculate option values for purposes of this note, as well as other currently accepted option valuation models (as called for in accordance with FAS 123), were developed to estimate the fair value of stock options that are freely tradable and fully transferable and that have no vesting restrictions. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated values. Accordingly, management believes that this model does not necessarily provide a reliable measure of the fair value of the Company's option awards.
1996 1995 ---- ---- (in thousands, except per share data) Net loss applicable to common shareholders: As reported $(1,192) $(5,902) Pro forma (1) $(2,709) $(7,056) Net loss per share: As reported $ (0.07) $ (0.38) Pro forma (1)...................................... $ (0.15) $ (0.46)
- -------- (1) Because FAS 123 is applicable only to awards granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1998. 1992 Directors' Stock Option Plan Under the 1992 Directors' Stock Option Plan, the Company has reserved 300,000 shares of common stock for issuance to non-employee directors. Such options may only be non-qualified stock options issued at not less than fair market value, and all options granted must be exercised within five years from the date of grant. Each eligible director is to be granted annually on December 31 an option to purchase 5,000 shares, exercisable after four years. Each new director is to receive an initial option grant to purchase 20,000 shares, which becomes exercisable in 25 percent increments annually beginning after one year. 1988 Stock Option Plan Under the 1988 Stock Option Plan, which expires in 1998, a total of 4,650,000 shares have been reserved for issuance as of December 31, 1996. Options for shares of common stock may be granted to employees and consultants at not less than fair market. Options are exercisable at such times and under such conditions as determined by the board of directors. Options granted generally vest at the rate of 1/48th of the number of shares subject to such option at the end of each month for a period of 48 months from date of grant. However, certain options granted to replenish existing options do not begin vesting for up to 36 months from the date of grant (when vesting commences, it is generally prorated on a monthly basis over periods up to 48 months). 49 50 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Additional information relative to the Company's fixed stock option plans is as follows:
1996 1995 1994 --------------------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Options Average Options Average Options Average ------- Exercise Price ------- Exercise Price ------- Exercise Price -------------- -------------- -------------- Outstanding - beginning of year.................... 3,409,534 $8.49 2,555,172 $7.82 1,724,987 $ 6.14 Granted.................... 856,150 $9.38 1,537,150 $8.11 1,625,074 $11.28 Exercised.................. (225,359) $4.68 (357,333) $1.70 (228,533) $ 0.99 Canceled................... (415,290) $9.07 (325,455) $8.82 (566,356) $15.40 Outstanding - end of year 3,625,035 $8.88 3,409,534 $8.49 2,555,172 $ 7.82 Exercisable at end of year 1,534,494 1,032,902 673,593 Weighted-average fair value of options granted during the year................. $4.13 $3.67
Outstanding and Exercisable By Price Range as of December 31, 1996
Options Outstanding Options Exercisable ------------------------------------------------------------------------------------------------------- Number Weighted-Average Weighted- Number Weighted- Range of Outstanding As of Remaining Average Exercisable As of Average Exercise Prices December 31, 1996 Contractual Life Exercise Price December 31, 1996 Exercise Price --------------- ----------------- ---------------- -------------- ----------------- -------------- $ 0.2000 -- $ 0.4000 15,466 2.45 $ 0.2843 15,466 $ 0.2843 $ 0.5000 -- $ 1.5000 115,319 4.46 $ 0.5048 115,319 $ 0.5048 $ 2.5000 -- $ 4.0000 135,176 4.45 $ 3.1212 135,176 $ 3.1212 $ 6.8750 -- $10.5000 2,715,331 8.11 $ 8.6072 1,060,245 $ 8.8845 $11.0000 -- $12.6500 573,263 7.94 $12.0688 200,933 $11.8474 $19.5000 -- $20.2500 70,500 4.46 $19.8216 16,375 $19.5477 - -------------------- ---- -------- --------- -------- $ 0.2000 -- $20.2500 3,625,035 7.73 $ 8.8750 1,543,494 $ 8.1664
1992 Employee Stock Purchase Plan Under the 1992 Employee Stock Purchase Plan, substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of its fair market value as of certain specified dates. Stock purchases under this plan are limited to 10% of an employee's compensation, and in no event may exceed $8,500 per year. Under this plan a total of 200,000 shares of common stock have been reserved for issuance to employees. As of December 31, 1996, 159,865 shares had been issued under this plan, including 71,000 shares issued in 1996. 50 51 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NOTE 9. INCOME TAXES The provisions for income taxes for 1996, 1995 and 1994 consist of the following (in thousands):
1996 1995 1994 ---- ---- ---- Current: Federal $ -- $ -- $ 87 State -- -- 23 Foreign 1,769 735 1,155 ------- ----- ------ Subtotal 1,769 735 1,265 Deferred: Foreign (372) (144) 370 ------- ----- ------ Total provision: $ 1,397 $ 591 $1,635 ======= ===== ======
Foreign pre-tax income was $5,004,000, $1,215,000 and $2,469,000 in 1996, 1995 and 1994, respectively. The difference between the provision for taxes on income and the amount computed by applying the federal statutory income tax rate to income before provision for taxes is explained below (in thousands):
1996 1995 1994 ---- ---- ---- Tax at federal statutory rate $ 150 $(1,859) $(4,429) Unbenefited losses 3,307 3,325 5,482 Income taxed at higher/(lower) rates (1,840) (888) 465 Other (220) 13 117 ------- ------- ------- Provision for taxes on income $ 1,397 $ 591 $ 1,635 ======= ======= =======
At December 31, 1996, the Company had U.S. federal and state net operating loss carryforwards of approximately $31,000,000 and $8,600,000, respectively. The federal net operating loss carryforwards will expire at various dates beginning in 2002 through 2011, if not utilized. The California net operating loss carryforwards will expire at various dates beginning in 1997 through 2001, if not utilized. The Company had foreign net operating loss carryforwards of approximately $7.0 million at December 31, 1996, which will expire at various dates beginning in 1997 through 2002, if not utilized. Utilization of net operating losses may be subject to an annual limitation due to ownership change limitations provided in the Internal Revenue Code of 1986 and similar state provisions. As part of the acquisitions of Sonar and Viennatone, amortization of a portion of goodwill generated by the acquisitions will be deductible for German and Austrian tax purposes. 51 52 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Based upon the Company's earnings history, a valuation allowance for deferred tax assets of $19,637,000 and $16,346,000 at December 31, 1996 and 1995, respectively, is required to reduce the Company's net deferred tax assets to the amount realizable at present. Significant components of the Company's deferred tax assets and liabilities for federal and California income taxes as of December 31, 1996 and 1995 are as follows (in thousands):
1996 1995 ---- ---- Deferred tax assets: Net operating loss carryforwards $ 11,100 $ 11,300 Tax credits (expiring 2000 - 2011) 1,800 1,100 Allowance for returns and doubtful accounts 1,200 1,100 Litigation reserve 200 200 Depreciation and amortization 2,900 300 Warranty accruals 1,400 1,500 Inventory accrual 500 550 Other 900 935 -------- -------- Total gross deferred tax assets 20,000 16,985 Less valuation allowance (19,637) (16,346) -------- -------- Total deferred tax asset 363 639 Deferred tax liabilities: Other (363) (1,011) -------- -------- Total deferred tax liability (363) (1,011) -------- -------- Net deferred tax liability $ -- $ (372) ======== ========
The valuation allowance was $14,602,000 as of January 1, 1995. NOTE 10. RELATED PARTY TRANSACTIONS Hoya Corporation Hoya Corporation ("Hoya"), a shareholder of the Company during 1996, purchases from the Company certain inventory for resale in Japan under an exclusive distribution agreement entered into in June 1990. Sales to Hoya in 1996, 1995 and 1994 totaled $3.4 million, $1.9 million, and $1.6 million, respectively. Accounts receivable from Hoya at December 31, 1996 and 1995 were $569,000 and $375,000, respectively. California Ear Institute at Stanford Dr. Rodney Perkins, the Chairman of the Company's Board of Directors and a shareholder of the Company, is also the President of the California Ear Institute ("CEI") at Stanford. Sales of the 52 53 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Company's products to CEI in 1996, 1995 and 1994 totaled $192,000, $68,000, and $79,000, respectively. Accounts receivable from CEI were $16,000 and $69,000 at December 31, 1996 and 1995, respectively. NOTE 11. INDUSTRY SEGMENT, GEOGRAPHIC AND CUSTOMER INFORMATION The Company operates in a single industry segment consisting of the design, development, manufacturing and marketing of hearing devices for the hearing impaired. Its hearing device products utilize proprietary sound processing technology originally developed by AT&T and subsequently enhanced and refined by the Company; and technologies acquired through the purchases of Sonar, Viennatone and certain assets of the hearing health business activity of 3M. No one customer accounted for 10% or more of net revenues in fiscal 1996, 1995 or 1994. Sales in the United States to unaffiliated customers included export sales of $1,872,000, $1,573,000 and $4,392,000 in 1996, 1995 and 1994, respectively. Information regarding geographic areas is as follows (in thousands):
December 31, 1996 ----------------- United States Europe Elimination Total ------ ------ ----------- ----- Sales to unaffiliated customers $ 57,951 $ 67,695 $ -- $125,646 Intercompany transfers 2,329 48,375 (50,704) -- -------- -------- -------- -------- Net sales 60,280 116,070 (50,704) 125,646 Income (loss) from operations (2,018) 5,099 (473) 2,608 Identifiable assets 29,377 45,564 -- 74,941 Goodwill 13,750 26,061 -- 39,811
December 31, 1995 ----------------- United States Europe Elimination Total ------ ------ ----------- ----- Sales to unaffiliated customers $ 39,239 $68,091 $ -- $ 107,330 Intercompany transfers 9,482 28,982 (38,464) -- -------- ------ -------- --------- Net sales 48,721 97,073 (38,464) 107,330 Income from operations (5,979) 4,063 (1,167) (3,083) Identifiable assets 12,824 42,854 -- 55,678 Goodwill -- 27,692 -- 27,692
53 54 RESOUND CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
December 31, 1994 ----------------- United States Europe Elimination Total ------ ------ ----------- ----- Sales to unaffiliated customers $34,928 $27,325 $ -- $62,253 Intercompany transfers 10,328 2,544 (12,872) -- ------- ------- -------- ------- Net sales 45,256 29,869 (12,872) 62,253 Income from operations 3,387 2,967 (827) 5,527 Identifiable assets 24,269 43,745 -- 68,014 Goodwill -- 27,102 -- 27,102
54 55 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III Certain information required by Part III is omitted from this report because the Registrant will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A (the "Proxy Statement") for its annual meeting of shareholders to be held May 22, 1997 and the information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to directors of the Company and the Chairman of the Company's Board of Directors is incorporated by reference from the information under the caption "Election of Directors--Nominees" in the Registrant's Proxy Statement. The names of the Company's officers and certain information about them as of December 31, 1996, are set forth below:
Name Age Position ---- --- -------- Peter Riepenhausen............................. 60 President, Chief Executive Officer and Director Vincent Pluvinage, Ph.D........................ 38 Executive Vice President Stephan Becker-Vogt............................ 46 Senior Vice President and President, ReSound Europe Paul A. Busse.................................. 54 Senior Vice President, Finance and Administration, Chief Financial Officer and Assistant Secretary John H. Giroux................................. 52 Senior Vice President and President, ReSound U.S.A. Joseph E. Black................................ 53 Vice President, Human Resources
Mr. Riepenhausen has served as the President and Chief Executive Officer since May 1994 and as a director since July 1993. He also served as Chairman of ReSound's German subsidiary from its establishment in November 1992 until April 1994. From January 1990 until he became President and Chief Executive Officer of ReSound, Mr. Riepenhausen was an independent management consultant. From January 1993 until August 1994, Mr. Riepenhausen was President International of Chiron Vision Corporation, a manufacturer and distributor of ophthalmic devices, on a part-time basis. Mr. Riepenhausen is currently a director of Chiron Vision Corporation. From 1984 to December 1989, Mr. Riepenhausen served as Executive Vice President and Vice Chairman of the Board of Directors of The Cooper Companies Inc., a health care products company, and was responsible for its worldwide pharmaceutical business. Prior to 1984, Mr. Riepenhausen was President and Chief Executive Officer of Blendax Werke R. Schneider GmbH & Co., a European health care products company. Prior to that, he was Senior Vice President with overall management responsibility for the Eastern hemisphere for PepsiCo. Inc. Mr. Riepenhausen is also a director of Advanced Polymer Systems Inc., a manufacturer of controlled release delivery systems for dermatological products, Caradon Europe Limited, plc, a European manufacturer of heating and 55 56 sanitary products and Weru AG, a manufacturer of doors and windows. Mr. Riepenhausen attended the Akademie fur Welthandel in Wiesbaden, Germany and apprenticed as a Commercial Agent with diploma as "Industriekaufmann" at Siemens-Schuckert in Bad Neustadt, Cologne and Erlangen, Germany. Dr. Pluvinage joined the Company in March 1987 as Director of Bioengineering. In March 1989, Dr. Pluvinage was elected Vice President, Research and Development. From May 1991 to November 1992, Dr. Pluvinage served as Vice President, Research and International Operations. From November 1992 to June 1993, Dr. Pluvinage served as Vice President, International Operations and from June 1993 until January 1996, he served as President, International Operations. In January 1996, Dr. Pluvinage was elected Executive Vice President of the Company. Dr. Pluvinage is also a director and Chairman of the Board of RSND Asia Ltd., the Company's Asian joint venture, a member of the supervisory board of ReSound Viennatone AG and Chairman of the Board of ReSound GmbH Hortechnologie. Before joining the Company, from June 1985 to March 1987, Dr. Pluvinage worked at AT&T Bell Laboratories, where he was in charge of digital processing hardware and clinical research in connection with sound processing. He was a member of the internal venture at AT&T Bell Laboratories that originally developed the technology that is employed in ReSound's current products. Dr. Pluvinage holds a Ph.D. in bioengineering from the University of Michigan and an engineering degree (summa cum laude) in applied physics engineering from Universite Catholique de Louvain in Belgium. Mr. Becker-Vogt joined the Company in August 1992, establishing the Company's German subsidiary and becoming its Managing Director in November 1992. In January 1995 he was promoted to Vice President Europe. In January 1996, he was elected Senior Vice President of the Company and President of ReSound Europe. Mr. Becker-Vogt is also a Director of ReSound bv, the Netherlands. Before joining the Company, Mr. Becker-Vogt was Managing Director of both Pilkington Barnes-Hind, Germany and of Contacta Vienna, the leading Optometric Clinic in Austria, from 1989 to 1992. From 1983 to 1989 he was Managing Director, and from 1980 to 1983 he was Director, Sales and Marketing, of CooperVision, Germany. From 1973 to 1979, Mr. Becker-Vogt was Sales Manager of Burton Parsons Chemicals, Germany, a Chicago-based ophthalmic pharmaceutical company. Mr. Becker-Vogt was educated in banking and received his diploma as "Bankkaufmann," granted by the Chamber of Commerce, Dusseldorf. Mr. Busse has been Senior Vice President, Finance and Administration, Chief Financial Officer and Assistant Secretary of the Company since June 1993. From October 1992 until June 1993, he served as Vice President, Finance and Administration and Chief Financial Officer. Before joining ReSound, Mr. Busse was President, Chief Operating Officer and Chief Financial Officer of Graphtec Precision Image Corp., a manufacturer and seller of electronic plotters, from 1988 to 1992. From 1984 to 1988, Mr. Busse headed his own consulting business. From 1983 to 1984, Mr. Busse was Senior Vice President and Chief Financial Officer for System Industries, a manufacturer of disk and tape systems. Mr. Busse was Vice President and CFO of Azurdata Inc., a manufacturer of data entry terminals from 1980 to 1983. From 1974 to 1980, Mr. Busse was Vice President and Treasurer of Pertec Computer Corp., a computer systems and peripheral company. Prior to 1974, Mr. Busse held various financial and accounting management positions at Ford Aerospace Corp., a division of Ford Motor Co. Mr. Busse holds an M.B.A. degree from Northwestern University and a B.A. from Valparaiso University and is licensed as a CPA in the state of Washington. Mr. Busse announced his resignation from the Company in January 1997, effective upon a successor being named. 56 57 Mr. Giroux joined the Company in January 1991 as Vice President, Marketing. He was elected Vice President, Sales and Marketing in December 1991 and in June 1993 was promoted to Senior Vice President, Sales and Marketing. In January 1996, he was elected Senior Vice President of the Company and President of ReSound U.S.A. Mr. Giroux has 26 years of experience in the marketing of consumer health care products. Before joining the Company, Mr. Giroux was Vice President of Marketing for Allergan Optical at Allergan, Inc., a manufacturer of pharmaceutical ophthalmologics, from February 1988 to June 1990. Prior to joining Allergan, Inc., Mr. Giroux was Vice President at Ogilvy & Mather Worldwide, an advertising firm, from July 1984 to February 1988. Prior to July 1984, Mr. Giroux was Vice President, Sales and Marketing of the Consumer Products Division of G.D. Searle and Company, a pharmaceutical company. Mr. Giroux holds a B.A. in economics from Providence College. Mr. Black joined the Company in August 1995 as Vice President, Human Resources. Mr. Black has 26 years of experience in human resource management and consulting positions. From 1987 until joining the Company, Mr. Black headed his own consulting business since 1987. Prior to that time, Mr. Black was Corporate Director of Organizational Development at CooperVision Inc. from 1985 to 1987. From 1982 to 1985, Mr. Black was Human Resources Director for Eaton Corp. - Semiconductor Equipment Operations. From 1972 to 1982, Mr. Black held various human resource management positions at GenCorp - Aerojet General. From 1969 to 1972, Mr. Black held various human resource staff and management positions at Singer Co. - Link Simulation. Mr. Black holds an M.S.O.D. degree from Pepperdine University and a B.A. from Parsons College. ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference from the information under the captions "Compensation of Executive Officers" and "Transactions with Management and Others" in the Registrant's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference from the information under the caption "Common Stock Ownership of Certain Beneficial Owners and Management" in the Registrant's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference from the information under the captions "Compensation of Executive Officers" and "Transactions with Management and Others" in the Registrant's Proxy Statement. 57 58 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Report:
PAGE ---- (1) Financial Statements and Report of Ernst & Young, LLP, Independent Auditors Report of Ernst & Young LLP, Independent Auditors. 32 Consolidated Balance Sheets at December 31, 1996 and 1995. 33 Consolidated Statements of Operations - Years ended December 31, 1996, 1995 and 1994. 34 Consolidated Statement of Shareholders' Equity - Three Years ended December 31, 1996, 1995 and 1994. 35 Consolidated Statements of Cash Flows - Years ended December 31, 1996, 1995 and 1994. 36 Notes to Consolidated Financial Statements. 37 (2) Financial Statement Schedules The following financial statement schedule is included herein: Schedule II - Valuation and Qualifying Accounts 62 All other schedules are omitted because they are not required or the required information is included in the financial statements or notes thereto. (3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
Exhibit Number Description - ------- ----------- 3.1 Amended and Restated Articles of Incorporation of Registrant. (3) 3.2 Bylaws of Registrant, as amended. (1) 4.1 Certificate of Determination of Rights, Preferences and Privileges of Series B Preferred Stock of ReSound Corporation. (6) 10.1 1988 Stock Option Plan, as amended. (5)
58 59 10.2 1992 Directors' Stock Option Plan, as amended. (5) 10.3 Form of Directors' and Officers' Indemnification Agreement. (1) 10.4 Amendment Number Eight to and Restatement of Registration Rights Agreement of ReSound Corporation dated as of August 21, 1992, as amended October 19, 1992. (1) 10.5 Contract Consulting Agreement dated July 25, 1996 with Dr. Rodney Perkins. (9) 10.6 Contract Consulting Agreement dated July 25, 1996 with Dr. Richard L. Goode. (9) 10.7 Lease Agreement between the Registrant and Seaport Centre Phase II dated June 15, 1988, as amended on August 31, 1988, March 21, 1991, November 27, 1991 and December 28, 1992. (1) 10.8 Fifth Amendment dated December 5, 1995 to Lease Agreement with Seaport Centre Phase II (Exhibit 10.7). (6) 10.9 Sublease between the Registrant and Devices for Vascular Intervention, Inc. dated as of December 29, 1995. (6) 10.10 Technical Information and Patent License Agreement with American Telephone and Telegraph Company dated as of February 27, 1987, as amended effective January 1, 1988. (1) 10.11 Custom IC Agreement with American Telephone and Telegraph Company dated 1987, as supplemented on April 6, 1990, April 24, 1990, July 15, 1992 and December 11, 1992, for the manufacture of custom integrated circuits. (1)(2) 10.13 Loan and Security Agreement with Silicon Valley Bank dated as of December 23, 1994. (5) 10.16 Loan Agreement between the Registrant, ReSound GmbH and Bank Austria Aktiengesellschaft dated December 7, 1994. (4) 10.17 Note Purchase Agreement between the Registrant and Cagen Holdings Limited dated as of February 21, 1995 and related Convertible Promissory Note. (5) 10.18 Note Purchase Agreement between the Registrant and The Mingly Corporation Limited dated as of February 21, 1995 and related Convertible Promissory Note. (5) 10.19 Note Purchase Agreement between the Registrant and Charter Ventures II, L.P. dated as of February 21, 1995 and related Convertible Promissory Note. (5) 10.20 Loan and Security Agreement with Silicon Valley Bank dated October 27, 1995, and related Registration Rights Agreement, Patent Mortgage and Collateral Assignment Agreement and Warrant. (6) 10.21 Note and Warrant Purchase Agreement between the Registrant and Cagen Holdings Limited dated as of November 21, 1995 and related Convertible Promissory Note and Warrant. (6)
59 60 10.22 Note and Warrant Purchase Agreement between the Registrant and Charter Ventures II, L.P. dated as of November 21, 1995 and related Convertible Promissory Note and Warrant. (6) 10.23 Form of Common Stock warrant dated December 1, 1995 issued to certain directors of the Registrant. (6) 10.24 Purchase Agreement by and between the Registrant and Minnesota Mining and Manufacturing Company dated June 28, 1996. (8) 10.25 Letter agreement with respect to Purchase of Series B Preferred Stock dated March 8, 1996 between the Company and S-E-Banken Lakemedelsfond. (7) 10.26 AudioLogic Hearing Systems, L.P. Amended and Restated Agreement of Limited Partnership dated as of September 30, 1996. (7) (10) 10.27 Series C Convertible Preferred Stock and Common Stock Purchase Agreement dated September 30, 1996. (7) 10.28 Development, Licensing and Distribution Agreement by and among AudioLogic, Inc., GN Danavox A/S, ReSound Corporation and AudioLogic Hearing Systems, L.P. dated September 30, 1996. (7) (10) 10.29 The Assignment Agreement between ReSound Corporation and K/S HIMPP.25. (7) 10.30 Lease Agreement dated September 24, 1996 between the Registrant and Don and Carole Tanklage dba Tanklage Properties. (9) 11.1 Statement of Computation of Net Loss Per Share. (9) 22.1 Subsidiaries of Registrant. (9) 23.1 Consent of Ernst & Young LLP, Independent Auditors (see page 63). (9) 24.1 Power of Attorney (see pages 64 and 65). (9) 27.1 Financial Data Schedule. (9) (b) Reports on Form 8-K: None
- -------------------- (1) Incorporated by reference to exhibits filed in response to Item 16(a), "Exhibits," of the Registrant's Registration Statement on Form S-1 and Amendment No. 1, Amendment No. 2 and Amendment No. 3 thereto (File No. 33-46527), which became effective on March 4, 1993. (2) Confidential treatment granted by order effective February 24, 1993. 60 61 (3) Incorporated by reference to exhibits filed in response to Item 14, "Exhibits, Financial Statement Schedules and Reports on Form 8-K," of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (4) Incorporated by reference to exhibits filed in response to Item 7, "Financial Statements, Pro Forma Financial Information and Exhibits," of the Registrant's Report on Form 8-K dated December 9, 1994. (5) Incorporated by reference to exhibits filed in response to Item 14, "Exhibits, Financial Statement Schedules and Reports on Form 8-K," of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (6) Incorporated by reference to exhibits filed in response to Item 14, "Exhibits, Financial Statement Schedules and Reports on Form 8-K," of the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (7) Incorporated by reference to exhibits filed in response to Item 14, "Exhibits, Financial Statement Schedules and Reports on Form 8-K," of the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 1996. (8) Incorporated by Reference to exhibits filed Report on Form 8-K with the Securities and Exchange Commission on July 15, 1996 (as amended and filed September 12, 1996). (9) Filed herewith. (10) Confidential treatment granted by order effective March 1997.
61 62 SCHEDULE II RESOUND CORPORATION VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED AGAINST BALANCE AT BEGINNING SALES OR TO RETURNS/ END OF DESCRIPTION PERIOD EXPENSE WRITE OFFS PERIOD ----------- ---------- --------------- ---------- ---------- Year ended December 31, 1994: Allowances for estimated returns and doubtful accounts $ 1,708 $ 10,786 $ 9,811 $ 2,683 Reserves for warranty expenses 1,796 3,594 2,028 3,362 ------- -------- -------- -------- $ 3,504 $ 14,380 $ 11,839 $ 6,045 ======= ======== ======== ======== Year ended December 31, 1995: Allowances for estimated returns and doubtful accounts $ 2,683 $ 12,820 $ 11,380 $ 4,123 Reserves for warranty expenses 3,362 5,174 3,951 4,585 ------- --------- --------- -------- $ 6,045 $ 17,994 $ 15,331 $ 8,708 ======= ========= ========= ======== Year ended December 31, 1996: Allowances for estimated returns and doubtful accounts $ 4,123 $ 16,041 $ 15,390 $ 4,774 Reserves for warranty expenses 4,585 5,981 5,466 5,100 ------- --------- --------- -------- $ 8,708 $ 22,022 $ 20,856 $ 9,874 ======= ========= ========= ========
62 63 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to incorporation by reference in the Registration Statement (Form S-8 Nos 333- 09303 and 33-61302) pertaining to the 1988 Stock Option Plan, the 1992 Employee Stock Purchase Plan and the 1992 Directors Stock Option Plan of ReSound Corporation and in the Registration Statement (Form S-3/A No. 333-10189) of ReSound Corporation and related Prospectus of our report dated January 28, 1997, with respect to the consolidated financial statements and schedule of ReSound Corporation, included in this Annual Report (form 10-K), for the year ended December 31, 1996. /s/ Ernst & Young LLP ------------------------- Ernst & Young Palo Alto, California March 27, 1997 63 64 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. RESOUND CORPORATION Date: March 27, 1997 By: /s/ Peter Riepenhausen ---------------------- Peter Riepenhausen President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Rodney Perkins, Peter Riepenhausen and Paul A. Busse, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----- /s/ Rodney Perkins, M.D. Chairman of the Board of Directors March 27, 1997 ---------------------------------------- (Rodney Perkins, M.D.) /s/ Peter Riepenhausen President, Chief Executive Officer March 27, 1997 ---------------------------------------- and Director (Peter Riepenhausen) /s/ Paul A. Busse Senior Vice President of Finance March 27, 1997 ---------------------------------------- and Administration and Chief (Paul A. Busse) Financial Officer (Principal Financial and Accounting Officer) and Assistant Secretary /s/ Robert K. Anderson Director March 27, 1997 ---------------------------------------- (Robert K. Anderson) /s/ Richard L. Goode, M.D. Director March 27, 1997 ---------------------------------------- (Richard L. Goode, M.D.) /s/ Donald M. Kendall Director March 27 1997 ---------------------------------------- (Donald M. Kendall)
64 65 /s/ Eugene Kleiner Director March 27, 1997 ---------------------------------------- (Eugene Kleiner) /s/ Philip S. Schlein Director March 27, 1997 ---------------------------------------- (Philip S. Schlein) /s/ Robert C. Wilson Director March 27, 1997 ---------------------------------------- (Robert C. Wilson)
65 EX-10.5 2 CONTRACT CONSULTING AGREEMENT 1 Exhibit 10.5 RESOUND CORPORATION CONTRACT CONSULTING AGREEMENT This agreement, commencing between Rodney Perkins, M.D. and RESOUND CORPORATION, a California corporation, respectively referred to hereinafter as "Consultant" and "Company", is for the purpose of expressing the mutual obligations of Consultant and Company as follows: 1. Consultant agrees to perform the duties set forth in Section 2 below for a period not to exceed six (6) months, beginning July 1, 1996 through December 31, 1996, and will be compensated for said services at the rate of $5,833.00 per month by Company. 2. Consultant's duties: Product Development Marketing and financial consulting 3 Timing of payment will be within thirty (30) days from time of submission of an invoice unless otherwise agreed upon, but in no case will exceed forty-five (45) days after termination of this agreement. 4. Either the Company or the Consultant may terminate this agreement at any time by giving of written notice of such intention to terminate to the other party. The expiration or termination of this agreement shall not terminate the obligation of the Consultant specified hereinafter. 5. Consultant agrees not to disclose, publish or reveal to any other party whatsoever any trade secrets, techniques, inventions, discoveries, technology or processes which relate to the practices and businesses of the Company (collectively, the "Information") and to treat all such Information as secret and confidential, both during the duration of this agreement and after its termination. Consultant further agrees not to make use of, either directly or indirectly, any of the Information which Consultant receives from the Company other than with the specific prior written authorization of an authorized officer of the Company. 2 Page Two 6. All concepts, designs, design analyses, inventions, improvements, trade secrets and other proprietary information created in whole or in part by Consultant during the term of this agreement which relate to or are useable with respect to the subject matter of this consulting agreement or its design, manufacture or use shall be the sole property of the Company. Consultant agrees to promptly and fully disclose in writing all such concepts, designs, design analyses, inventions, improvements, trade secrets and other proprietary property to the Company and to execute patent applications relating to such inventions and assignments of the entire interest therein to the Company as requested, whether or not within the term of this agreement. 7. All notes and records and copies thereof made or maintained by Consultant relating to his or her performance of this agreement are the property of Company and will be delivered to Company upon termination of this agreement. 8. Consultant agrees to indemnify Company against any losses or expenses sustained by Company, including reasonable attorney's fees, by reason of the breach by Consultant of any term of this agreement. 9. Nothing contained in this agreement shall be construed to constitute a partnership, joint venture, agency or employment relationship between the Company and Consultant, it being understood that Consultant shall at all times remain an independent contractor, and that the Company shall in no event be liable for the debts, liabilities or other obligations of the Consultant. Consultant shall have no authority to bind or otherwise obligate the Company to any contract or agreement and Consultant agrees that he will not represent to third parties that he has the authority to do so. 10. The rights and obligations of the parties under this agreement shall be binding upon, and inure to the benefit of, their respective successors and assigns: RESOUND CORPORATION By /s/ Paul A. Busse ------------------------------------------- Paul A. Busse Senior Vice President, Finance and Administration and Chief Financial Officer CONSULTANT By /s/ Rodney Perkins, M.D. -------------------------------------------- Rodney Perkins, M.D. 3 EX-10.6 3 CONTRACT CONSULTING AGREEMENT 1 Exhibit 10.6 RESOUND CORPORATION CONTRACT CONSULTING AGREEMENT This agreement, commencing as of July 1, 1996 between Richard L. Goode, M.D. and RESOUND CORPORATION, a California corporation, respectively referred to hereinafter as "Consultant" and "Company", is for the purpose of expressing the mutual obligations of Consultant and Company as follows: 1. Consultant agrees to perform the duties set forth in Section 2 below for a period not to exceed six (6) months, commencing July 1, 1996, and will be compensated for said services at the rate of $2500.00 per month by Company. 2. Consultant's duties: R&D Support 3 Timing of payment will be within thirty (30) days from time of submission of an invoice unless otherwise agreed upon, but in no case will exceed forty-five (45) days after termination of this agreement. 4. Either the Company or the Consultant may terminate this agreement at any time by giving of written notice of such intention to terminate to the other party. The expiration or termination of this agreement shall not terminate the obligation of the Consultant specified hereinafter. 5. Consultant agrees not to disclose, publish or reveal to any other party whatsoever any trade secrets, techniques, inventions, discoveries, technology or processes which relate to the practices and businesses of the Company (collectively, the "Information") and to treat all such Information as secret and confidential, both during the duration of this agreement and after its termination. Consultant further agrees not to make use of, either directly or indirectly, any of the Information which Consultant receives from the Company other than with the specific prior written authorization of an authorized officer of the Company. 2 Page Two 6. All concepts, designs, design analyses, inventions, improvements, trade secrets and other proprietary information created in whole or in part by Consultant during the term of this agreement which relate to or are useable with respect to the subject matter of this consulting agreement or its design, manufacture or use shall be the sole property of the Company. Consultant agrees to promptly and fully disclose in writing all such concepts, designs, design analyses, inventions, improvements, trade secrets and other proprietary property to the Company and to execute patent applications relating to such inventions and assignments of the entire interest therein to the Company as requested, whether or not within the term of this agreement. 7. All notes and records and copies thereof made or maintained by Consultant relating to his or her performance of this agreement are the property of Company and will be delivered to Company upon termination of this agreement. 8. Consultant agrees to indemnify Company against any losses or expenses sustained by Company, including reasonable attorney's fees, by reason of the breach by Consultant of any term of this agreement. 9. Nothing contained in this agreement shall be construed to constitute a partnership, joint venture, agency or employment relationship between the Company and Consultant, it being understood that Consultant shall at all times remain an independent contractor, and that the Company shall in no event be liable for the debts, liabilities or other obligations of the Consultant. Consultant shall have no authority to bind or otherwise obligate the Company to any contract or agreement and Consultant agrees that he will not represent to third parties that he has the authority to do so. 10. The rights and obligations of the parties under this agreement shall be binding upon, and inure to the benefit of, their respective successors and assigns: RESOUND CORPORATION By /s/ Paul A. Busse ------------------------------------------- Paul A. Busse Senior Vice President, Finance and Administration and Chief Financial Officer CONSULTANT By /s/ Richard L. Goode, M.D. ------------------------------------------- Richard L. Goode, M.D. EX-10.30 4 LEASE AGREEMENT 1 Exhibit 10.30 LEASE THIS LEASE, executed in duplicate as of this 24th day of September 1996, by and between Don and Carole Tanklage dba Tanklage Properties hereafter called LESSOR, and RESOUND CORPORATION, A California Corporation hereafter called the LESSEE (Lessor and Lessee being for convenience herein, in the singular number and masculine gender), WITNESSETH: Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, for and in consideration of the rent herein reserved and covenants herein contained and upon the conditions hereof, that certain real property situated in the City of Redwood City, County of San Mateo, State of California, commonly known as 30 Stein am Rhein Court, Units J, K, & L and described as follows: Approximately 6575 sq. ft. as per exhibits A, B, C, D, & E "AS IS" attached. A. The term of this lease shall be for four (4) years, beginning on the 15th day of December 1996 and ending on the 14th day of December 2000 inclusive, for a monthly base rental of $4,208.00 per month in advance, commencing with the first day of said term and on the same day of each succeeding month thereof. Receipt of the first month's rent in the amount of $ -0- is hereby acknowledged. B. As consideration for the execution of this lease, the Lessee shall pay to the Lessor the sum of $3,945.00*, receipt of which is hereby acknowledged. In the event Lessee is not then in default under terms of this lease, said sum of $3,945.00* shall be applied toward rental due for the last month of the extended term, in lieu of the last month of the initial term. C. The base rental above set forth shall be subject to escalation as follows: At the end of the first twelve (12) months of the lease term, the monthly rental shall be increased as follows for the next and each succeeding twelve (12) month period of the lease term: (a) The Consumer Price Index, for all Urban consumers, as published by the U.S. Department of Labor, Bureau of Labor Statistics, All Items for the United States Average (1967 = 100) is the "Index" herein referred to. Said Index as published shall be used herein, whether or not certain items may hereafter be added or deleted therefrom by the Bureau of Labor Statistics, or whether a "successor index" is published. (b) The "Base Year Index" shall be the average monthly Index over the twelve (12) month period ending with the calendar month immediately preceding the month in which the term of this lease commences. (c) Commencing with the second twelve (12) months of the lease term, and continuing thereafter for each remaining twelve (12) month], monthly rent for each such period of the term shall be increased in the same ratio that the average monthly Index for the previous twelve (12) months preceding the month in which such rental period commences, shall have increased over the Base Year Index. In no event shall the rental for any month of the lease term be less than the base rental for the first month of the lease term. IT IS HEREBY AGREED BY LESSOR AND LESSEE that this lease is made upon the following terms, covenants and conditions: 1. RENTAL. The Lessee will pay said rental monthly in advance and without deductions to Lessor at the office listed as Lessor's address under lessor's signature hereto, or at such place or places as Lessor may in writing designate, without grace or previous demand. 2. POSSESSION. If Lessor is unable to deliver possession of the premises to Lessee for damages therefor, but there shall in such event be a deduction of rent for the pro rata period during which possession is delayed. Neither such delay nor occupancy by Lessee prior to the commencement date shall extend or shorten the term, but Lessee shall pay rent for such latter period at the initial monthly rate. 3. USES OF PREMISES. The Lessee shall during the term hereof exclusively conduct therein and thereon the sole business of administration, warehousing and distribution of hearing aid products. Roof surfaces shall not be penetrated by Lessee or his agents without prior written consent of Lessor. The premises shall not be used for living quarters. 2 Motor vehicle parking, if any, provided to Lessee under this lease shall be non-exclusive, subject to reallocation by Lessor from time to time, and Lessee agrees that no vehicle will be parked on the leased premises for longer than eighteen (18) hours in any twenty-four (24) hour period. Lessee agrees that in the event this provision is violated, the motor vehicle may at Lessor's option be towed away at Lessee's expense. Lessee shall not use solid hard tires on any fork lifts or dollies on paved parking, truck loading or driveway areas, and in the event Lessee violates this provision, Lessee shall be responsible for the cost of resurfacing the entire area. Lessee shall not use any machinery on said premises the use of which will shake or vibrate the improvements thereon, or any part thereof, to such a degree that injury will be done to such improvements. No use of said premises shall be made, or any act committed thereon, which would increase the existing rate of fire insurance upon the improvements upon said premises or cause a cancellation of such insurance; that Lessee shall not commit any act on said premises, the doing of which is prohibited by any condition or restriction or record affecting the title to or the right to occupy that property; that no public sale or auction shall be conducted on said premises; and that Lessee shall not in the use of said premises violate any present or future law, ordinance or regulation of any public authority; and that no waste or public or private nuisance shall be committed on said premises. No corrosive chemicals, acids, inflammable liquids, paints, dangerous or toxic substances or similar materials shall be used or stored on the leased premises. Lessee shall comply with all federal, state and local environmental laws, ordinances and regulations, and shall indemnify Lessor against any liability, claims and expense at any time incurred for violation of this subparagraph, including any sum assessed against Lessor for any violations of said laws, regulations or ordinances or incurred at any time for the elimination of toxic substance effects or soil removal. Lessee agrees in this connection to waive the statute of limitations applicable to any action brought hereunder. 4. ALTERATIONS. No alterations shall be made on or of said premises without the written consent of Lessor first have been obtained, and any alterations of said premises or additions thereto shall, when affixed to the realty, become a part thereof, except moveable furniture and trade fixtures. (See paragraph #34) No additional lock or locks shall be placed by Lessee on any door, nor shall any existing lock be re-keyed, unless written consent of Lessor shall first have been obtained. Two keys will be furnished by Lessor. All keys shall be surrendered to Lessor upon termination of the lease term. The following items, whether installed by Lessor or Lessee shall be deemed permanent improvements and not trade fixtures, but shall be subject to the election by Lessor to require removal of any or all of them at the termination of the lease: Electrical wiring, panels and conduit; all piping and ductwork; heating units, air conditioners, lighting fixtures, ballasts, globes and tubes; and hot water heaters, shelving and counters, and partition walls. 5. REPAIRS. Lessee accepts said premises (including glazing, outside adjacent sidewalks and parking areas, if any) in their present condition, acknowledging same to be in good order and repair; Lessee shall maintain the said premises in as good order and repair as when received, damage by fire, war, earthquake, or reasonable use wand wear thereof, excepted; unless said fire be caused by the negligence of Lessee, his employees or invitees. Lessee waives the provisions of Sections 1941 and 1942 of the California Civil Code, or any other law which would permit Lessee to make repairs at Lessor's expense. Lessee agrees to water, maintain and replace, when necessary, any shrubbery, landscaping, exterior lighting, sprinklers and other such facilities provided by Lessor on the leased premises. If parking and landscaping are provided for an entire building or building site, the maintenance cost of such parking and landscaping, including sweeping service, by a service designated by Lessor shall be prorated on a square footage or other equitable basis as calculated by Lessor. Lessee agrees to pay this cost in addition to the monthly rental. 3 Included in repairs and maintenance for which the Lessee is obligated to pay are: replacement when necessary of light globes, fluorescent tubes, ballasts and starters in all lighting equipment; and for repairs to doors, storefronts and windows, including glazing, door closers, locks and frames, landscape sprinkler system, toilet fixtures, fire sprinkler and fire sprinkler supervisory systems, due to damage from any cause. This list is not intended to be exclusive and shall not limit the general provisions hereof concerning repairs. For the duration of the lease, Lessee agrees to maintain and pay for a service contract which meets the manufacturer's recommendations of the air conditioning and heating systems installed in the leased premises. Lessor shall not be obligated to repair minor settlement cracks on walls or floor of the leased premises, and shall not be responsible for the leaking of said walls due thereto or as the result of porosity thereof. 6. INDEMNIFICATION OF LESSOR; INSURANCE Lessee assumes all risk of injury to person and property in or about said premises, including lessee's property, and will hold Lessor free and harmless from liability therefor, including costs and counsel fees. Lessee shall secure and keep in force a public liability insurance policy on an occurrence basis covering leased premises, including parking areas, if any, included in this lease, insuring Lessee and naming Lessor as an additional insured, and a copy of same shall be delivered to Lessor. Said insurance Policy shall have minimum limits of coverage of $500,000 personal injury and property damage. Lessee shall further insure, at his expense, the glass, glazing, window frames, skylights, door, mullions and storefront window wall, if any, in said premises in a company and in an amount acceptable to Lessor; loss, if any, to be payable to Lessor. A copy of said policy shall be delivered to Lessor; and if the Lessee does not so deliver said policy to Lessor, Lessor may insure said glass and glazing, and collect the cost thereof from Lessee. All policies shall be kept current and provide for non-cancellation and non-modification without 30 days advance notice advance notice to Lessor. 7. UTILITIES. Lessee will pay, when due, all charges incurred by him for water, light, power, heat, gas, garbage removal, sewer charges (rental, tax assessment or other), telephone and other services furnished to said premises, including fire sprinkler supervisory. If any such charges are assessed to a larger building of which the leased premises are a part, such charges shall be appropriately prorated on the basis of area by the Lessor. All such charges incurred by Lessor for the common areas of an entire premises of which the leasehold is a part, including but not limited to walkways, driveways, parking areas and landscaping, shall be prorated on square footage or other equitable basis as calculated by Lessor. lessee agrees to pay this cost in addition to the monthly rental. 8. ASSIGNMENT. Lessee shall not assign this lease, or any interest therein, or sub-lease said premises, or any portion thereof, or license the use thereof, or any portion thereof, without the written consent of Lessor first had and obtained; that consent given by Lessor to one or more assignments, sub-leases or licenses shall not be construed as a subsequent or continuing consent; and that any such assignment, sub-letting or licensing (including transfer by operation or law) without such consent shall at Lessor's option terminate this lease. In the event of any assignment or sub-lease hereunder whether consented to by Lessor or not, Lessee agrees to pay Lessor monthly 100% of the excess of the rent provided under assignment or sub-lease over the rent specified herein. 9. SUBORDINATION TO DEED OF TRUST. This lease at the option of Lessor shall be subordinate to any deed of trust now existing or which Lessor may in the future execute covering said premises. Lessee agrees forthwith upon request of lessor to execute such documents providing subordination of this lease to any such deed of trust executed now or in the future. Lessee shall from time to time upon (10) days, prior written request by Lessor execute, acknowledge and deliver to Lessor (a) a statement in writing certifying, if such be true, that his Lease is unmodified and in full force and effect (or if there have been modifications that the same is in full force and effect as modified and stating the modifications) and the dates to which rental and other charges have been paid; and (b) such other instruments as may reasonably be required or requested by any mortgagee, beneficiary of a deed of trust or holder of any other encumbrance on the Premises. 10. DESTRUCTION OF PREMISES. In the event the premises are totally destroyed, then this lease will be forthwith terminated. In the event the demised premises are part of a building and such building is damaged to such an extent that the cost of repairs exceeds one-third of the cost of replacement of said building, then at the option of the Lessor, this lease shall terminate. In the event of partial destruction of the premises, which Lessor elects to or is bound to repair, the same shall be repaired by Lessor as soon as reasonably possible if such repairs can be made in ninety (90) working days after receipt of all 4 permits under the laws, ordinances and regulations applicable thereto, and also if necessary financing therefor is obtainable on a reasonable basis from local lending agencies; but if such repairs cannot be so made, then this lease, at the option of Lessor, shall terminate; but if not so terminated, then Lessor shall repair the same as soon as reasonable possible. During the time such repairs are being made Lessor shall not unreasonably interfere with Lessee's business, and the rent for such period shall be reduced proportionately to the extent Lessee is deprived of the use of the premises. lessee wives the provisions of sections 1932 subdivision 2) and 1933 (subdivision 4) of the California Civil Code. In the event of partial or total destruction, Lessee shall have the right to cancel this lease. 11. DEFAULT. In the event Lessee defaults in the terms hereof, Lessor, at his option, and in addition to any other rights he may have, may re-enter and repossess said premises and remove all property therefrom and store the same at the expense of Lessee. Lessor, upon default of Lessee, may relet said premises or any portion thereof, in a changed condition or otherwise, for such rental and upon such terms as he deems reasonable, and hold Lessee for the difference received, plus expenses of reletting and collecting such rental, and the rental herein provided. No such re-entry or taking of possession by Lessor shall be deemed an election to terminate this lease unless Lessee is served with notice of said termination by Lessor or same be decreed by a court of competent jurisdiction. In the event Lessee shall breach this lease and abandon the demised premises, Lessor may also elect to continue the lease in effect and Lessor may enforce all rights and remedies hereunder, including the right to recover rent as it becomes due, all pursuant to the provisions of Section 1951.4 of the California Civil Code. In the even of such election by Lessor to continue the lease, Lessee hereby irrevocably appoints Lessor the agent of Lessee to enter upon the demised premises and remove any and all persons and/or property whatsoever situated upon said premises, and to place all or any portion of said property, except such property as may become the property of Lessor, in storage for the account of and at the expense of Lessee; and, in such case, Lessor may relet the demised premises upon such terms as to it may seem fit, and if a sufficient sum shall not be thus realized, after paying expenses of such reletting and collecting, to satisfy the rent and such other sums as may be reserved herein to be paid, Lessee shall satisfy and pay any deficiency, and pay the expenses of such reletting and collecting. Lessee hereby releases Lessor and agrees to save harmless Lessor from any cost, loss or damage arising out of or caused by any such entry or reentry upon the demised premises and/or the removal of persons and/or property and storage of such property by Lessor or his agents. 12. ATTORNEY'S FEES. In the event of any suit, action or proceeding brought by either party for the breach of any term hereof, or to enforce any provisions hereof, or for unlawful detainer, the losing party will pay to the other reasonable counsel fees in said action or proceeding as fixed by the court. In the event Lessee is in default in payment of rent for any period or in Lessee's performance of any covenant hereof, and the Lessor engages an attorney to prepare a notice of such default for service on the Lessee, the Lessee agrees to reimburse the Lessor for the services of such attorney; and in the event the default is cured prior to institution of suit, the fee for the preparation of such notice shall be a reasonable amount therefor, plus actual costs of service. 13. ENTRY AND INSPECTION. Lessor reserves the right to enter said premises at all reasonable times for the purpose of repairing, altering or maintaining the improvements thereon, inspecting said premises, showing the same to prospective encumbrances, lessees, insurers, or purchasers, posting any notice or sign deemed necessary by him to protect his title or interest in said property; and during the last one hundred twenty (120) days of the term hereof placing and maintaining therein customary "for sale" or "to let" signs. 14. WAIVER. The waiver by Lessor of any breach hereof shall not be deemed a waiver of any subsequent breach of the terms hereof. 15. HOLDING OVER. Should Lessee remain in said premises after the expiration of this lease, such holding over shall be construed as a tenancy from month to month upon such increase in rental, if any, as established by notice from Lessor, but otherwise on the terms and conditions hereof so far as applicable, including rent, and the provisions for cost of living increases therein (if any) and tax reimbursement. This paragraph shall in no sense imply any consent by Lessor to such holding over. 5 16. NOTICES TO LESSEE. All notices required by law or this lease to be given to Lessee by Lessor may be given personally to Lessee or mailed to him by United States mail, postage prepaid and addressed to Lessee at the premises, whether or not Lessee has abandoned or vacated them. 17. TRANSFER OF SECURITY. In the event any security be given by the Lessee to secure the faithful performance of this lease, Lessor shall not be chargeable with interest thereon, and in the event of a sale of said premises he may transfer such security to the purchaser and be relieved of further liability therefor. 18. INSOLVENCY OR BANKRUPTCY. To the extent permitted by law, the interest of Lessee in such premises and this lease, at the option of Lessor, shall terminate in the event of levy of execution against Lessee upon such interest (provided Lessee fails for a period of five (5) days to discharge or bond against said levy), or upon Lessee filing or having filed against him bankruptcy proceeding or other proceedings under the bankruptcy statutes, or upon Lessee making a general assignment for the benefits of creditors, or upon the appointment of a receiver to take possession of all or substantially all of Lessee's assets. 19. LIENS. In the event any lien is filed against said premises for any claim against Lessee, Lessee shall remove the same forthwith; but failing to do so, Lessor may remove the same at the expense of Lessee. Lessee may, however, dispute the validity of such lien, but as a condition thereof, shall file with Lessor a surety bond covering the amount thereof. 20. SIGNS. Lessee shall not place any signs, visible from the exterior, or any part of the premises without the written consent of Lessor. Upon the expiration of this lease, Lessee shall remove all signs or decorations placed on or in said premises and shall repair any damage done by placing, maintaining or removing of said signs or other equipment on the roof or other portions of the premises. Lessee may place professionally designed signs in and on said building advertising Lessee's business after written approval by Lessor, and governmental entities. Signs shall include tethered airborne objects and mobile units. 21. SURRENDER OF PREMISES. Lessee agrees to surrender the premises at the termination of the tenancy herein created, in the same condition as herein agreed they have been received, damage caused by war, earthquake, and ordinary wear and tear excepted; and upon the surrender of the premises, either at the expiration of the term or otherwise, Lessee agrees to remove all personal property and rubbish from the premises; but if not so removed by Lessee, Lessor may have the same removed at Lessee's expense. In the event of surrender of this lease, Lessor shall have the option of terminating all existing sub-leases or of assigning said sub-leases to Lessor. At the time of termination of this lease, Lessor may require any or all of the alterations or additions installed by Lessee or by Lessor for the benefit of Lessee at Lessee's request, to be removed and the premises restored to their original condition,whether or not said alterations or additions have become part of the premises under paragraph 4 hereof. 22. SUCCESSORS AND ASSIGNS. The covenants and conditions herein contained, subject to the provisions as to assignment, shall apply to and bind the heirs, executors, administrators, successors and assigns of Lessor and Lessee. The term "Lessor" as used herein shall mean only the owner or owners at the time in question of the fee title or a Lessee's interest in a ground lease of the Premises, and except as expressly herein provided, in the event of any transfer of such title or interest, Lessor herein named (and in case of any subsequent transfers the then grantor) shall be relieved from and after the date of such transfer of all liability as respects Lessor's obligations thereafter to be performed, provided that any funds in the hands of Lessor or the then grantor at the time of such transfer, in which Lessee has an interest, shall be delivered to the grantee. The obligations contained in this Lease to be performed by Lessor shall, subject as aforesaid, be binding on Lessor's successors and assigns, only during their respective periods of ownership. 23. TIME. Time is of the essence of this lease. 24. RECORDING. This lease shall not be recorded by Lessee, but in the event the interest of Lessee herein is shown as an exception to title in any title company report of title, Lessee agrees to execute and deliver to Lessor a quitclaim deed covering all Lessee s interest in said premises, forthwith upon termination of this lease. 6 25. TAX INCREASES. Lessee agrees to pay Lessor the amount of any increase in city, county and district real estate taxes assessed against said premises, in excess of the taxes for the fiscal year 96-97. Included in "taxes" shall be any levy, tax, charge or fee levied by a governmental entity on parking spaces or privileges or parking uses in the leased premises and any tax on Lessor's gross rental receipts (other than income tax). Also included in said taxes shall be any future special assessments for local improvements of any sort. If said assessments are permitted to go to bond, the total amount of the annual installment shall be added to the tax bill for the purpose of the computation of any increase in taxes; if Lessor discharges said assessment and does not permit the same to go to bond, the amount which each annual installment, less interest, would have been if the same had gone to bond, shall be annually added to Lessor's tax bill for the purpose of tax increase computation. Lessee shall pay Lessor the amount of any such increase in real property taxes, as above defined, in two equal installments, one on December 1 and the other on April 1 of the said fiscal tax years. Submission of copies of tax bills by Lessor shall be evidence of and notice of the amount of said taxes. The amount of said increase shall be prorated in the event this lease commences or terminates during any fiscal tax year, and in such event the split-period, portable semi-annual installment of the tax increase shall be paid either thirty (30) days prior to the termination of this lease or within ten (10) days of notification by the Lessor to the Lessee of the amount of said increase. In the event said tax reimbursement payments are not made to Lessor on or before the dates herein set forth, the Lessee shall pay to Lessor a ten percent (10%) per annum late charge for such delinquency to be added to the tax reimbursement payment due. If said taxes and assessments are assessed against the entire building and building site, the taxes and assessments allocated to the leased premises shall be prorated on a square footage or other equitable basis, as calculated by Lessor. If the assessed value of the Lessor's premises is increased by the inclusion therein of a value placed upon the personal property or improvements of the Lessee, and if the Lessor pays the taxes based on such increased assessment, the Lessee shall, upon demand, repay to the Lessor the portion of such taxes resulting from such increase in assessment. 26. OUTSIDE STORAGE. No materials, supplies, equipment, finished products or semi-finished products, raw materials or articles of any nature shall be stored upon or permitted to remain on any portion of the leased premises outside of the building constructed thereon, except with the prior written consent of the Lessor. Notwithstanding the above, Lessee has the right to provide trash dumpsters. No waste materials or refuse shall be dumped upon or permitted to remain unreasonably upon any part of the leased premises outside of building proper, unless approved by Lessor. 27. OTHER RULES. Lessor reserves the right to make such other reasonable rules and regulations, including parking regulations, as in Lessor's judgment may from time to time be necessary for the safety, cleanliness and orderly operation of the leased premises for the benefit of all the tenants in the area. Lessee agrees to require its employees, executive, invitees and customers to abide by such rules and regulations, including parking regulations. 28. CONDEMNATION. In the event more than ten percent (10%) of the building area or more than twenty percent (20%) of the surrounding land in the demised premises shall be condemned by any public authority under eminent domain, this lease shall terminate and the award for damages shall belong entirely to Lessor, except as to trade fixtures of Lessee. If a lesser portion of the premises be condemned, the Lessee shall be entitled to a reasonable abatement of rent proportionate to the loss of use of space being leased. The granting by Lessor of storm drainage or utility easements over the demised premises shall not involve any reduction in rent, unless such easements materially affect Lessee's use of the demised premises. 29. NOTICES TO LESSOR. All notices required by law or this lease to be given to Lessor by Lessee shall be mailed to Lessor, registered or certified mail, return receipt requested, by United States Mail, postage prepaid to Lessor at the following address or such other address as Lessor may direct in writing: 7 1025A Tanklage Road San Carlos, CA 94070 30. ROOF MAINTENANCE. Notwithstanding the provisions of Paragraph 5, Lessor shall maintain the roof and structural components of the leased premises, such duty to repair being subject to the condition precedent that Lessee shall give prior written notice of at least 24 hours to Lessor (during working hours) specifying the need for such repairs. Structural components are defined as outside walls (excluding windows, doors, doorframes, storefront, glazing, door closers, locks and hardware), footings, columns, floor slab, and roof structure systems. The Lessee, however, shall be obligated to make any and all repairs caused by any act or omission of Lessee, his employees or invitees. 31. ADDITIONAL CLAUSES TO THIS LEASE. The following additional paragraphs have been included in this lease as attachments thereto: No. 32, 33 and 34. In the event any of the provisions of said added paragraphs conflicts with the provisions of paragraphs 1 through 31 hereof, the additional paragraphs shall control and shall be effective. IN WITNESS WHEREOF, Lessor and Lessee have executed this lease the day and year first above written. Don and Carole Tanklage dba RESOUND CORPORATION a California LESSOR: TANKLAGE PROPERTIES LESSEE: Corporation /s/ Don Tanklage /s/ Paul Busse ---------------- -------------- Don Tanklage, (owner) Paul Busse, Chief Financial Officer Address: 1025 Tanklage Road, Unit A Address: 200 Saginaw Drive San Carlos, California 94070 Redwood City, California 94063
32. Lessee shall not generate or cause any of the following; Noise, vibrations, odor or dust discernible or audible to adjoining tenants and in the event of any complaint by any adjoining tenant, Lessor or and Municipal entity or agency, then Lessee shall cure such breach of the lease within 60 days of said notice. 33. Notwithstanding the alterations provisions of this lease, Lessee shall be allowed to install, at Lessee's expense, an alarm system which shall remain the property of the Lessee. At the termination of the lease, Lessee agrees to remove alarm system and repair any damage to premises which resulted from the alarm system installation. 34. Any other provisions of this lease not withstanding, the parties hereby agree that the demised premises may be subject to the terms and conditions of the Americans with Disabilities Act of 1990 (herein after the "ADA"), as a result of Lessee's use of said premises. The parties further agree and acknowledge that it shall be the sole responsibility of the Lessee to comply with any and all provisions of the ADA, as such compliance may be required to operate the demised premises. The Lessee further agrees to indemnify and hold the Lessor harmless against any claims which may arise out of Lessee's failure to comply with the ADA. Such indemnification shall include, but not necessarily be limited to reasonable attorney's fees, court cost and judgments as a result of said claims. 8 TANKLAGE PROPERTIES License no. 401618 GENERAL OUTLINE SPECIFICATION - For Future Improvements GENERAL: 1) Lessor to review and approve all plans and specifications prior to submittal for permit. 2) Submit all plans and Title 24 calculations for approval from local building department and secure all necessary permits. 3) Lessor to inspect all work at same intervals as local building department. 4) All workmanship to be equal to the best practices in modern construction. 5) Do not drill into or through glulam beams, purlins, or any major structural element. 6) Do not support any piping or equipment, etc., from 2x4 roof members; employ purlins or place additional 2x6 frame between purlins for support. 7) Do not route piping or conduits over or on roof surface (except condensate drains). 8) All roof penetrations to be approved by owner and coordinated with owners roofing subcontractor ROOFING: 1) All roof penetrations to be mopped in by original roofing subcontractor 2) Clean roof of all debris and trash to assure roof and drains are clear of all construction materials. HARDWARE: 1) Any locks to be re-keyed must be keyed to Tanklage's master key system and should also pass meter room. 2) Provide Lessor with a key to all re-keyed locks. FIRE SPRINKLER: 1) Install additional heads as required to conform to local codes, I.S.O and Fire Marshall. HEAT, VENT & A/C: 1) No equipment to be located on roof closer than 25 ft. from outside wall, keep out of normal line of sight. 2) All A/C units, fans, blowers, plenums, etc. added to roof to be primed and painted to match existing. 3) All equipment to be mounted on built up curbs with G.I. covers. All penetrations necessary for this equipment to be incorporated within this curb (i.e. duct penetrations, electrical conduit, gas lines, etc.). 4) No curb, fan or any type of roof penetration to be located less than 16" from skylight, roof hatch, parapet wall or other roof penetration. 5) Provide sight screens as required by local codes. PLUMBING: 1) Do not sawcut concrete, jackhammer only. All reinforcing steel to remain intact. Exhibit "A" /s/ Don Tanklage /s/ Paul Busse ----------------- --------------- Don Tanklage Paul Busse
9 TANKLAGE PROPERTIES OUTLINE SPECIFICATIONS Lease space at 30 Stein am Rhein Court, Redwood City, California Units J, K & L Office and warehouse space to be leased "AS IS" OFFICE: Painted sheetrock walls - 8 ft. high Painted sheetrock ceiling and T-bar suspended ceiling system Carpet glued direct with rubber base Prefinished wood doors and H.M. frames Electric heat Unit "L" Heat Pump H,V,A/C system - Unit J & K Normal office lighting and plugs Aluminum and glass entry units with 3' x 7' door Tenant Improvements to be completed in Units J, K & L: a) Shampoo carpet in offices. b) Provide one unit heater in unit "J", BTU output to be per Title 24 requirements c) Painted surfaces in the office areas to remain "AS IS" with the exception of those areas which need repair. Repaired areas will be touched up with a similar, but not exact color paint. TOILET ROOMS: Enameled sheetrock walls and ceiling Marlite wainscote - 4 ft. high Sheetvinyl flooring Prefinished wood doors and H.M. frames Water closed and lavy, exhaust fan Light, switch and plug Electric water heater T.P. holder and mirror WAREHOUSE: Lights - "AS IS" Finishes - unfinished concrete floors, fire taped sheetrock wall, gravity vents and skylights per plan, foil insulation at underside roof. Electrical service and distribution to be "AS IS". Note: No loads to be hung from 2x4 roof joists No lines to run above or no roof All roof penetrations to be approved by owner and coordinated with owners roofing subcontractor. ALL HEATING AND LIGHTING SUBJECT TO TITLE 24 REGULATIONS Exhibit "B" /s/ Don Tanklage /s/ Paul Busse ----------------- --------------- Don Tanklage Paul Busse
EX-11.1 5 COMPUTATION OF NET LOSS PER SHARE 1 Exhibit 11.1 RESOUND CORPORATION STATEMENT OF COMPUTATION OF NET LOSS PER SHARE (in thousands except per share data)
Year ended December 31, ----------------------- 1996 1995 1994 ---- ---- ---- Net loss applicable to common shareholders ($1,192) ($5,902) ($14,289) ============================== Average number of common and common equivalent shares: Average common shares outstanding 17,591 15,439 15,089 Dilutive options (1) -- -- -- ------------------------------ Total shares for primary net loss per share 17,591 15,439 15,089 ============================== Net loss per share (2) ($0.07) ($0.38) ($0.95) ==============================
Notes: (1) Dilutive options have not been included in the calculation of primary earning per share since their inclusion would have had an anti-dilutive effect. (2) Fully diluted amounts do not differ. Preferred stock is not included in the calculation of the fully diluted earnings per share since their inclusion would have had an anti-dilutive effect. EX-22.1 6 SUBSIDIARIES OF REGISTRANT 1 Exhibit 22.1 RESOUND CORPORATION SUBSIDIARIES OF REGISTRANT
Subsidiary Jurisdiction Also Doing Business As - ---------- ------------ ---------------------- RSND Asia Limited British Virgin Islands ReSound Asia Limited ReSound Pty Ltd. Australia ReSound GmbH Germany Hortechnologie ReSound-Sonar GmbH Germany ReSound Deutschland GmbH Hortechnologie und Design ReSound-Viennatone Austria Viennatone AG ReSound BV Netherlands ReSound-Viennatone Ltd. United Kingdom ReSound-Viennatone France Viennatone S.A.R.L. ReSound AB Sweden ReSound Ireland Ltd. Ireland Viennatone GmbH & Co. OHG Germany ReSound Holdings Ltd. Bermuda Sonar Hearing Health Corporation Delaware
EX-27.1 7 FINANCIAL DATA SCHEDULE
5 1,000 US DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 7,980 0 25,271 4,774 23,853 56,548 28,673 15,179 114,752 31,171 25,985 0 5,225 90,680 38,309 114,752 0 125,646 57,241 57,241 66,156 0 1,819 430 1,397 (967) 0 0 0 (1,192) (.07) (.07)
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