SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
0-20256
(Commission file number)
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Kurzweil Applied Intelligence, Inc.
(Name of small business issuer as specified in its charter)
Delaware 04-2815079
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
411 Waverley Oaks Road
Waltham, Massachusetts 02154
(Address, including zip code, of principal executive offices)
(617) 893-5151
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(g) of the Exchange Act:
Title of each class
Common Stock, Par Value $.01
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 filings
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- B 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-KSB or any amendment for
this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $8,547,000.
The aggregate market value of voting stock held by non-affiliates of the
Registrant was $25,907,330 on April 15, 1997. The number of shares of common
stock outstanding at April 15,1997 was 9,085,974.
Documents Incorporated by Reference
Portions of Registrant's Definitive Proxy Statement for the 1997 Annual Meeting
of the Registrant, which will be filed by the Registrant within 120 days after
the close of the fiscal year, are incorporated by reference into Part III.
TABLE OF CONTENTS
ITEM PAGE
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PART I
1. Description of Business................................................................. 3
2. Description of Property.................................................................16
3. Legal Proceedings.......................................................................17
4. Submission of Matters to a Vote of Security Holders.....................................19
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................................22
6. Selected Financial Data.................................................................23
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..........................................................24
8. Financial Statements and Supplementary Data.............................................31
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................................57
PART III
10. Directors and Executive Officers of the Registrant; Compliance with
16(a) of the Exchange Act............................................................57
11. Executive Compensation..................................................................57
12. Security Ownership of Certain Beneficial Owners
and Management.................................................................57
13. Certain Relationships and Related Transactions..........................................57
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................58
(a) Financial Statements
(b) Reports on Form 8-K
(c) Exhibits
Signatures ......................................................................................63
2
PART I
Item 1. Description of Business
For purposes of this Annual Report on Form 10-KSB, all references to fiscal
years 1995, 1996, 1997 and 1998 mean the Company's fiscal year ending on January
31 in each year.
GENERAL
The Company was incorporated in 1983 in Delaware as a successor by merger to
Kurzweil Alpha Systems, Inc., a Massachusetts corporation which had been formed
in 1982. The Company's principal executive offices are located at 411 Waverley
Oaks Road, Waltham, Massachusetts 02154, and its telephone number is (617)
893-5151.
The Company develops, markets and supports automated speech recognition systems
used to create documents and interact with computers by voice, and structured
report generating software systems. The Company's speech recognition technology
is speaker-independent, in that most users do not have to "train" the system on
their voice to achieve satisfactory initial accuracy, and it is
speaker-adaptive, in that the system is able to adapt with use to the acoustic,
phonetic and linguistic patterns of individual users, and thereby further
boosting accuracy. The Company's large vocabulary systems, which recognize up to
60,000 words, accept discrete speech, which requires the user to pause briefly
between words. The Company's software technology is designed to run on 486 or
Pentium(TM)-based industry standard personal computers running MS-DOS(R) and the
Windows(R) operating systems.
On April 15, 1997 the Company announced that it has entered into an Agreement
and Plan of Merger with Lernout & Hauspie, Speech Products, N.V. ("L&H"), a
Belgium corporation listed on the Nasdaq National Market (Nasdaq Symbol: LHSPF),
and a subsidiary of L&H ("L&H USA") pursuant to which each outstanding share of
the Company's Common Stock will be exchanged for $4.20 in cash and $1.05 in
common stock of L&H, subject to adjustment in certain circumstances. The closing
of the business combination is subject to certain conditions and approvals,
including the approval of the stockholders of the Company. See Item 7. "
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Merger with Lernout & Hauspie Speech Products, N.V."
RISKS AND UNCERTANTIES
There are certain risks associated with the Company's business. The most
critical relate to obtaining financing to continue operations and fund
anticipated losses, and the timing and success of new and enhanced product
introductions.
Operations
The Company experienced losses from operations in fiscal years 1995, 1996, and
1997. Beginning in 1994, the Company increased research and development staffing
and spending to develop new and enhanced products for both the medical and
personal computer markets in order to increase revenue. The delay in the
delivery of the new and enhanced products, and the decrease in revenues from the
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DOS-based VoiceMED(R) medical products adversely affected fiscal 1996 and fiscal
1997 revenues, and resulted in operating losses which are expected to continue
into fiscal 1998, as the Company continues its investment in research and
development. The Company introduced new and enhanced products during the second
half of fiscal 1997, but there can be no assurance that these new and enhanced
products will be purchased in sufficient quantities to materially improve
revenues or create profits.
Financing
The Company has incurred operating losses since its inception. Since operating
losses are expected to continue into fiscal 1998 it is critical to the Company's
future that the Company obtain additional financing. If the proposed merger with
L&H is not consummated, the Company may be required to sell or license all or
part of its operations or technology. The long term financial stability of the
Company will be dependent upon achieving sustained profitable operations, and
obtaining additional financing, or selling all or part of the Company.
There can be no assurance that any future additional financing will be available
on commercially reasonable terms, or at all, and the success or lack of success
of the Company's new and enhanced products may have a critical effect on the
Company's ability to raise funds through the sale of stock or otherwise. In the
event that the proposed merger is not consummated, and the Company is unable to
promptly obtain additional financing, the Company will be forced to restructure
its operations, curtail its expenditures in research and development, sell all
or part of the Company, possibly attempt a merger with another company, or seek
protection under the bankruptcy laws.
At January 31, 1997, the Company was not in compliance with the Nasdaq By-Laws
net worth requirements for the continued listing of the Company's Common Stock
on the Nasdaq National Market. The Company will request an exemption from Nasdaq
for the continued listing of the Common Stock on the Nasdaq National Market
pending the stockholder approval of the merger with L&H. If an exemption is not
granted, the Company will request that it be eligible for re-admission to the
Nasdaq National market without having to comply with the higher initial listing
requirements. If the Company is not granted such an exemption and is required to
meet the initial or relisting requirements to be re-admitted for listing on the
Nasdaq National Market, it may not qualify for such re-admission for an
undetermined period of time. Any delisting of the Company's Common Stock from
trading on the Nasdaq National Market may adversely affect the price of the
Company's Common Stock.
To finance the Company's working capital needs, L&H USA has agreed to loan to
the Company up to $1.5 million under a line of credit (the "Loan") pursuant to
the terms of a Loan Agreement dated April 14, 1997 (the "Loan Agreement"). The
Company may, subject to the terms and conditions of the Loan Agreement, draw on
the line of credit until June 30, 1997. The Loan is evidenced by a line of
credit note dated April 14, 1997 in the original principal amount of $1.5
million ( the "Note). The Note bears interest at the "prime rate" as published
in The Wall Street Journal on April 14, 1997. All outstanding principal and
interest under the Note is due and payable in full on October 31, 1997, and is
secured by the Company's assets. See Item 7. "Management's Discussion and
Analysis of Financial Cindition and Results of Operations - Merger with Lernout
& Hauspie Speech Products, N.V."
4
PRODUCTS
The Company has two main product groups that develop, market and support
products in two distinctive markets.
The Medical Products Group sells, markets, and supports the Kurzweil VoiceMED(R)
and Kurzweil Clinical Reporter(TM) product for the medical market. The
Medical Products Group consists of clinical reporting software systems which
utilize voice input to create structured documents.
The PC Applications Group sells, markets, and supports the Kurzweil Voice for
Windows products to the general personal computer marketplace. These products
allow users to voice-enable Windows-based PCs and software applications, and to
enter data and create text through dictation.
Medical Products Group
The Medical Products Group is dedicated to developing, marketing and supporting
medical reporting software systems for clinicians. These systems are used to
support the direct voice dictation of clinical charts and reports by voice. In
addition, these products can also be implemented as a front-end for a
Computerized Patient Record (CPR), utilizing an interface that extracts clinical
data from the chart to populate the clinical database. The goal of the Medical
Products Group is to support high-quality clinical data management while
expediting the natural workflow of the clinicians providing for patient care.
The Kurzweil VoiceMED and Kurzweil Clinical Reporter products both have up to a
60,000 word vocabulary capacity, and run on Intel-compatible personal computers
under the PC/DOS and Windows operating systems. With systems in use at over 500
medical institutions, the Company believes the Kurzweil Medical Products Group
is a leader in the rapidly emerging market for clinical reporting systems using
voice input technology.
The Company's medical products have three essential elements which the Company
believes make them both useful and cost effective.
1) A knowledge base for clinician documentation that can be fully customized
by the user to satisfy one standard of care. These knowledge bases are used
to prompt users to create reports that:
[bullet] Provide a complete medical record to the clinical staff in real
time
[bullet] Meet Resource- Based Relative Value Scale (RBRVS) standards to
support reimbursement claims
[bullet] Provide a comprehensive record of each clinical event to
minimize liability risk
[bullet] Structure medical information at the point of entry for use by
healthcare institutions in outcomes analysis
5
2) A fully-integrated, multi-modal user interface which supports input by
keyboard, mouse, pen, bar code and voice recognition, depending on the
clinician's individual approach to computing as they access and enter
information into the system.
3) Systems integration of hospital departments and/or hospital information
systems. This interconnecting software supports the seamless two-way
transfer of critical information using standard formats such as HL-7.
The Company believes its VoiceMED and Clinical Reporter products enable
physicians and other healthcare professionals to quickly and efficiently prepare
complete, accurate, immediately available and cost-efficient printed reports by
voice. The products are targeted to specific medical disciplines which utilize
identical and discrete speech recognition technology, and features a customized
knowledge base specific to the medical specialty. With the introduction in July
1996 of the Company's Windows based Clinical Reporter System, the Company made
an effort to reduce the selling and marketing of the DOS-based VoiceMed System.
The Company believes its Medical Product provides a solution for medical
reporting in six medical specialties:
[bullet] Emergency Medicine [bullet] Cardiology
[bullet] Radiology [bullet] Orthopedics
[bullet] Pathology [bullet] Primary Care
Kurzweil Clinical Reporter(TM)
In March 1996, the Company announced a new Window-based system for creating
complete medical reports by voice. The Kurzweil Clinical Reporter system
integrates medical knowledge bases and a structured report generator and
utilizes the Kurzweil Voice for Windows (release 2.0) voice product as the voice
interface to collect patient data and produce medical reports. The Company
commenced shipment of product to customers in July 1996.
The Clinical Reporter product is available for emergency medicine, radiology,
pathology, and primary care. The Company also introduced Clinical Reporter for
cardiology in March 1997. These products can be run on laptop computers and can
interface mobile monitors ("Cruise Pads"). The product can also support mouse
and pen input devices.
The Clinical Reporter system runs on a Pentium 133 MHz system with 32 megabytes
of RAM on the Windows operating system. The Company currently anticipates a
release of the Clinical Reporter system for the existing knowledge bases on a
system that will run on Windows 95 and NT platforms in the second quarter of
fiscal 1998.
In December 1995, the Company was awarded a $2 million grant by the Commerce
Department's National Institute of Standards and Technology (NIST) Advanced
Technology Program (ATP). The award provides funding for the research and
development of medical record documentation systems
6
using open systems standards for linking with other healthcare information
systems, and applying user interface technologies including large vocabulary
speech recognition and pen input combined with flexibly structured knowledge
bases designed to facilitate ease of use. Medical record documentation systems
are a prerequisite to the creation of useful clinical databases for outcome
studies, cost-effectiveness studies, and other efforts to improve both the
quality and the cost-effectiveness of medical care in the United States.
The technology developed under the ATP grant is designed to be capable of
accepting clinical information from the care giver (physician exam notes, for
example) and feeding back information, such as clinical treatment guidelines,
from central data repositories.
Product sales to military and veterans hospitals owned by the United States
government totaled $3,525,000, $1,127,000, and $541,000 or 28%, and 12%, and 6%
of the Company's total revenues in fiscal years 1995, 1996, and 1997
respectively.
PC Applications Group
The PC Applications Group sells, markets and supports products used in the
general PC marketplace. The group is focused on becoming the market leader in
voice-enabled PCs and PC applications. The PC Applications Group's key
objectives are:
[bullet] To encourage selection of the "Kurzweil" brand by individuals
and, eventually, third party developers to voice-enable their
PCs and PC applications.
[bullet] To introduce products featuring ease-of-installation, learning
and use.
[bullet] To provide an easily affordable upgrade path for customers to
take advantage of new enhancements, products and product
upgrades.
Kurzweil VOICE(TM) for Windows.
Kurzweil VOICE for Windows Release 1.0 incorporated a new version of the
Company's large vocabulary, speaker-independent, discrete speech recognition
technology. Users could choose either a 30,000-word or a 60,000-word active
vocabulary. Kurzweil VOICE for Windows Release 1.0 featured an on-line
dictionary including acoustic recognition models and spellings, for a total of
200,000 words. The system is speaker-independent in that most users do not have
to "train" the system on their voice to achieve satisfactory initial accuracy.
The Company announced Kurzweil VOICE for Windows Release 1.0 in April 1994 and
shipments to customers began in July 1994.
Kurzweil VOICE for Windows supports voice input for dictation, which enables the
user to create text and enter data simply by speaking; and navigation, which
controls the Windows operating system and Windows-based applications on a
command and control basis.
7
Kurzweil VOICE for Windows version 1.2 was released in November 1994 and
shipped with the IBM MWave Windsurfer sound board as its platform. In June 1995,
the Company released Kurzweil VOICE for Windows version 1.5 which included
improved recognition accuracy, continuous digits, increased usability and
shipped with the Spectrum FX sound board.
In April 1996, the Company announced Kurzweil VOICE for Windows Release 2.0
which runs on the industry standard Sound Blaster 16 platform sound board. This
software only release combines a new, more accurate speech recognizing engine,
Windows 95 and network compatibility, and improved speaker independence and
usability.
In November 1996, the Company announced the following product releases:
Kurzweil VOICE Release 2.5 ( Professional Edition ) has a 60,000 word active
vocabulary version, with a suggested retail price of $595. This product is
designed for business people and other professionals with extensive and/or
unique vocabulary requirements. Kurzweil VOICE Release 2.5 (Personal Edition)
has a 30,000 word active vocabulary, with a suggested retail price of $295. Both
versions of Kurweil VOICE Release 2.5 have on-line dictionaries, including
acoustic recognition models, and spelling for a total of 200,000 words.
Kurzweil VOICE Release 2.5 enables PC users to combine voice input with the
keyboard and mouse. The release supports voice input for navigation, which
controls the Windows operating system and Windows-based applications on a
command and control basis, as well as dictation, which enables users to create
text and enter data simply by speaking into a microphone attached to their PCs.
The Company believes Release 2.5 improves user productivity through increased
recognition accuracy and throughput, and through the integration of its
navigation and dictation capabilities into the Windows operating system
including the leading Windows-based applications. The product is
speaker-independent, with an initial "out-of-the-box" accuracy rate which can be
up to 90% or higher. The product also automatically adapts to the user's speech
and language patterns over time, which can boost the ongoing recognition
accuracy rate up to 97% or higher, with easy error correction.
In addition to the price/performance benefits of the Personal and Professional
Editions, Kurzweil VOICE for Windows Release 2.5 includes five enhancements
which ease-of-use:
[bullet] Point & Fix(TM) Editing Capabilities: With this new editing
feature, users can now generate a lengthy document in Microsoft
Word 6.0 and 7.0, or Corel WordPerfect 7.0, go to any location
in that document and dictate their edits. If the word was
previously dictated (as opposed to being entered by keyboard),
this editing feature can fix a misrecognition by selecting the
correct word from a list of alternatives. This enables the user
to concentrate on text creation and throughput, leaving the
editing to the final stage. "Point & Fix" editing is an
easy-to-use, flexible solution, designed to increase dictation
throughput by significantly reducing dictation interruptions.
8
[bullet] Enhanced Command Learning: This new feature makes it easier for
users to voice-enable applications with Kurzweil VOICE for
windows, requiring no training for words in the menus and
dialog boxes. This feature can also be used to train any voice
macros that are added to the system.
[bullet] Enhanced Application Integration & Support: Release 2.5
includes many new commands designed to increase users
productivity and efficiency when working with spreadsheets and
word processors. Also, Netscape Navigator and QualComm's Eudora
have been added to the extensive list of Windows applications
that Kurzweil VOICE for windows supports with built-in
commands.
[bullet] New Child Profile: New speaker profiles for users under 17
years of age have been included to boost recognition accuracy
to levels equivalent to adult users The addition of three new
speaker independent profiles to Kurzweil VOICE for windows is
designed to provide a high level of recognition performance.
[bullet] MMX Technology: Kurzweil VOICE for windows Release 2.5 now
supports MMX technology, and takes advantage of new
enhancements to the Intel architecture to deliver improved
accuracy and faster throughput.
Kurzweil VoicePAD
In June 1996, the Company announced the release of Kurzweil VoicePAD for Windows
1.0 available as a download. This evaluation version of Kurzweil VoicePAD is
available as a download over the Internet as shareware from Kurzweil's site on
the World Wide Web (@ kurzweil.com). Through January 31, 1997 over 45,000 people
have downloaded the shareware version. This version has an active vocabulary of
12,000 commonly spoken words with an additional customized vocabulary capability
of 500 words. The free shareware release is a limited version that restricts
dictation to only 2,500 words. When the word limit is reached the program no
longer operates and the user is encouraged to purchase the Company's product
offerings.
In November 1996, the Company introduced a version of Kurzweil VoicePAD for
Windows Release 1.0. This version of VoicePAD enables the user to seamlessly
integrate voice input with the keyboard and mouse, creating a natural and
intuitive approach to document creation. Like the shareware version, this
product combines the Company's latest discrete speech recognition technology and
allows the user to create text and enter data simply by speaking into the word
processing application. In addition, the user can navigate through the
application on a command and control basis.
Kurzweil VoicePAD for Windows Release 1.0 can be used to create memos, letters,
reports and other documents. Users can format text, navigate through the
application's menus and dialogs, change the application's settings, and preview
and print documents using intuitive voice commands. In addition, by integrating
the continuous digit recognition with the discrete dictation capabilities, users
can quickly and efficiently enter telephone numbers, street addresses, zip
codes, dollar amounts, social security numbers and other numeric data into their
documents.
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This version of Kurzweil VoicePAD Pro for Windows Release 1.0 has an active
vocabulary of 17,000 words, with an additional customized vocabulary capability
of 3,000 words. The product does not require any training and the initial
recognition accuracy rate can be up to 90% or higher. Like the other Kurzweil
Voice products, Voice Pad automatically adapts to the user's speech and language
patterns over time, with the capability of improving the accuracy rate up to 97%
or higher, with easy error correction.
DESCRIPTION OF TECHNOLOGY
The Company has developed proprietary technology that incorporates speech
recognition, enabling software and specific knowledge bases.
The Company's approach to speech recognition applies a broad variety of methods,
including techniques derived from statistical, phonetic and linguistic
approaches as well as advanced pattern recognition. The Company's speech
recognition technology is implemented as a collection of software "experts".
These experts focus on different aspects of the recognition process, including
acoustics, statistics, phonetics and linguistics. Results from the experts are
combined to provide a final recognition through the use of the Expert Manager
software module, which coordinates the activities of the other software experts.
If one expert is unable to recognize a spoken word in a particular situation,
the Company's multi-expert approach makes it more likely that another expert
will be able to recognize the word accurately.
The Company's enabling software includes: he Structured Report Generator,
comprised of a database manager, knowledge base shell and word processor; a
knowledge base editor (KBEdit(TM)) program that allows users and developers to
create and edit knowledge bases; and an on-line editor that permits users to
alter the knowledge base while dictating. The Structured Report Generator
includes the ability to respond to a "trigger phrase," which is a single spoken
word or phrase that can trigger an entire pre-defined report segment, with
"fill-in-the-blank" capability for customization. The Company's enabling
software permits users to create their own voice-activated structured reports,
and contains tools for modifying or creating knowledge bases and creating
customized reporting systems.
The Company has developed a set of techniques and development tools which
enables its knowledge engineering organization to develop knowledge bases in the
context of speech recognition. Knowledge engineering is a complex, analytical
process in which a particular field of expertise (a "domain") is organized into
a hierarchical data structure which can be stored and manipulated in a personal
computer. Building a knowledge base for voice reporting requires developing
domain specific vocabularies, appropriate trigger phrases and an underlying
logical framework. Once designed and combined with speech recognition
technology, the knowledge base permits professionals in a personal particular
field to use speech technology to generate reports which reflect their
professional training.
The Company has devoted substantial time and resources in developing and
refining its knowledge bases, and for its Medical Products Group has
collaborated with practicing physicians in relevant fields.
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The Company continues its commitment to enhancing and developing the Company's
technology and products. The Company also continues to increase staffing in the
areas of core recognition development, programming development and knowledge
engineering.
MARKETING, SALES AND DISTRIBUTION
The principal elements of the Company's Medical Products Group distribution
strategy are as follows:
[bullet] Unbundling of Product Offerings: Clinical Reporter and VoiceMED
customers have the option of purchasing the software and sound
board from the Company. They also are able to buy from the
Company, personal computers, and services (such as
installation, training, ongoing support, and maintenance)
separately. This enables users to buy what they need, when they
need it.
[bullet] Pricing: Customers can purchase Clinical Reporter and VoiceMED
on a single-user basis, rather than the previous
workstation/multi-user basis. For example, the suggested list
price to purchase the software, PC and soundboard for an
individual user is currently $12,000.
[bullet] Distribution: The Company primarily sells direct to end users.
In addition to its own direct sales force, Clinical Reporter is
also being distributed by value added resellers (VARs), system
integrators and dealers in the healthcare industry. The Company
has approximately 15 active resellers and two VARs that
distribute the product.
[bullet] Customer Service and Support: The Company continues to focus on
providing a high level of service and support to its customers
and distribution partners. Offerings continue to include
field-based installation, training, ongoing support and
maintenance, as well as toll-free end-user support.
[bullet] Strategic Relationships and Alliances: The Company is striving
to establish relationships with key strategic partners within
the healthcare industry.
[bullet] Recurring Revenue: The Company's marketing and pricing
objectives are also focused on generating revenue from annually
renewable contracts for customer support and regular updates of
its VoiceMED and Clinical Reporter products.
As part of its marketing effort, the Company gathers input from physician
advisor groups consisting of practicing physicians and other healthcare
professionals, as well as the collation of customer feedback gathered from phone
calls to the Company's support service "hot-line", the sales and support staff,
the research and development staff, and management. After collecting, analyzing
and prioritizing the data, the Company determines the specifications for
features and functions of the next set of product releases in the context of the
Company's own strategic planning. In some cases, physicians and clinicians
assist the Company's knowledge engineers in developing portions of the product.
The implementation of this process has led to significant product improvements,
making it easier for customers to use the Company's Clinical Reporter products
and to become more productive in their work.
11
The Company is involved in a wide range of promotional activities targeted at
potential Medical Products Group users. The Company conducts marketing programs
including direct mail, public relations, advertising, and trade shows. The
Company also presents its products on its own home page on the world wide web.
(kurzweil.com.)
The Company has a contract with the General Services Administration ("GSA") for
the period of March 1997 to March 1998 under which various government agencies
may order certain of the Company's products in minimum and maximum amounts
through the GSA at discount prices specified in the GSA contract.
The principle elements of the Company's PC Application Groups distribution
strategy are as follows:
[bullet] As of April 1997, there are over 25 authorized VAR's selling Kurzweil
VOICE for Windows in the United States, Canada, Australia and Europe.
[bullet] The Company distributes its PC Application products through six
national personal computer software catalogs.
[bullet] The Company has a PC Applications sales department that supports its
distribution channels and sells to customers who elect to buy directly
from Kurzweil AI.
[bullet] In October 1996 the Company entered into an agreement with Andrea
Electronics pursuant to which Andrea bundles a version of Kurzweil
VoicePAD software with Andrea's headset microphone. The microphone and
software package is expected to be sold at various retail outlets.
[bullet] The Company announced on October 4, 1996 an agreement with NEC Computer
Systems that provides for NEC to bundle the Company's special version
of Voice commenced shipment in December 1996.
[bullet] On October 31, 1996 the Company announced an agreement with The
Learning Company (formerly Softkey) under which the Company's special
version of Kurzweil VoicePAD Platinum Edition will be distributed by
The Learning Company through its software kiosks at various retail
outlets.
[bullet] The Company expects to distribute a special version of Kurzweil
VoicePAD through an agreement with Creative Labs, Inc. which will
feature the bundling of the special version of VoicePAD with (over two
million) Creative sound boards.
[bullet] On December 3, 1996 the Company announced an agreement with Alpha
Software Corporation pursuant to which Alpha will distribute the
Company's PC Application products for resale in the retail marketplace.
This retail channel includes outlets such as CompUSA, Computer City,
Egghead, Best Buy, Staples and Office Max.
12
The Company is involved in a wide range of marketing and promotional activities
targeted at the general personal computer marketplace. The Company conducts
programs utilizing a public relations firm, direct mail, and trade shows, and
uses its home page on the World Wide Web to facilitate its presence on the
internet and to the general public.
RESEARCH AND DEVELOPMENT
The Company has assembled a research and development team that includes
linguists, computer scientists, speech scientists, software engineers, knowledge
engineers and experts in pattern recognition and artificial intelligence
techniques. This team, consisting of 64 full-time employees as of April 15,
1997, is divided into four groups. The Core Research Group, which develops the
underlying speech recognition technology; the Product Development Group, which
develops the user interface, Structured Report Generator, and the application
development tools; the Knowledge Engineering Group, which develops "domain
specific" knowledge bases for the Company's products, and assists applications
developers outside the Company; and the Customer Education Group, which is
responsible for all print documentation, on-line help and tutorials.
The Company is currently focusing its resources on enhancing certain products
that already operate within the Windows operating system; developing a large and
medium vocabulary continuous speech recognition system; and continuing to
enhance its existing product lines.
In fiscal 1996, the Company delivered a voice recognition system operating on
the Unix operating system for GTE as part of a government subcontract. This
CHS.2 contract will voice-enable Unix applications on Sun Solaris workstations
as part of a contract with the U. S. Army extending to 2005.
In November 1993, the Company announced that it had been awarded a grant from
the Advanced Technology Program at the National Institute of Standards (NIST), a
division of the United States Department of Commerce. The grant was a three-year
project which ended on February 28, 1997. As of April 15, 1997, the Company has
received $ 1.7 million in reimbursement under this project. The NIST grant
supported the Company's development of a spoken language interface capable of
controlling personal computer software applications through "natural language"
instruction in combination with a keyboard and a pointing device. The effort is
focused on a new speech recognition interface based on natural language
understanding and continuous speech technology, allowing for the recognition and
interpretation of commands in everyday English from a continuous stream of
words.
In October 1995, the Company announced that it was awarded a second grant from
NIST for a $2 million, two year project. The award provides funding for the
development of medical record documentation systems using open systems standards
for linking with other health care information systems, and applying user
interface technologies including large vocabulary speech-recognition and pen
combined with flexibly structured knowledge bases designed to assure ease of
use. Medical record documentation systems are a prerequisite to the creation of
useful clinical databases for outcome studies, cost effectiveness studies, and
other efforts to improve both the quality and the cost effectiveness of medical
care in the United States.
13
The technology developed under the second NIST grant will be a two-way system --
accepting clinical information from the care giver (physician exam notes, for
example) and feeding back information such as clinical treatment guidelines from
central data repositories.
SUPPORT SERVICES
Achieving a high level of customer satisfaction is a priority for the Company.
To meet this goal, the Company offers a number of services to assist its
customers in becoming successful users of its products. These services include
in-house and regional training programs, on-site installation and training,
ongoing maintenance programs, a support service hot-line for end-user telephone
support during the warranty period (available 8:00 a.m. to 8:00 p.m., Eastern
Time, Monday through Friday), a multi-media on-line tutor for new users, and
extensive documentation.
The Company currently offers a 90-day warranty that guarantees its products will
be free from defects in materials and workmanship and that the software will
perform in accordance with stated specifications. The Company is obligated to
repair or replace, at its option, any products that do not meet the warranty.
Annual maintenance agreements are offered after the expiration of the initial
warranty period.
MANUFACTURING
The Company's product development organization produces a set of master
diskettes and documentation for each product which are then used for production
in quantity. Software duplication, assembly and shipping are performed by the
Company's manufacturing organization for the Medical Products Group. There were
four people in this department as of April 15, 1997 .
For the PC Applications Group, the Company utilizes a third-party manufacturing
and fulfillment house to print the documentation, reproduce the software, and
package and ship the product to customers.
To date, the Company has not experienced any material difficulties or delays in
production and distribution of its products.
COMPETITION
The speech recognition industry is highly competitive and characterized by
rapidly advancing technology. In order to maintain or improve its position in
this industry, the Company must enhance its current products continually and
develop and introduce new products that address the rapidly changing needs of
the marketplace.
The Company believes that the combination of features currently available in the
discrete speech technology, including the Medical Products and the PC
Applications products, are the basis for the Company's strengths. Yet with the
advancement of the Company's competitors into continuous speech products, it is
important that the Company strive to meet those advancements. Nonetheless, no
assurance can be given that the Company will be able to compete effectively in
the future.
14
In the healthcare market, the Company's Medical Products Group competes with
traditional report generation methodologies (such as handwritten notes, tape
dictation, transcription, keyboard entry systems, pen-based task systems, and
mouse entry systems) as well as a limited number of speech recognition systems.
The principal competitive factors in the clinical reporting market are product
functionality, performance, ease of use, support services and price. The
Company's PC Applications Group is competing in the general personal computer
market. The principal competitive factors in this market are, application
integration, ease of use, overall product functionality, and overall
price/performance. This market is highly competitive and the Company can make no
assurances as to the ongoing market acceptance of its products.
The Company expects to encounter significant competition in this broader
personal computer market. The Company's primary competitors are Dragon Systems,
Inc.("Dragon") and IBM, which offer products that compete directly with the
Company's. Dragon sells a large vocabulary speaker-independent, discrete and
continuous speech recognition product for personal computers running on both
MS-DOS and Windows. IBM has also developed and sells large vocabulary,
speaker-independent, discrete speech products for personal computers.
Many companies, including AT&T, Microsoft, Bolt, Beranek and Newman, Voice
Processing Corp., Lernout & Hauspie Speech Products N.V., Philips, and Apple
Computer, Inc. among others, have either announced or are known to be involved
in speech recognition research and development activities. Many of the Company's
potential competitors in this market have financial, technical and marketing
resources that are substantially greater than those available to the Company.
DRAGON SETTLEMENT AND CROSS LICENSE AGREEMENT
On September 23, 1993, the Company and Dragon settled certain patent
infringement litigation between the companies, which included the licensing and
cross-licensing of certain patents related to continuous speech and other
aspects of speech recognition technology. The Company entered into these
agreements to avoid the cost, management distraction, and risks of litigation
with regard to the two patents which Dragon had asserted the Company was
infringing, and to obtain the right to use additional Dragon patents, including
all twelve patents issued to Dragon prior to the date of the agreement and all
future patents issued to Dragon for which applications are filed by Dragon prior
to the end of fiscal 1998. In consideration of such license, the Company agreed
to make payments to Dragon from fiscal 1994 through fiscal 1999, starting at
$625,000 annually and increasing each successive year by 13%. Of these payments,
$625,000 was charged to fiscal 1994 operations as a settlement for products sold
during periods prior to September 23, 1993. The Company paid Dragon $1,331,000,
$798,000 and $902,000 in fiscal years 1994, 1996, and 1997 respectively, and is
committed to pay Dragon an additional total of $2,171,000 through fiscal 1999.
Of the $2,171,000 total due, the Company is required to pay $1,019,000 to Dragon
in fiscal 1998.
The Company has the option to extend its license by continuing to make such
payments to Dragon through fiscal 2006, at which time its license would be fully
paid. If the Company were to elect to renew its license each year, the agreement
provides that the Company would pay Dragon an aggregate of $13,539,000 in fiscal
years 2000 through 2006. On April 14, 1997, the Company entered into a
15
Loan Agreement with a subsidiary of L&H pursuant to which the lender committed
to provide the Company with a working capital loan of up to $1.5 million through
October 31, 1997. The Company currently believes that the technology claimed to
be covered by Dragon's patents is necessary to the Company's current product
viability and marketability. The Company cannot provide any assurances that it
will be successful in developing or acquiring alternative technology that would
not be covered or claimed to be covered by the Dragon patents, thereby
eliminating its need to continue to license the Dragon patents in the future, or
that, if the Company's products embody technology claimed to be covered by
Dragon's patents, and the Company elects not to continue the license, the
Company will be successful in any future litigation if Dragon asserts claims of
patent infringement.
PROPRIETARY RIGHTS
The Company regards its software as proprietary and relies on a combination of
copyright, patent, trade secret and trademark laws and license agreements to
protect its rights. The Company also enters into software license agreements
with end-users of its products, and requires all employees to enter into
confidentiality and non-disclosure agreements. Despite these precautions, it may
be possible for unauthorized third parties to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. The Company has obtained fourteen United States patents (expiring
between 2006 and 2009) on various aspects of its speech recognition technology,
and has ten United States patent applications pending. There can be no assurance
that any issued patents will provide the Company with significant protection
against competitors. Certain of the Company's competitors have obtained patent
protection and the Company believes that certain of its competitors are seeking
patent protection on various aspects of their speech recognition technology.
EMPLOYEES
At April 15, 1997, the Company employed a total of 113 persons, 36 of which are
in marketing, sales and customer/field support, 64 of which are in product
research, development and customer education, four of which are in
manufacturing, systems integration and testing, and nine of which are in
management, finance and administrative activities. None of the Company's
employees is represented by a labor union. The Company believes that its
employee relations are good.
Item 2. Description of Property
The Company occupies approximately 27,000 square feet of space at its
headquarters in Waltham, Massachusetts under a lease expiring in fiscal 2000.
The current annual rent under this lease is approximately $400,000. The Company
currently has no arrangements to extend this lease or to lease alternate
premises. However, the Company believes that suitable space will be available
upon expiration of its Waltham lease to conduct the Company's operations. In the
past, the Company has leased a number of small sales and support offices
throughout the United States. During 1994, the Company closed all but one of its
sales and support offices. The Company's aggregate annual rental expense for the
one facility which remained open during fiscal 1995, 1996, and 1997 was
approximately $4,500, $5,700 and $4,680, respectively. The Company believes that
its existing facilities are adequate for its current needs.
16
Item 3. Legal Proceedings
Class Action Litigation. Subsequent to the Company's announcement on April 28,
1994 that the Company and its auditors were reviewing certain aspects of the
Company's revenue recognition policies and practices and related matters, and
that the Company expected this review to result in a substantial loss for fiscal
1994, five purported class action lawsuits were filed in the United States
District Court for the District of Massachusetts. These lawsuits were eventually
combined into one class action suit.
These lawsuits were purportedly brought by and on behalf of purchasers of the
Company's Common Stock pursuant or traceable to the Company's Prospectus dated
August 17, 1993 and in its after market through April 28, 1994. These lawsuits
were filed against the Company and certain of them also named as defendants
Raymond C. Kurzweil (the Company's Founder, former Chairman, Chief Technology
Officer and director and former Co-Chief Executive Officer), Bernard F.
Bradstreet (former Co-Chief Executive Officer, President, Chief Financial
Officer, and director), the underwriters of the Company's August 1993 initial
public offering of Common Stock, Robertson, Stephens & Co., L.P. and Needham &
Company, Inc., and the Company's former public accountants, Coopers & Lybrand
L.L.P.
On April 27, 1995, the Company received final court approval of an agreement to
settle this litigation. In accordance with the settlement, the class members and
their counsel received a total of 1,475,827 shares of Common Stock having a
value of $7,250,000 based on the average closing price of shares of Common
Stock, during the five consecutive trading days starting May 19, 1995. In June
1995, the class members' counsel received their portion of the shares, 442,748
shares in the aggregate. In March 1996, the remaining 1,033,079 shares of Common
Stock were distributed to class members. In addition, as part of the settlement,
the Company made a cash payment of $250,000, and assigned any claims it might
have against its former public accountants, Coopers & Lybrand L.L.P., to the
class members. The Company believes these proceedings are now concluded as to
the Company's involvement.
SEC Investigation. On June 3, 1994, the Company announced that it had been
notified by the Securities and Exchange Commission ("SEC") that the SEC had
commenced a formal investigation of the Company. The SEC requested that the
Company provide the SEC with certain documents concerning possible violations of
the federal securities laws in connection with the Company's public reports and
financial statements. On July 26, 1995 the Company announced that it had entered
into a settlement with the SEC. The Company agreed to an order pursuant to
Section 8A of the Securities Act of 1933 and Section 21C of the Securities
Exchange Act of 1934, whereby the Company agreed to cease and desist from
committing or causing any future violation of certain enumerated sections of
those acts and rules promulgated thereunder. The Company believes that the SEC's
investigation of the Company has now been concluded.
Department of Justice. In August 1994, the Company received a subpoena from the
U.S. Department of Justice ("DOJ") to produce documents in connection with a
grand jury investigation regarding the irregularities identified in the
information filed in the Company's previous press releases and financial
statements. The Company was not notified by the DOJ that it was a target or
subject of this
17
investigation. On July 26, 1995, the Company announced that the DOJ had
concluded its investigation as to the Company without further action.
Nasdaq Proceedings. On June 3, 1994, the Company announced that it had been
notified by the National Association of Securities Dealers, Inc. ("NASD") that
it was conducting a review of trading in the Company's securities and had
requested that the Company provide it with certain documents and information.
The Company cooperated with the NASD in connection with this review. On July 26,
1995, the Company announced that the NASD had concluded its investigation as to
the Company without further action.
The Company was in violation of the requirements for continued listing of its
Common Stock on the Nasdaq National Market due to its failure to file in a
timely fashion all required financial statements and public reports. The
Company's Common Stock was delisted from the Nasdaq National Market on November
14, 1994 and listed and traded on the Nasdaq SmallCap Market pursuant to a
temporary exemption from certain listing requirements.
On December 27, 1994, Nasdaq relisted the Company's Common Stock on the Nasdaq
National Market after Nasdaq's Listing Qualifications Committee determined that
the Company had substantially met all the criteria necessary for inclusion on
the National Market. See further discussion under "Status of Operations".
Texas Litigation On September 11, 1995, one of the Company's shareholders who
elected not to be included in the settlement of the shareholder class action
litigation discussed above, filed a complaint in Dallas County, Texas. The
matter is entitled Caffey v. Kurzweil Applied Intelligence, Inc., et al. Mr.
Caffey's complaint asserts that the Company and certain former officers and
directors committed fraud and violated Texas state law and unnamed federal
securities laws. The Complaint seeks $1,500,000 in damages.
The Company moved the case to the United States District Court for the Northern
District of Texas on November 6, 1995. The case was assigned Docket No.
3:95-CV-2660-J. On November 13, 1995, the Company filed an answer to the
complaint, which contained an offer of settlement pursuant to which the Company
offered to repurchase from Mr. Caffey his 1,000 shares of Company stock at the
original price he paid for such shares plus interest and certain attorneys'
fees. Mr. Caffey has rejected the Company's offer. This case is in the
deposition and pre-trial discovery stage, and at this point, the Company does
not believe that the outcome will have a material adverse effect on the
financial position of the Company.
On December 10, 1996, David Earl, the Company's former Vice President of
Operations, filed a Complaint in Middlesex Superior Court, Civil Action No.
96-07037, asserting claims against the Company and the Lexington Insurance
Company ("Lexington"), an entity that issued a directors and officers insurance
policy. The Complaint alleged that the Company breached the Massachusetts
Consumer Protection Act (M.G.L. c. 93A) and various contractual duties allegedly
owed to Mr. Earl by refusing to indemnify Mr. Earl against claims brought by the
United States Attorney's Office, the Securities and Exchange Commission and Mr.
Caffey. The Complaint also alleges that the Company improperly refused to permit
Mr. Earl to exercise certain stock options and that Lexington breached
contractual duties by refusing to reimburse Mr. Earl for costs associated with
those claims. Mr. Earl seeks an unspecified amount of damages.
On January 13, 1997, Lexington filed an Answer to the Complaint and asserted
cross-claims against the Company, alleging that the policy should be rescinded
and that the Company violated M.G.L. c. 93A because it obtained the insurance
policy by fraudulent means. Lexington also asserted a claim for common law
indemnification, claiming that to the extent Lexington is liable to Mr. Earl,
the Company is liable to Lexington.
On January 28, 1997, the Company filed an Answer to Mr. Earl's Complaint and
Lexington's cross-claim and asserted counterclaims against Mr. Earl and
cross-claims against Lexington. The parties have recently commenced discovery.
On April 8, 1997, the Company was served with a complaint in an action entitled
R. E. Thomason General Hospital District v. Kurzweil Applied intelligence, Inc.
No. EP-97-CA-129, which is pending in the United States District Court for the
Western District of Texas, El Paso Division. The plaintiff seeks approximately
$160,000 in actual damages, plus interest, attorneys fees, and court costs and
such other relief as it is entitled to. The complaint arises out of the sale by
the Company of a VoiceMED
18
system to the plaintiff in April 1993, which the plaintiff claims failed to
perform as warranted. The Company believes that the complaint is without merit
and intends to vigorously defend this law suit.
By letter dated April 16, 1997, the Company received a "Notice of Consumer Legal
Action, Notice of Class Action and Demand for Remedy" from the "American Justice
Center" of Irvine, California notifying the Company and other defendants of a
claim under various sections of the California Civil Code that the Company's
VoicePad product does not perform as advertised. The plaintiff demands that the
Company recall all VoicePad products sold to date, refund to purchasers their
purchase price, reimburse the plaintiff for its legal costs, cease the
activities complained of, and otherwise comply with the California Civil Code.
The notice and demand was filed in the California Superior Court for the County
of Los Angeles and is styled Melanie Shah & all purchasers of VOICEPAD Software,
the American Justice Center, et al. Plaintiff(s) v. CompUSA; Best Buy Co., Inc.:
Alpha Software Corp.; SoftQuad international, Inc.: Kurzweil Applied
Intelligence, Inc.; Andrea Electronics Corp.; et al. Defendant(s). The plaintiff
purports to represent a class consisting of all purchasers of the Company's
VoicePad product. The Company believes that the demand is without merit and
intends to vigorously defend against this action.
Item 4. Submission Of Matters To A Vote Of Security Holders
No matters were submitted to a vote of shareholders of the Company during the
fourth quarter of the fiscal year ended January 31, 1997.
19
EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the names, ages, positions with the Company and a brief
description of the business experience during the last five years of the
executive officers of the Company, all of whom serve until they resign or are
removed by the Board of Directors:
Name Age Position
---- --- --------
Thomas E. Brew, Jr. 54 Chairman of the Board of Directors
President, Chief Executive Officer
Thomas B. Doherty 38 Chief Financial Officer, Vice President of
Finance and Treasurer
Mark D. Flanagan 44 Executive Vice President
W. Francis Ganong 44 Vice President, Research
Raymond C. Kurzweil 49 Chief Technology Officer
John J. Scarcella 42 Vice President of Sales
Thomas E. Brew, Jr. Effective November 1, 1994, Mr. Brew joined the Company and
became Chief Executive Officer and President of the Company. He had been serving
as Acting Co-Chief Executive Officer and President of the Company since May 23,
1994. Mr. Brew is also a Director of the Company and was elected Chairman of the
Board in June 1995. Mr. Brew is a founder and from 1988 to November 1994 was
Executive Vice President of Argus Management Corporation ("Argus"), a management
consulting firm which provides interim management services. Mr. Brew is a
director of Cambridge Soundworks, Inc., a factory direct stereo company.
Thomas B. Doherty became the Company's Vice President of Finance, Treasurer and
Chief Financial Officer on November 1, 1994. He had been serving as Acting Chief
Financial Officer of the Company since May 23, 1994. Prior thereto, Mr. Doherty
had been a financial consultant at Argus since 1988.
Mark D. Flanagan joined the Company in January 1993 and was elected Vice
President of Business Development in May 1993. Mr. Flanagan was elected
Executive Vice President in June 1994. Prior to joining the Company, Mr.
Flanagan served as President and CEO of Lotus Publishing Corporation, a
subsidiary of International Data Group, Inc. from 1991 to 1992. Mr. Flanagan
also worked at Lotus Development Corporation from 1988 to 1991 in various
positions including President of Lotus Publishing Corporation and Vice President
of Corporate Marketing from 1988 to 1989.
20
W. Francis Ganong joined the Company in 1982 and became Vice President, Research
in May 1993. Mr. Ganong was formerly Director of Research of the Company. Mr.
Ganong holds a Ph.D. and is a graduate of MIT and Harvard.
Raymond C. Kurzweil, the founder of the Company, has been Chief Technology
Officer since the Company's inception in 1982. He also served as the Company's
Chief Executive Officer from 1982 to 1991, as Co-Chief Executive Officer from
1991 to November 1994, and as Chairman from 1982 to 1995. Mr. Kurzweil is a
Director of Wang Laboratories, Inc., and is the Chairman of its Strategy and
Technology Committee.
John J. Scarcella joined the Company in 1985 as a Sales Manager for the
Company's Mid- Atlantic territory. Prior to being elected the Company's Vice
President of Sales in September 1995, he served as Vice President of National
Accounts and Government Operations.
____________________
21
PART II
Item 5. Market For Registrant's Common Equity And Related Stockholder Matters
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol KURZ. The following table reflects the range of bid prices of the Common
Stock by fiscal quarter for fiscal years 1996 and 1997. This information is
based on prices reported on the Nasdaq National Market.
Bid Prices
----------
1996 High Low
---- -----------------
First Quarter (ended April 30, 1995)...................... $ 6.000 $ 4.375
Second Quarter (ended July 31, 1995) ..................... $ 5.250 $ 2.750
Third Quarter (ended October 31, 1995) ................... $ 4.750 $ 2.750
Fourth Quarter (ended January 31, 1996) .................. $ 7.125 $ 2.750
1997
----
First Quarter (ended April 30, 1996) ..................... $ 4.750 $ 2.370
Second Quarter (ended July 31, 1996) ..................... $ 5.062 $ 1.687
Third Quarter (ended October 31, 1996) ................... $ 4.562 $ 2.000
Fourth Quarter (ended January 31, 1997) .................. $ 4.312 $ 2.750
At January 31, 1997, there were 876 holders of record of the Company's Common
Stock. The Company has not paid any dividends since its inception and does not
intend to pay any dividends on its Common Stock in the foreseeable future.
22
Item 6. Selected Financial Data
The following selected financial data for the five years ended January 31, 1997
are derived from financial statements of the Company. The data should be read in
conjunction with the financial statements, related notes and other financial
information included herein.
(In thousands, except for per share amounts)
Fiscal Year
--------------------------------------------------------------------
1993 1994 1995 1996 1997
--------- ----------- ----------- ------------ ------------
Statement of Operations
Revenues
Product and license revenue $10,772 $9,157 $11,174 $7,680 6,686
Maintenance revenue 348 970 1,188 1,680 1,861
--------- ----------- ----------- ------------ ------------
Total revenues 11,120 10,127 12,362 9,360 8,547
Operating costs and expenses:
Cost of product and maintenance revenue 4,103 6,490 5,689 4,777 3,937
Cost of contract revenue 366 -- -- -- --
Inventory write-down -- 800 -- -- --
Sales and marketing 5,825 6,488 5,882 3,582 4,057
Research and development 1,549 2,742 2,587 2,341 3,066
General and administrative 1,489 4,226 2,316 1,503 1,752
--------- ----------- ----------- ------------ ------------
Total operating costs and expenses 13,332 20,746 16,474 12,203 12,812
--------- ----------- ----------- ------------ ------------
Operating loss (2,212) (10,619) (4,112) (2,843) (4,265)
Interest expense 129 161 19 12 4
Interest income 41 174 219 197 115
Other income (expense), net 16 (10) (30) 72 14
Settlement of stockholders' lawsuit -- -- 7,250 -- --
--------- ----------- ----------- ------------ ------------
Loss before income taxes (2,284) (10,616) (11,192) (2,586) (4,140)
Provision for income taxes 9 -- -- -- --
--------- ----------- ----------- ------------ ------------
Net loss ($2,293) ($10,616) ($11,192) ($2,586) ($4,140)
========= =========== =========== ============ ============
Per common share:
Net loss ($18.48) ($3.99) ($2.13) ($0.38) ($0.50)
Weighted average number of common
shares outstanding 124 2,661 5,248 6,756 8,342
========= =========== =========== ============ ============
January 31,
--------------------------------------------------------------------
1993 1994 1995 1996 1997
--------- ----------- ----------- ------------ ------------
Balance Sheet
Working capital $775 $7,643 $3,717 $660 ($97)
Total assets 6,945 18,364 13,041 8,864 8,173
Long-term debt 2,100 -- -- -- --
Capital lease obligations 412 79 142 29 --
Stockholders' equity 1,653 9,328 5,327 2,888 2,787
23
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis of the Company's results of operations and
liquidity is based on the Company's financial statements and should be read in
conjunction with the financial statements and notes thereto contained elsewhere
herein.
RESULTS OF OPERATIONS
The Company's revenues are derived from the sale of Kurzweil VoiceMED, Kurzweil
Clinical Reporter Products, maintenance contracts (the "Medical Products") and
Kurzweil Voice for WINDOWS (the "PC Application Products") products.
Total revenues declined over the three year period from $12,362,000 in fiscal
1995 to $9,360,000 in fiscal 1996 and $8,547,000 in fiscal 1997. Within product
and license revenues, sales of Medical Products (excluding maintenance
contracts) declined from $10,273,000 in fiscal 1995 to $5,465,000 in fiscal 1996
and $3,628,000 in fiscal 1997. This decline reflected the significant decrease
in shipments of the Company's VoiceMED product in fiscal 1996 and 1997 due to
the reduced acceptance in the marketplace of the Company's DOS-based operating
platform technology, a reduction in the Company's direct medical sales force,
and decrease in orders from the government sector. As a result of these declines
in sales, the gross margins in this product line also declined from 49% in
fiscal 1995 to 38% in fiscal 1996 and 36% in fiscal 1997, and revenues related
to the product line began to increase in the second half of fiscal 1997. The
Company transitioned the Medical Products line from DOS-based VoiceMED products
to the Windows-based Clinical Reporter product during fiscal 1997. Product sales
to military and veterans hospitals owned by the United States Government, which
had totaled $3,525,000 in fiscal 1995 declined to $1,127,000 in fiscal 1996 and
$541,000 in fiscal 1997 (or 28%, 12% and 6% of total revenues in those years)
because of changes in government funding levels and the lower acceptance of the
DOS-based product.
Within product and license revenues during the three year period, revenues from
the PC Application product line increased from $901,000 in fiscal 1995 to
$2,215,000 in fiscal 1996 and $3,058,000 in fiscal 1997. This revenue growth was
the result of enhancements in the product line and expansion of distribution
channels. The gross margins on revenues was 48% in fiscal 1995, 37% in fiscal
1996 and 48% in fiscal 1997. The fluctuation in margin for those years was due
to the mix of unit product shipments and the higher margin license revenues.
Through the Alpha software agreement, the Company introduced PC Application
products into retail distribution at the end of fiscal 1997. Based upon results
of initial trials, retail distribution of the PC Application Product was
expanded during the first quarter of fiscal 1998 and preliminary results
indicate that retail product market acceptance could increase revenues for that
product line, although there can be no assurance that this will occur.
Maintenance revenue increased during the three year period from $1,188,000 in
fiscal 1995 to $1,680,000 in fiscal 1996 and $1,861,000 in fiscal 1997 as a
result of a larger installed customer base for the Medical Products, and
programs implemented to increase the use of maintenance contracts.
24
Cost of Product and Maintenance Revenue
---------------------------------------
Cost of product and maintenance revenue includes hardware costs, manufacturing
overhead, system replacement parts associated with maintenance contracts,
third-party software royalties and license fees, amortization of capitalized
costs and amortization of expenses for certain patients settlements. Cost of
product and maintenance revenue declined from $5,689,000 in fiscal 1995, to
$4,777,000 in fiscal 1996 and $3,937,000 in fiscal 1997 as revenues declined.
Costs of product and maintenance revenues in fiscal 1996 and 1997 included
$1,107,000 in amortization expense for the Dragon patent settlement. See Item 1.
"Description of Business-Dragon Settlement and Cross License Agreement". Also
included in cost of product and maintenance revenue were royalty expenses of
$192,000, $96,000 and $47,000 in fiscal 1995, 1996 and 1997, respectively, and
the amortization of capitalized software development costs.
Cost of product and maintenance revenue as a percentage of total revenues went
from 46 in fiscal 1995 to 51% in fiscal 1996 and 46% in fiscal 1997. The
increase in the cost as a percentage of total revenue in fiscal 1996 was
primarily the result of amortization of the fixed expense for the Dragon patent
settlement against a lower revenue base. The decrease in the cost of product and
maintenance revenues as a percentage of revenue in fiscal 1997 was primarily the
result of an increase in the amount of software-only and license revenue for the
PC Application Product line.
Capitalized software amortization expense for fiscal 1995, 1996 and 1997 was
$790,000, $1,081,000 and $909,000, respectively.
In the fourth quarter of fiscal 1996, the Company recorded a reserve against
capitalized software and increased the amortization by $400,000 to adjust
capitalized software to its estimated net realizable value, reflecting the
Company's declining revenues in the last two quarters of fiscal 1996 and its
dependence on market acceptance of new products to be introduced in fiscal 1997
Sales and Marketing Expenses. Sales and marketing expenses include costs for
marketing, selling, and supporting the Company's products. These expenses
decreased from $5,882,000 in fiscal 1995 to $3,582,000 in fiscal 1996, and
increased to $4,057,000 in fiscal 1997, representing 48%, 38%, and 47% of total
revenues, respectively. The largest component of these costs relates to
compensation for sales and support personnel, travel, and office expenses. The
Company's sales and support personnel increased from 29 employees at January 31,
1995 to 31 employees at January 31, 1996 to 35 employees at January 31, 1997.
The lower level of sales and marketing expenses in fiscal 1995 and 1996 was a
result of the Company reorganizing its distribution strategy for its Medical
Products group by focusing on VAR's, system integrators and dealers and using a
smaller direct sales force. The reorganization resulted in a 20%
25
reduction in the Company's workforce, mainly in the sales and field support
organizations. The Company also experienced an unexpected attrition in the
medical sales force during the period in question. The Company also closed all
but one of its sales and support offices, outside of the Waltham, Massachusetts
facility, to reduce costs. See Item 1 "Business - Marketing, Sales and
Distribution".
The increase in fiscal 1997 expenses over 1996 was due to the marketing expenses
associated with the launching of the Windows-based Medical Products, increased
Medical Products sales staffing, and an increase in catalog advertising prices
for the PC Application Product line.
Research and Development Expenses. Research and development expenditures consist
principally of personnel costs, allocated facility costs, and associated
equipment amortization and depreciation. A portion of the total research and
development expenditures are capitalized in accordance with Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed," the amortization of which
is included in cost of product and maintenance revenue.
Total research and development expenses, net of capitalization, decreased from
$2,587,000 in fiscal 1995 to $2,341,000 in fiscal 1996, and increased to
$3,066,000 in fiscal 1997, representing 21%, 25%, and 36% of total revenues,
respectively. The decrease in research and development expense between fiscal
1995 and 1996 was due to the capitalization of the various development projects,
including product upgrades, new versions of Kurzweil VOICE for Windows and the
development of the Kurzweil Clinical Reporter for the Medical Products Group.
The increase in fiscal 1997 R&D expenses was due primarily to the 23% increase
in employees from fiscal 1996.
The Company's research and development personnel increased from 42 employees at
January 31, 1995, to 52 employees at January 31, 1996, to 64 employees at
January 31, 1997. In order to maintain its competitive position and to develop
new and enhanced products, the Company intends to continue its investment in
research and development.
General and Administrative Expenses. General and administrative expenses
decreased from $2,316,000 in fiscal 1995 to $ 1,503,000 in fiscal 1996, and
increased to $1,752,000 in fiscal 1997, representing 18%, 16% and 20% of total
revenues, respectively. The decrease in fiscal 1996 was due to continued
emphasis on reducing overhead costs and stringent cost controls. Included in
general and administrative expenses was $232,000, $105,000, and $75,000 as
provisions for doubtful accounts for fiscal 1995, 1996, and 1997, respectively.
The increase in the fiscal 1997 general and administrative expenses was due
mainly to the continuing legal costs of the Caffey litigation and a claim
against the Company for reimbursement of legal expenses by a former officer of
the Company.
Interest Income. Interest income is generated by invested cash and marketable
securities. Interest income decreased from $219,000 in fiscal 1995 to $197,000
in fiscal 1996 to $115,000 in 1997, due to a decrease in the amount of cash
available for investment.
Settlement of Stockholders Lawsuit. On April 27, 1995, the Company received
final court approval of the stockholder class action settlement. The settlement
provided for the class
26
members to receive 1,475,827 shares of Common Stock having a market value of
$7,250,000. The number of shares of Common Stock was based on the average
closing prices during the five consecutive trading days starting May 19, 1995.
In June 1995, the class members' counsel received 442,748 of the shares in
partial payment of legal fees. In March 1996, the remaining 1,033,079 shares
were distributed to class members. In addition, the Company made a cash payment
of $250,000 in fiscal 1996, and assigned any claims it may have against its
former public accountants, Coopers & Lybrand L.L.P., to the class members.
Income Taxes. At January 31, 1997, the Company had federal net operating loss
carryforwards of approximately $54,000,000. In addition, at January 31, 1997 the
Company had federal tax credit carryforwards of approximately $900,000. The net
operating loss carryforwards expire during the years 1998 through 2010 and the
tax credit carryforwards expire during the years 1998 through 2010.
Substantially all of the Company's net operating loss and tax credit
carryforwards are subject to limitation under the provisions of Section 382 of
the Internal Revenue Code. The limitation impacts both the amount of the net
operating loss and tax credit carryforwards available to offset future income
and income tax liabilities. Limitations are imposed when an ownership change, as
defined by federal tax law, has occurred. The limitation depends in part upon
the value of the Company immediately prior to the ownership change. The Company
believes an ownership change did occur in connection with the Company's initial
public offering in August 1993. Prior to the initial public offering, the
Company may have incurred an ownership change in connection with prior
financings. If an ownership change did in fact occur in an earlier year, the
annual limitation and available carryforward could be reduced significantly.
LIQUIDITY AND CAPITAL RESOURCES
At January 31, 1997, the Company's principal sources of liquidity were cash,
cash equivalents, and marketable securities of $1,439,000, and the Company had a
working capital deficit of $97,000. If the merger with L&H is not consummated,
the Company's financial condition and growth will be dependent upon obtaining
adequate additional financing to support the anticipated continuation of losses
in fiscal 1998, and until profitable operations are achievable.
The Company's operating activities used cash of $2,405,000 in fiscal 1995,
$376,000 in fiscal 1996, and $2,102,000 in fiscal 1997. The Company will be
required to pay $1,019,000 to Dragon on June 1, 1997 as part of the patent cross
license agreement. See Item 1. "Description of Business - Dragon Settlement and
Cross Licensing Agreement".
The Company has incurred operating losses since its inception and these losses
are expected to continue into fiscal 1998. On May 10, 1996 the Company received
$2,376,000 from the private sale of 1,320,050 shares of Common Stock to an
investment fund. On July 31, 1996, the Company received approximately $1,669,000
from the private sale of 927,000 shares of Common Stock to accredited investors.
There can be no assurances that these financings will be sufficient to sustain
the Company's operations through the end of fiscal 1998.
27
Pursuant to the terms of a Loan Agreement dated April 14, 1997 (the "Loan
Agreement"), L&H USA agreed to loan to the Company up to $1.5 million under a
line of credit (the "Loan") to finance the Company's working capital needs,
including certain license payments due to Dragon. The Company may, subject to
the terms and conditions contained in the Loan Agreement, draw on the line of
credit until June 30, 1997. The Loan is evidenced by a line of credit note dated
April 14, 1997 in the original principal amount of $1.5 million (the "Note").
The Note bears interest at the "prime rate" as of April 14, 1997 as published in
The Wall Street Journal. All outstanding principal and interest under the Note
is due and payable in full on October 31, 1997. The Company has drawn down the
entire amount of the loan on April 30, 1997 Once repaid, the Loan may not be
reborrowed. The Company's obligations under the Loan Agreement and the Note are
secured by a security interest in all of its assets.
In consideration for the commitment to make the Loan, the Company issued to L&H
USA a warrant to purchase 185,000 shares of the Company's Common Stock at a
price of $3.21 per share pursuant to the terms of a common stock warrant (the
"Warrant") dated April 14, 1997. The Warrant is immediately exercisable and
expires on April 14, 2002 (the "Expiration Date"); provided, that L&H USA's
right to exercise the Warrant will expire immediately upon L&H USA's failure to
make the Loan as required in the Loan Agreement or the termination by the
Company of the Merger Agreement as a result of L&H USA breach of certain
provisions thereof; and, provided, further, that L&H USA may not exercise the
Warrant for so long as L&H USA is in default of its obligation to loan funds in
accordance with the Loan Agreement and such default is continuing.
The consummation of the merger with L&H is subject to approval by the Company's
stockholders. If the acquisition is not consummated, the Company will be forced
to seek to obtain additional capital to fund its operations through fiscal 1998.
There can be no assurances that the merger with Lernout & Hauspie will be
consummated, or that, if it is not consummated, that the Company will be able to
raise the necessary capital to continue in operation. If additional financing is
not obtained, the Company will be required to restructure its operations,
curtail its spending in research and development, attempt a merger with another
company, or seek protection under the bankruptcy laws. The Company's inability
to obtain an audit opinion on its fiscal 1993 financial statements and its
statements of operations, cash flows, and stockholders equity for fiscal 1994
prevented the Company from accessing the public financial markets in 1994 and
1995. Public financing would be subject to market conditions and other
uncertainties, and no assurance can be given that the Company could obtain
public financing at any time. Either public or private equity financing would
likely result in dilution of the Company's existing stockholders.
At January 31, 1997, the Company was not in compliance with the Nasdaq By-Laws
net worth requirements for the continued listing of the Company's Common Stock
on the Nasdaq National Market. The Company will request an exemption from Nasdaq
for the continued listing of the Common Stock on the Nasdaq National Market
while it seeks stockholder approval of the merger with L&H. If the merger is not
completed, then the Company will seek to obtain additional financing. If an
exemption is not granted, the Company will request that it be eligible for
re-admission to the Nasdaq National Market without having to comply with the
higher initial listing requirements. If the Company does not meet the listing
requirements, it may not qualify for re-admission to the Nasdaq National Market
for an undetermined period of time. Any delisting of the Company's Common Stock
from trading on the National Market may adversely affect the price of the Common
Stock.
28
MERGER WITH LERNOUT AND HOUSPIE SPEECH PRODUCTS, N.V.
On April 14, 1997, the Company entered into an Agreement and Plan of Merger with
L & H and L&H USA, whereby L&H USA would be merged into the Company and each
outstanding share of the Company's Common Stock will be exchanged for $4.20 in
cash and $1.05 in common stock of L&H, subject to adjustment in certain
circumstances. The closing of the business combination is subject to certain
conditions and approvals, including the approval of the stockholders of the
Company.
Founded in 1987, L&H develops and sells a broad variety of speech and language
technology, products and services. L&H licenses and distributes its products to
companies in the telecommunications, telephony, computer, consumer electronics
and automotive electronics industries. L & H's corporate headquarters is located
in Ieper, Belgium, and its Common Stock is traded on the Nasdaq National Market
under the symbol LHSPF.
Achieving the anticipated benefits of the merger will depend on , among other
things, the integration of the companies' respective product offerings,
coordination of sales and marketing organizations, and research and development
efforts. There can be no assurance that integration will be accomplished
smoothly and successfully. The integration of certain operations following the
merger will require the dedication of management resources which may temporarily
distract the attention from the day-to-day business of the respective companies.
The inability of management to successfully integrate the operations of the two
companies could have an adverse effect on the business and results of operations
of the combined companies. In addition, there can be no assurance that present
and potential customers of the Company and L&H will continue their current
buying patterns and any significant delay or reduction in orders could have an
adverse effect on the results of operations. In the event the merger is not
consummated, the Company's stock price may decline and its results of operations
could be materially and adversely affected. In addition, the Company's
relationships with its customers and position in the industry could be
materially and adversely affected. Further, such failure could have a negative
impact on the Company's ability to attract and retain key personnel.
Certain Factors that May Affect Future Results
The Company's future results are subject to substantial risks and uncertainties.
The Company currently derives substantially all of its revenue from the sale of
software licenses that utilize speech recognition to create text documents.
The Company believes that factors affecting the ability of the Company's
products to achieve general market acceptance include product performance,
price, ease of installation, learning and use. To be successful in the future
the Company must respond promptly and effectively to the challenges of
technological change and its competitors' innovations by continually enhancing
its current products and developing new products on a timely basis. Certain
current and potential competitors of the
29
Company that are more established benefit from greater market recognition and
have substantially greater financial, development and marketing resources than
the Company. Competitive pressures or other factors, including entry into new
markets, may result in significant price erosion that could have a material
adverse effect on the Company's results of operations.
The Company believes that its operating results could vary significantly from
quarter to quarter. The Company's license fee revenue in any quarter is
substantially dependent on orders booked and shipped in that quarter. The timing
of license fee revenue is influenced by a number of factors, including the
timing of individual orders and shipments of its products, customer buying
patterns, changes and delays in product development, and the amount and timing
of sales and marketing expenditures. Because the Company's operating expenses
are based on anticipated revenue levels, and a high percentage of the Company's
expenses are relatively fixed in the short-term, variations in revenue can cause
significant fluctuations in operating results from quarter to quarter and may
result in anticipated quarterly earnings falling below anticipated levels and/or
losses.
Cautionary Statement
From time to time, information provided by the Company or statements made by its
employees may contain "forward-looking" information which involves risks and
uncertainties. In particular, statements contained in this "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations", which
are not historical facts (including, but not limited to statements concerning
anticipated operating expense levels and such expense levels relative to the
Company's total revenues and expected losses) are "forward-looking statements."
The Company's actual future results may differ significantly from those stated
in any forward-looking statements. Factors that may cause such differences
include, but are not limited to, the factors discussed above as well as the
accuracy of the Company's internal estimates of revenue and operating expense
levels. Each of these factors, and others, are discussed from time to time in
the Company's Securities and Exchange Commission filings.
30
Item 8. Financial Statements and Supplementary Data
Reports of Independent Public Accountants and Auditors.
Balance Sheets at January 31, 1996 and 1997.
Statement of Operations for the fiscal years ended January 31, 1995,
1996 and 1997.
Statements of Changes in Stockholders' Equity for the fiscal years ended
January 31, 1995, 1996 and 1997.
Statements of Cash Flows for the fiscal years ended January 31, 1995,
1996 and 1997.
Notes to Financial Statements
Schedule II - Valuation and Qualifying Accounts
31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Shareholders and Directors of
Kurzweil Applied intelligence, Inc.
We have audited the accompanying balance sheet of Kurzweil Applied Intelligence,
Inc. as of January 31, 1997 and the related statements of operations,
stockholders' equity, and cash flows for the year then ended. These financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Kurzweil Applied Intelligence,
Inc. at January 31, 1997 and the results of its operations and its cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
The accompanying financial statements and schedule have been prepared assuming
that Kurzweil Applied Intelligence, Inc. will continue as a going concern. As
more fully described in Note 3 to the financial statements, the Company has
incurred substantial losses and had negative cash flows from operations in each
of the last three fiscal years and has experienced declining revenues each of
the last two years. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans with regard to these
matters are also described in Note 3. The financial statements and schedule do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The Schedule of Valuation and Qualifying Accounts,
included in Schedule II on page 55, is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
/s/ Arthur Andersen LLP
Boston, Massachusetts
March 21, 1997 except for Note 3, as to which
the date is April 14, 1997
32
REPORT OF INDEPENDENT AUDITORS
------------------------------
The Shareholders and Directors of
Kurzweil Applied Intelligence, Inc.
We have audited the accompanying balance sheet of Kurzweil Applied Intelligence,
Inc. as of January 31, 1996 and the related statements of operations,
stockholders' equity, and cash flows for the two years then ended. Our audit
also included the financial statement schedule for the years ended January 31,
1995 and 1996 listed in the Index at Item 14(a) 2. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Kurzweil Applied Intelligence,
Inc. at January 31, 1996 and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule for
the years ended January 31 1995 and 1996, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Kurzweil
Applied Intelligence, Inc. will continue as a going concern. As more fully
described on Note 3 to the financial statements, the Company has incurred
substantial losses and had negative cash flows from operations in each of the
last three fiscal years and experienced a decline of approximately 25% in total
revenues during 1996 compared with the prior year. These conditions raise doubt
about the Company's ability to continue as a going concern. Management's plans
with regard to these matters are also described in Note 3. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
Boston, Massachusetts /s/ Ernst & Young LLP
March 29, 1996, except for
Note 3 as to which the date
is May 9, 1996
33
KURZWEIL APPLIED INTELLIGENCE, INC.
BALANCE SHEETS
January 31,
--------------------------
1996 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $2,083,898 $456,886
Marketable securities available for sale 500,623 981,875
Trade accounts receivable, less allowances
of $287,000 and $325,000
at January 31, 1996 and 1997, respectively 1,221,469 2,157,730
Inventory 398,483 354,322
Other current assets 261,800 187,633
------------ ------------
Total current assets 4,466,273 4,138,446
Property and equipment, net 924,061 721,305
Intangible assets 1,744,976 678,047
Capitalized software development costs, net 1,592,850 2,531,605
Other assets 135,770 103,796
------------ ------------
Total assets $8,863,930 $8,173,199
============ ============
LIABILITIES
Current liabilities:
Accounts payable $664,786 $1,114,561
Accrued expenses 2,211,107 2,100,982
Capital lease obligations 28,688 --
Current portion of other long-term liabilities 901,810 1,019,460
------------ ------------
Total current liabilities 3,806,391 4,235,003
Other long-term liabilities 2,169,128 1,151,523
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none issued and outstanding
Common stock, $.01 par value; 15,000,000 shares
authorized; 5,733,387 and 9,061,880 shares
issued and outstanding at January 31, 1996
and 1997, respectively 57,334 90,619
Additional paid-in capital 57,647,425 66,727,014
Common stock to be issued 5,075,000 --
Accumulated deficit (59,891,348) (64,030,960)
------------ ------------
Total stockholders' equity 2,888,411 2,786,673
------------ ------------
Total liabilities and stockholders' equity $8,863,930 $8,173,199
============ ============
These notes are an integral part of the financial statements.
34
KURZWEIL APPLIED INTELLIGENCE, INC.
STATEMENTS OF OPERATIONS
Years Ended January 31,
---------------------------------------------
1995 1996 1997
------------- ------------ -------------
Revenues:
Product and license revenue $11,174,125 $7,680,006 $6,686,249
Maintenance revenue 1,188,000 1,680,000 1,861,115
------------- ------------ -------------
Total revenues 12,362,125 9,360,006 8,547,364
------------- ------------ -------------
Operating costs and expenses:
Cost of product, license and
maintenance revenue 5,688,685 4,776,578 3,937,106
Sales and marketing 5,881,827 3,581,677 4,056,802
Research and development 2,587,421 2,340,519 3,066,031
General and administrative 2,316,351 1,502,927 1,751,736
------------- ------------ -------------
Total operating costs and expenses 16,474,284 12,201,701 12,811,675
------------- ------------ -------------
Operating loss (4,112,159) (2,841,695) (4,264,311)
Interest expense 19,095 12,197 3,632
Interest income 219,293 196,637 114,885
Other (expense) income, net (30,121) 71,749 13,446
Settlement of stockholders' lawsuit 7,250,000 ---- ----
------------- ------------ -------------
Net loss ($11,192,082) ($2,585,506) ($4,139,612)
============= ============ =============
Net loss per common share ($2.13) ($0.38) ($0.50)
============= ============ =============
Weighted average number of common
shares outstanding 5,247,895 6,755,779 8,342,157
============= ============ =============
The accompanying notes are an integral part of the financial statements.
35
KURZWEIL APPLIED INTELLIGENCE, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the years ended January 31, 1995, 1996 and 1997
Adjustment to
unrealized
gains/(losses)
Additional Common on securities Total
Common Paid-In Stock to be available Accumulated Stockholders'
Stock Capital Issued for sale Deficit Equity
------- ----------- ---------- -------------- ----------- -------------
Balance at January 31, 1994 $52,433 $55,389,444 ($46,113,760) $9,328,117
Issuance of 3,000 shares of common stock at
$7.00 per share to existing shareholder
upon exercise of warrants 30 20,970 21,000
Issuance of 7,224 shares of common stock
at $1.50 per share to employees upon
exercise of options, net of expenses 72 10,702 10,774
Common stock to be issued for settlement
of stockholders' lawsuit $7,250,000 7,250,000
Unrealized gains/(losses) ($91,250) (91,250)
Net loss (11,192,082) (11,192,082)
------- ----------- ----------- --------- ------------ ----------
Balance at January 31, 1995 52,535 55,421,116 7,250,000 (91,250) (57,305,842) 5,326,559
Issuance of 37,104 shares of common stock
at $ 1.50 per share to employees upon
exercise of options, net of expenses 371 55,737 56,108
Common stock issued as partial settlement
of stockholders' lawsuit 4,428 2,170,572 (2,175,000)
Unrealized gain 91,250 91,250
Net loss (2,585,506) (2,585,506)
------- ----------- ----------- --------- ------------ ----------
Balance at January 31, 1996 57,334 57,647,425 5,075,000 0 (59,891,348) 2,888,411
Issuance of 47,870 shares of common stock
at $1.50 per share to employees upon
exercise of options, net of expenses 479 71,326 71,805
Common stock issued for settlement
of stockholders' lawsuit 10,331 5,064,669 (5,075,000)
Issuance of 1,320,050 shares of common stock
at $2.00 per share in a private sale
to an investment fund on May 10, 1996,
net of expenses 13,200 2,323,130 2,336,330
Issuance of 927,500 shares of common stock
at $2.00 per share in a private sale
to accredited investors on July 31,
1996, net of expenses 9,275 1,620,464 1,629,739
Net loss (4,139,612) (4,139,612)
------- ----------- ----------- --------- ------------ ----------
Balance at January 31, 1997 $90,619 $66,727,014 $0 $0 ($64,030,960) $2,786,673
======= =========== =========== ========= ============ ==========
The accompanying notes are an integral part of the financial statements
36
KURZWEIL APPLIED INTELLIGENCE, INC.
STATEMENTS OF CASH FLOWS
Year Ended January 31,
----------------------------------------------------
1995 1996 1997
------------ ------------ -----------
Cash flows from operating activities:
Net loss ($11,192,082) ($2,585,506) ($4,139,612)
Adjustments to reconcile net loss to net cash
(used) in operating activities:
Depreciation 519,081 565,074 506,423
Amortization 1,909,783 1,804,633 2,037,044
Provision for doubtful accounts 231,756 105,000 75,000
Settlement of stockholders' lawsuit 7,250,000
Change in operating assets and liabilities:
(Increase) decrease in accounts receivable (637,774) 101,929 (1,011,261)
Decrease in inventory 633,736 638,446 44,161
Decrease (increase) in other assets 265,375 (179,038) 45,056
(Decrease) increase in accounts payable (147,759) (1,356) 449,775
(Decrease) in accrued expenses
and other liabilities (1,237,461) (825,555) (108,269)
---------- ---------- ---------
Net cash (used) in operating activities (2,405,345) (376,373) (2,101,683)
---------- ---------- ---------
Cash flows from investing activities:
Purchase of marketable securities available for sale (481,252)
Sale of marketable securities available for sale 6,003,596 1,000,627
Payments for property and equipment, net (509,248) (829,410) (303,667)
Capitalized software development costs (725,993) (1,162,273) (1,847,785)
---------- ---------- ---------
Net cash provided by (used) in investing activities 4,768,355 (991,056) (2,632,704)
---------- ---------- ---------
Cash flows from financing activities:
Payments on capital lease obligations (187,975) (113,479) (28,688)
Payments on licensing agreement (798,062) (901,810)
Proceeds from issuance of capital stock, net 31,774 56,108 4,037,873
------- ------- ---------
Net cash provided by (used) in financial activities (156,201) (855,433) 3,107,375
---------- ---------- ---------
Net increase (decrease) in cash 2,206,809 (2,222,862)
(1,627,012)
Cash and cash equivalents, beginning of period 2,099,951 4,306,760 2,083,898
---------- ---------- ---------
Cash and cash equivalents, end of period $4,306,760 $2,083,898 $456,886
========== ========== ========
Supplementary disclosure of cash flow information:
Cash paid during year for:
Interest $19,095 $12,197 $3,632
The accompanying notes are an integral part of the financial statements
37
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Kurzweil Applied Intelligence, Inc. (the "Company") develops, markets and
supports automated speech recognition systems used to create documents and
interact with computers by voice. The Company has concentrated initially on the
healthcare industry, where there is a need for accurate and timely reporting for
patient care, risk management, billing and third party reimbursement. The
Company also developed and is marketing Kurzweil VOICE for Windows, which
incorporates a large vocabulary, speaker-independent, and discrete speech
recognition technology running in the Windows operating environment.
2. SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of the financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts represented
in the financial statements and accompanying notes. Actual results could differ
from these estimates.
Cash and Cash Equivalents
Cash equivalents consist of liquid investments with original maturities of three
months or less at the date of acquisition. The carrying amount reported in the
balance sheet for cash and cash equivalents approximates fair value.
Marketable Securities
The Company classifies its investments in marketable securities as "available
for sale." Marketable securities are stated at fair market value and consist of
non-equity corporate securities and liquid U.S. Government obligations. At
January 31, 1996 and 1997 there were no unrealized gains or losses recorded as
cost approximates market value.
Inventory
Inventory is stated at the lower of cost or market. Cost is determined using the
first-in, first-out method.
38
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Property and Equipment
Property and equipment are stated at cost. Equipment and furniture and fixtures
are depreciated on the straight-line basis over the estimated useful life of the
asset, generally three years.
Research and Development Costs
Costs incurred in the research and development of new software products and
significant enhancements to existing software products are expensed in the
period incurred until technological feasibility has been established, after
which point they are capitalized until such products are released for sale.
Capitalized software costs are amortized on a product by product basis
commencing with the release of the related software product. The amortization
included in product cost of revenue is the greater of the amount computed using
the ratio of current gross revenue to total current and anticipated gross
revenue on the straight-line method over the estimated useful life of the
product not to exceed three years. The Company continually compares the
unamortized portion of capitalized software development costs to the net
realizable value of the related product. The net realizable value is the
estimated future gross revenue from the product reduced by estimated future
costs of completing and disposing of that product. The amount by which the
unamortized capitalized costs exceed the net realizable value is written off.
Amortization expense for fiscal years 1995, 1996 and 1997 was $790,000,
$1,081,000, and $909,000, respectively. In fiscal year 1996 the Company provided
$400,000 of additional amortization due to the uncertainty of recoverability of
certain previously capitalized software development costs.
In November 1993, the U.S. Department of Commerce selected the Company to
participate in the Department's National Institute of Standards and Technology
(NIST) Advanced Technology Program. Under the program, the Company is developing
software to allow users to operate their personal computers through normal
spoken language. The program is a government reimbursed arrangement which is
billed monthly as costs are incurred. The program operated from March 1994
through February 1997. The Company's policy is to offset research and
development expense for amounts billed under the program. Billings totaled
$440,000, $469,500, and $723,000 for fiscal year 1995, 1996, and 1997,
respectively.
In December 1995, the Company announced it had been awarded a $2 million grant
by the Commerce Department's National Institute of Standards and Technology
(NIST) Advanced Technology Program. The award provides funding for the
development of medical record documentation systems using open systems standards
for linking with other health care information systems, and applying user
interface technologies including large vocabulary speech-recognition and pen
combined with flexibly structured knowledge bases to assure ease of use. Medical
record documentation systems are a prerequisite to the creation of useful
clinical databases for outcome studies, cost effectiveness studies, and other
efforts to improve both the quality and the cost effectiveness of medical care
in the United States.
39
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
The technology developed under the NIST grant will be two-way accepting clinical
information from the care giver (physician exam notes, for example) and feeding
back information such as clinical treatment guidelines from central data
repositories. The program is a government reimbursement arrangement which is
billed monthly as costs are incurred. The program is expected to continue
through November 1997. The Company's policy is to offset research and
development expense for the amounts billed under the program. Billings totaled
$78,600 and $779,000 for fiscal year 1996 and 1997, respectively. Amounts funded
by the government under these grants are paid as costs are incurred.
Revenue Recognition
Revenue from product sales is recorded at the time of shipment if no significant
obligation relating to the sale remains and collection is deemed probable.
Maintenance revenue is recognized ratably over the term of the maintenance
agreements. Maintenance revenue for the years ended January 31, 1995, 1996 and
1997 totaled $1,188,000, $1,680,000, and $1,861,000, respectively. Related cost
of maintenance revenue is expensed as incurred over the term of the maintenance
agreements.
In fiscal 1995, 1996 and 1997, product sales to military and veterans hospitals
owned by the United States government totaled $3,525,000, $1,127,000 and
$541,000 respectively, representing 28%, 12% and 6% of the Company's total
revenues.
Cost of Product and Maintenance Revenue
Cost of product and maintenance revenue includes hardware costs, manufacturing
overhead, system replacement parts associated with maintenance contracts, third
party software royalties and license fees, and amortization of capitalized
software.
Warranties and Customer Support
The Company's products include a 90-day warranty that products will be free from
defects in materials and workmanship and that the software will perform in
accordance with applicable specifications. The Company is obligated to repair or
replace, at its option, any products that do not meet specifications. The
Company currently receives a one-year warranty from its existing CPU vendor.
This vendor-provided warranty reduces, in part, the Company's warranty costs.
An accrual is made for warranty costs and is charged to expense at the time of
sale.
The Company provides post-sale customer support free of charge for a 90 day
period. An accrual is made for customer support at the time of sale.
Income Taxes
40
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
The Company records income taxes in accordance with Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes" (SFAS 109), which
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under this method, deferred tax liabilities and
assets are determined based on the difference between the financial statement
and tax bases of assets and liabilities using enacted tax rates in effect for
the year in which the differences are expected to reverse. SFAS 109 also
requires a valuation allowance against net deferred tax assets if, based on the
weighted available evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized.
Stock Based Compensation
In October 1995, the Financial Accounting Standards Board (FASB) issued
Statement No. 123, Accounting for Stock Based Compensation. Presently, the
Company grants stock options for a fixed number of shares to employees with an
exercise price equal to the fair market value of the shares at the date of
grant. As allowed under the new standard, the Company accounts for stock option
grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and accordingly, recognizes no compensation expense for the stock
option grants. The Company will continue to account for stock options under this
method.
Loss Per Share
Loss per share data is based solely on the weighted average number of shares of
common stock outstanding. The weighted average number of shares outstanding
includes the shares associated with the shareholders' lawsuit. Common equivalent
shares outstanding have not been included because they would be anti-dilutive
under the treasury stock method.
Impact of Recently Issued Accounting Standards
In March 1995, the FASB issued Statement No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the carrying amount of the assets.
Statement No.121 also addresses the accounting for long-lived assets that are
expected to be disposed of. The Company adopted Statement No.121 in the first
quarter of 1997 and there was no material impact on the financial statements for
the year ended January 31, 1997.
In February 1997, the FASB issued Statement No. 128, Earnings Per Share, which
established new standards for computing and presenting earnings per share (EPS).
Statement No. 128 is effective for fiscal years ending after December 15, 1997
and will require restatement of prior period EPS. Early adoption is not
permitted. The Company does not believe the adoption of Statement No. 128 will
have a material effect on EPS as reported in the financial statements.
41
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Reclassifications
Certain prior years' amounts have been reclassified to conform to the current
year presentation.
3. STATUS OF OPERATIONS AND LEGAL PROCEEDINGS
Merger
On April 14, 1997 the Company entered into an Agreement and Plan of Merger with
Lernout & Hauspie, Speech Products, N.V. (" L&H") a Belgian corporation listed
on the Nasdaq National Market (Nasdaq symbol: LHSPF), and a subsidiary of L&H
("L&H USA") pursuant to which L&H USA would be merged into the Company and each
outstanding share of the Company's Common Stock will be exchanged for $4.20 in
cash and $1.05 in common stock of L&H, subject to adjustment in certain
circumstances. The closing of the business combination is subject to certain
conditions and approvals, including the approval of the stockholders of the
Company.
On April 14, 1997, the Company entered into a Loan Agreement with L&H USA.
Pursuant to the terms of a Loan Agreement dated April 14, 1997 (the "Loan
Agreement"), L&H USA agreed to loan to the Company up to $1.5 million under a
line of credit (the "Loan") to finance the Company's working capital needs,
including certain license payments due to Dragon. The Company may, subject to
the terms and conditions contained in the Loan Agreement, draw on the line of
credit until June 30, 1997. The Loan is evidenced by a line of credit note dated
April 14, 1997 in the original principal amount of $1.5 million (the "Note").
The Note bears interest at the "prime rate" as of April 14, 1997 as published in
The Wall Street Journal. All outstanding principal and interest under the Note
is due and payable in full on October 31, 1997. The Company has drawn down the
entire amount of the loan on April 30, 1997. Once repaid, the Loan may not be
reborrowed. The Company's obligations under the Loan Agreement and the Note are
secured by a security interest in all of its assets.
In consideration for the commitment to make the Loan, the Company issued to L&H
USA a warrant to purchase 185,000 shares of the Company's Common Stock at a
price of $3.21 per share pursuant to the terms of a common stock warrant (the
"Warrant") dated April 14, 1997. The Warrant is immediately exercisable and
expires on April 14, 2002 (the "Expiration Date"); provided, that L&H USA's
right to exercise the Warrant will expire immediately upon L&H's failure to make
the Loan as required in the Loan Agreement or the termination by the Company of
the Merger Agreement as a result of L&H USA breach of certain provisions
thereof; and, provided, further, that L&H USA may not exercise the Warrant for
so long as L&H USA is in default of its obligation to loan funds in accordance
with the Loan Agreement and such default is continuing.
Operations
The Company experienced losses and negative cash flows in each of the last three
fiscal years. Beginning in 1994, the Company increased research and development
staffing and spending to develop new and enhanced products for both the medical
and personal computer markets in order to increase revenue. The delay in the
delivery of the new and enhanced products and the decrease in revenues from the
DOS- based VoiceMED medical products adversely affected fiscal 1996 and fiscal
1997 revenues, and resulted in operating losses which are expected to continue
into fiscal 1998, as the Company continues its investment in research and
development. The Company delivered new and enhanced products during the second
half of fiscal 1997, but there can be no assurance that the Company's new and
enhanced products will be purchased in sufficient quantities to materially
improve revenues or generate profits.
On May 10, 1996, the Company raised approximately $2.3 million from the private
placement of 1,320,050 shares of its Common Stock. In addition, on July 31,
1996, the Company raised approximately $1.6 million from the private sale of
Common Stock. There can be no assurances that the May 10, 1996 or July 31, 1996
financing will be sufficient to sustain the Company's operations through all of
fiscal 1998. The Company's future capital requirements will depend on many
factors, including the progress and scope of its research and development
programs. To the extent that the Company is not able to fund its future
operations through the sale of its products, the Company will need to obtain
additional funds through private or public financing. The Company's inability to
obtain an audit opinion on its fiscal 1993 financial statements and its
statements of operations, cash flows, and stockholders
42
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
equity for fiscal 1994 prevented the Company from seeking public financing in
1994 and 1995. Public financing would be subject to market conditions and other
uncertainties, and no assurance can be given that the Company could obtain
public financing on acceptable terms, it at all. Either public or private equity
financing is likely to result in dilution of the Company's existing stockholders
and there can be no assurance that the Company would be able to obtain such
additional financing.
As discussed above, if the merger with L&H is not consummated and if additional
financing is not obtained as discussed above, the Company will be required to
restructure its operations, curtail its spending in research and development, or
attempt a merger with another company.
At January 31, 1997, the Company was not in compliance with Nasdaq By-Laws net
worth requirements for the continued listing of the Company's Common Stock on
the Nasdaq National Market. The Company will request an exemption from Nasdaq
for the continued listing of its Common Stock on the Nasdaq National Market
pending stockholders approval of the merger with L&H. If an exemption is not
granted, the Company will request that it be eligible for re-admission to the
Nasdaq National Market without having to comply with the higher initial listing
requirements. If the Company is not granted such an exemption and is required to
meet the initial or relisting requirements to obtain re-admission to the Nasdaq
National Market, it may not qualify for such re-admission for an undetermined
period of time. Any delisting of the Company's Common Stock from trading on the
Nasdaq National Market may adversely affect the price of the Company's Common
Stock.
Legal Proceedings
Class Action Litigation. The Company announced on April 28, 1994 that the
Company and its auditors were reviewing certain aspects of the Company's revenue
recognition policies and practices and related matters and that the Company
expected this review to result in a substantial loss for fiscal 1994.
Subsequently, five purported class action lawsuits were filed in the United
States District Court for the District of Massachusetts. These lawsuits were
purportedly brought by and on behalf of purchasers of the Company's Common Stock
pursuant or traceable to the Company's Prospectus dated August 17, 1993 and in
the aftermarket through April 28, 1994. These lawsuits were filed against the
Company and certain of these also named as defendants, Raymond C. Kurzweil (the
Company's former Chairman, Chief Technology Officer and former Co-Chief
Executive Officer), Bernard F. Bradstreet (former Co-Chief Executive Officer,
President, and Chief Financial Officer and director), and the underwriters of
the Company's August 1993 initial public offering of Common Stock, Robertson,
Stephens & Co., L.P., Needham & Company, Inc. and the Company's former auditors,
Coopers & Lybrand L.L.P.
On April 27, 1995, the Company received final court approval of the agreement to
settle the stockholder class action litigation. In accordance with the
settlement, the class members and
43
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
their counsel received 1,475,827 shares of Common Stock having a value of
$7,250,000 based on the average closing price of shares of Common Stock during
the five consecutive trading days starting May 19, 1995.. In June 1995, the
class members' counsel received their portion of the shares, 442,748 shares in
the aggregate. In March 1996, the remaining 1,033,079 shares of Common Stock
were distributed to class members. In addition, as part of the settlement, the
Company made a cash payment of $250,000, and assigned any claims it may have
against its former public accountants, Coopers & Lybrand L.L.P. to the class
members. The Company believes these proceedings are now concluded as to the
Company's involvement.
SEC Investigation. On June 3, 1994, the Company announced that it had been
notified by the Securities and Exchange Commission ("SEC") that it had commenced
a formal investigation of the Company. The SEC has requested that the Company
provide certain documents concerning possible violations of the federal
securities laws in connection with the Company's public reports and financial
statements.
Pursuant to the Company's Certificate of Incorporation, and certain of its
contractual obligations, the Company may be obligated to indemnify its current
and former officers and directors and certain other persons under claims arising
from the lawsuits, and to reimburse certain costs incurred by such persons as a
result of the lawsuits. Matters relating to the indemnification of and
reimbursement of certain costs to former officers involved in the lawsuits may
be on-going. Based on the Company's investigation and other facts presented in
various legal proceedings, it is the Company's belief that the Company is not
responsible for costs incurred by such persons as a result of these lawsuits and
legal proceedings. Although there can be no assurances that the Company will not
face a loss, an estimate of the possible loss or range of loss, if any, can not
be made since the outcome of certain proceedings are not final and, accordingly,
no accrual is recorded. It is not expected that the loss, if any, will have a
materially adverse effect on the Company.
In fiscal 1994, the Company accrued a liability of $2,000,000 for the expected
costs of the restatement of its financial statements, legal costs associated
with the shareholder lawsuits, and costs of the SEC investigation and related
matters. At January 31, 1995, 1996, and 1997 the accrued liability has a
remaining balance of approximately $700,000, $100,000, and $250,000
respectively. The increase in the accrued liability at January 31, 1997 relates
to expected costs associated with the Texas litigation described below.
On July 26, 1995, the Company announced that it had entered into a settlement
with the SEC. The Company agreed to a consent decree pursuant to Section 8A of
the Securities Act of 1933 and Section 21C of the SEC Exchange Act of 1934,
whereby the Company agreed to cease and desist from committing or causing any
violation of certain enumerated sections of those acts and rules promulgated
thereunder. The Company believes that the SEC's investigation of the Company has
now been concluded.
44
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Nasdaq Proceedings. On June 3, 1994, the Company announced that it had been
notified by the National Association of Securities Dealers, Inc. ("NASD") that
it was conducting a review of trading in the Company's securities. On July 7,
1995, the Company was informed by NASD that it had concluded its review of the
trading activity of the Company's stock without further action.
The Company was in violation of the requirements for continued listing of its
Common Stock on the Nasdaq National Market due to its failure to file in a
timely fashion all required financial statements and public reports. The
Company's Common Stock was delisted from the Nasdaq National Market on November
14, 1994 and listed and traded on the Nasdaq SmallCap Market pursuant to a
temporary exemption from certain listing requirements.
On December 27, 1994, Nasdaq relisted the Company's Common Stock on the Nasdaq
National Market after Nasdaq's Listing Qualifications Committee determined that
the Company had substantially met all the criteria necessary for inclusion on
the National Market. See further discussion under "Status of Operations".
Department of Justice. In August 1994, the Company received a subpoena from the
U.S. Department of Justice ("DOJ") to produce documents in connection with a
grand jury investigation regarding the irregularities identified in the
information filed in the Company's previous press releases and financial
statements. The Company was not notified by the DOJ that it was a target or
subject of this investigation. On July 26, 1995, the Company announced that the
DOJ has concluded its investigation as to the Company without further action.
Texas Litigation. On September 11, 1995, one of the Company's shareholders who
elected not to be included in the settlement of the shareholder class action
litigation, filed a complaint in Dallas County, Texas. The matter is entitled
Caffey v. Kurzweil Applied Intelligence, Inc., et al. Mr. Caffey's complaint
asserts that the Company and certain former officers and directors committed
fraud and violated Texas state law and unnamed federal securities laws. The
Complaint seeks $1,500,000 in damages.
The Company moved the case to the United States District Court for the Northern
District of Texas on November 6, 1995. The case was assigned Docket No.
3:95-CV-2660-J. On November 13, 1995, the Company filed an answer to the
complaint, which contained an offer of settlement pursuant to which the Company
offered to repurchase from Mr. Caffey his 1,000 shares of Company stock at the
original price he paid for such shares plus interest and certain attorneys'
fees. Mr. Caffey has rejected the Company's offer. This case is in the
deposition and pre-trial discovery stage, and although there can be no
assurances, the Company does not believe that the outcome will have a material
adverse effect on the financial position of the Company.
On April 8, 1997, the Company was served with a complaint in an action entitled
R. E. Thomason General Hospital District v. Kurzweil Applied intelligence, Inc.
No. EP-97-CA-129, which is pending in the United States District Court for the
Western District of Texas, El Paso Division. The plaintiff seeks approximately
$160,000 in actual damages, plus interest, attorneys
45
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
fees, and court costs and such other relief as it is entitled to. The complaint
arises out of the sale by the Company of a VoiceMED system to the plaintiff in
April 1993, which the plaintiff claims failed to perform as warranted. The
Company believes that the complaint is without merit and intends to vigorously
defend this law suit.
By letter dated April 16, 1997, the Company received a "Notice of Consumer Legal
Action, Notice of Class Action and Demand for Remedy" from the "American Justice
Center" of Irvine, California notifying the Company and other defendants of a
claim under various sections of the California Civil Code, that the Company's
VoicePad product does not perform as advertised. The plaintiff demands that the
Company recall all VoicePad products sold to date, refund to purchasers their
purchase price, reimburse the plaintiff for its legal costs, cease the
activities complained of, and otherwise comply with the California Civil Code.
The notice and demand was filed in the California Superior Court for the County
of Los Angeles and is styled Melanie Shah & all purchasers of VOICEPAD Software,
the American Justice Center, et al. Plaintiff(s) v. CompUSA; Best Buy Co., Inc.:
Alpha Software Corp.; SoftQuad international, Inc.: Kurzweil Applied
Intelligence, Inc.; Andrea Electronics Corp.; et al. Defendant(s). The plaintiff
purports to represent a class consisting of all purchasers of the Company's
VoicePad product. The Company believes that the demand is without merit and
intends to vigorously defend against this action.
On December 10, 1996, David Earl, the Company's former Vice President of
Operations, filed a Complaint in Middlesex Superior Court, Civil Action No.
96-07037, asserting claims against the Company and the Lexington Insurance
Company ("Lexington"), an entity that issued a directors and officers insurance
policy. The Complaint alleged that the Company breached the Massachusetts
Consumer Protection Act (M.G.L. c. 93A) and various contractual duties allegedly
owed to Mr. Earl by refusing to indemnify Mr. Earl against claims brought by the
United States Attorney's Office, the Securities and Exchange Commission and Mr.
Caffey. The Complaint also alleges that the Company improperly refused to permit
Mr. Earl to exercise certain stock options and that Lexington breached
contractual duties by refusing to reimburse Mr. Earl for costs associated with
those claims. Mr. Earl seeks an unspecified amount of damages.
On January 13, 1997, Lexington filed an Answer to the Complaint and asserted
cross-claims against the Company, alleging that the policy should be rescinded
and that the Company violated M.G.L. c. 93A because it obtained the insurance
policy by fraudulent means. Lexington also asserted a claim for common law
indemnification, claiming that to the extent Lexington is liable to Mr. Earl,
the Company is liable to Lexington.
On January 28, 1997, the Company filed an Answer to Mr. Earl's Complaint and
Lexington's cross-claim and asserted counterclaims against Mr. Earl and
cross-claims against Lexington. The parties have recently commenced discovery.
4. INVENTORY
Inventory as of January 31, 1996 and 1997 consisted of:
1996 1997
------------- ------------
Purchased parts $338,807 $238,432
Finished goods $59,676 $115,890
------------- ------------
$398,483 $354,322
============= ============
46
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
5. PROPERTY AND EQUIPMENT
Property and equipment as of January 3, 1996 and 1997 consisted of:
1996 1997
------------ -----------
Computer equipment $2,109,455 $2,413,122
Furniture and fixtures 45,340 45,340
------------ -----------
$2,154,795 $2,458,462
============ ===========
Less accumulated depreciation and amortization 1,230,734 1,737,157
------------ -----------
$924,061 $721,305
============ ===========
6. INTANGIBLE ASSETS AND OTHER LONG-TERM LIABILITIES
On September 23, 1993, the Company and Dragon Systems, Inc. ("Dragon") settled
certain patent infringement litigation between the two companies. As part of
such settlement, the Company licensed certain Dragon patents related to
continuous speech and other aspects of speech recognition technology. The
Company paid Dragon $1,331,250 in fiscal 1994, $798,000 in fiscal 1996 and
$901,810 in fiscal 1997. Under the terms of this agreement, the Company was
committed to make aggregate payments of $5,202,000, including $625,000 in
settlement of amounts due for products sold during periods prior to September
23, 1993. The following mandatory payments remain outstanding as of January 31,
1997:
June 1, 1997 1,019,460
June 1, 1998 1,151,523
-----------
Total $2,170,983
===========
The Company expensed $1,107,600 during each of fiscal 1995, 1996, and 1997. The
remaining asset of $369,200 will be amortized on a straight-line basis through
May 31, 1997. According to the agreement, the Company, if it chooses not to
extend the license, has use of the licensed technology through May 31, 1997.
The Company, at its option, can annually extend the license of the technology
through fiscal 2006, at which time the license would be fully paid. Total
additional payments during the extension period would approximate $13.5 million.
Under the terms of the settlement agreement, the Company may terminate its
payment obligations by notifying Dragon in writing, effective one year after the
date of the last payment made by the Company prior to the notice of termination,
provided that the Company would remain obligated for two additional payments
beyond the payments already made by the Company.
47
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
7. ACCRUED EXPENSES
Accrued expenses as of January 31, 1996 and 1997 consisted of:
1996 1997
------------- -----------
Deferred revenue $1,238,169 $846,912
Accrued vacation 210,366 244,257
Unbilled receipts 317,896 314,363
Accrued warranties and customer support 175,198 175,198
Legal, investigative, and audit restatement costs 100,000 249,706
Other 169,478 270,546
------------- -----------
$2,211,107 $2,100,982
============= ===========
8. COMMITMENTS
The Company leases its headquarters under a non-cancelable operating lease which
expires in fiscal 2000. Future non-cancelable minimum payments will be
approximately $400,000 in fiscal 1998, $426,000 in fiscal 1999 and $37,000 in
fiscal 2000. The Company also has a renewable annual lease on a sales office.
For the years ended January 31, 1995, 1996, and 1997, rent expense totaled
$512,000, $361,000, and $404,000, respectively.
9. CAPITAL STOCK
In connection with certain prior year financings, the Company issued warrants to
purchase shares of common stock which expire 5 years from their respective issue
dates. As of January 31, 1996 and 1997, there remained outstanding warrants to
purchase 157,760 and 106,286 shares of common stock at $7.00 per share
respectively.
In March 1994, as a result of the exercise of warrants, the Company issued to an
existing shareholder 3,000 shares of common stock. The warrants were exercisable
at a price of $7.00 per share.
During fiscal 1995, 1996 and 1997, 7,224 shares, 37,104 shares and 47,870 of
common stock were issued as a result of the exercise of stock options,
respectively. The options were exercisable at a price of $1.50 per share.
On May 10, 1996, the Company received net proceeds of approximately $2,336,000
from the private sale of 1,320,050 shares of common stock to an investment fund.
48
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
At the Company's Annual Meeting of the Stockholders on June 28, 1996, the
stockholders approved a resolution increasing the Company's authorized shares of
the Common Stock from 10 million to 15 million shares.
On July 31, 1996, the Company received net proceeds of approximately $1,630,000
from the private sale of 927,500 shares of common stock to accredited investors.
The Company also issued warrants to purchase 224,755 shares of the Company's
common stock for $2.00 per share in connection with the 1996 May and July
private placements.
The Company also issued to L&H USA a warrant to purchase 185,000 shares of
the Company's Common Stock for $3.21 per share in connection with the loan
commitment.
10. STOCK OPTIONS
Pro Forma Stock-based Compensation Plans Expenses
On October 5, 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based
Compensation," which sets forth a fair-value based method of recognizing
stock-based compensation expense. As permitted by SFAS No. 123, the Company has
elected to continue to apply APB 25 in accounting for its stock-based
compensation plans. Had compensation cost for awards in 1996 and 1997 under the
Company's stock-based compensation plans been determined based on the fair value
at the grant dates consistent with the method set forth under SFAS No. 123, the
effect on the Company's net loss and loss per share would have been as follows:
Net Loss 1996 1997
---- ----
As reported...................... ($2,585,506) ($4,139,612)
Pro forma........................ (2,912,587) (4,689,254)
Loss per share:
As reported...................... (0.38) (0.50)
Pro forma........................ (0.43) (0.56)
Because the method prescribed by SFAS No. 123 has not been applied to options
granted prior to February 1, 1995, the resulting pro forma compensation expense
may not be representative of the amount to be expected in future years. Pro
forma compensation expense for options granted is reflected over the vesting
period, therefore future pro forma compensation expense may be greater as
additional options are granted.
49
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
1996 1997
---- ----
Risk-free interest rate................................ 6.9% 7.0%
Expected life of options............................... 9 Years 10 Years
Expected volatility.................................... 96.8% 96.8%
The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
sensitive assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
Stock Option Plans Activity
In April 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan")
under which incentive and non-statutory stock options may be granted to purchase
a total of 600,000 common stock. The option price per share and the expiration
date are determined by the Compensation Committee of the Board of Directors at
the date of grant. Incentive stock options are granted at not less than their
fair market value as of the date of grant, and the options generally vest over
five years and expire ten years after the date of the grant. Transactions in
fiscal 1996 and 1997 under the 1995 Plan are as follows:
Option Option Price
Shares Per Share
--------- ---------------
Granted 245,750 $2.375 - $5.125
-
Cancelled (29,822) $2.375 - $5.125
--------
Outstanding at January 31, 1996 215,928 $2.375 - $5.125
Granted 318,500 $2.375 - $5.125
Cancelled (46,321) $2.375 - $5.125
--------
Outstanding at January 31, 1997 488,107 $2.375 - $5.125
========
Available for future grant 111,893 $2.375 - $5.125
========
Exercisable at January 31, 1997 40,838 $2.375 - $5.125
========
50
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
In April 1995, the Company adopted the 1995 Non-Employee Director Stock Option
Plan (the `Director Plan') under which non-statutory stock options are
automatically granted to non-employee directors. A total of 100,000 shares of
common stock are reserved for issuance under the Director Plan. The option price
per share is equal to the fair market value per share of common stock on the
date of grant. The option expiration date occurs on the tenth anniversary date
of the grant or the first anniversary of the date the optionee ceases to serve
as a director of the Company. Transactions in fiscal 1996 and 1997 under the
Director Plan are as follows:
Option Option Price
Shares Per Share
------- --------------
Granted 50,000 2.875 - $4.375
-------
Outstanding at January 31, 1996 50,000 2.875 - $4.375
Granted 12,000 2.875 - $4.375
-------
Outstanding at January 31, 1997 62,000 2.875 - $4.375
=======
Available for future grant 38,000 2.875 - $4.375
=======
Exercisable at January 31, 1997 56,000 2.875 - $4.375
=======
In April 1992, the Company adopted the 1992 Stock Option Plan (the "1992 Plan")
under which incentive and non-statutory stock options may be granted to purchase
a total of 150,000 shares of common shares. The option price per share and the
expiration date are determined by the Compensation Committee of the Board of
Directors at the date of grant. Incentive stock options are granted at not less
than their fair market value as of the date of grant and the options vest over a
four-year period and expire ten years after the date of grant. In April 1993,
stockholders increase the options available under the 1992 Plan to 450,000
shares. Transactions in fiscal 1995, 1996, and 1997 under the 1992 Plan are as
follows:
51
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Option Option Price
Shares Per Share
--------- ---------------
Outstanding at January 31, 1994 238,500 $2.437 - $4.125
Granted 251,790 $2.437 - $4.125
Exercised (300) $2.437 - $4.125
Cancelled (96,606) $2.437 - $4.125
---------
Outstanding at January 31, 1995 393,384 $2.437 - $4.125
Cancelled (23,905) $2.437 - $4.125
---------
Outstanding at January 31, 1996 369,479 $2.437 - $4.125
Cancelled (11,388) $2.437 - $4.125
---------
Outstanding at January 31, 1997 358,091 $2.437 - $4.125
=========
Available for future grant 91,909 $2.437 - $4.125
=========
Exercisable at January 31, 1997 84,577 $2.437 - $4.125
=========
Effective October 19, 1994, the Board of Directors approved the re-pricing of
certain stock options issued under the 1992 Plan to $4.125 per share. Of the
options than outstanding, options covering 13,780 shares were not re-priced.
In February 1990, the Company adopted the 1990 Stock Option Plan (the "1990
Plan") under which incentive and non-statutory stock options may be granted to
purchase a total of 400,000 shares of common stock. In fiscal 1990, the number
of shares authorized was increased to 540,000. The option price per share and
the expiration date are determined by the Compensation Committee of the Board of
Directors at the date of grant. Incentive stock options are granted at not less
than their fair market value as of the date of grant, and the options generally
vested and exercisable over a four-year period and expire ten years after the
date of grant. Transactions in fiscal 1995, 1996 and 1997 under the 1990 Plan
are as follows:
52
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Option Option Price
Shares Per Share
---------- -------------
Outstanding at January 31, 1994 500,448 $1.50 - 5.125
Granted 70,000 $1.50 - 5.125
Exercised (38,740) $1.50 - 5.125
Cancelled (149,822) $1.50 - 5.125
----------
Outstanding at January 31, 1995 381,886 $1.50 - 5.125
Granted 138,000 $1.50 - 5.125
Exercised (35,550) $1.50 - 5.125
Cancelled (21,512) $1.50 - 5.125
----------
Outstanding at January 31, 1996 462,824 $1.50 - 5.125
Exercised (47,870) $1.50 - 5.125
Cancelled (38,806) $1.50 - 5.125
----------
Outstanding at January 31, 1997 376,148 $1.50 - 5.125
==========
Available for future grant 163,852 $1.50 - 5.125
==========
Exercisable at January 31, 1997 248,417 $1.50 - 5.125
==========
On July 31, 1996 the Board of Directors approved the re-pricing of outstanding
options for current employees at $2.437 per share.
Holders of stock options granted under the 1990 Plan forfeited their rights to
exercise their stock options granted under the Company's 1984 Stock Option Plan
( the "1984 Plan"). As a result, in fiscal 1990, stock options covering 10,277
shares previously granted and outstanding under the 1984 Plan were canceled.
The 1984 Plan expired by its terms in 1994 . The 1984 Plan provides for the
grant of incentive and non-statutory stock options covering a total of 18,975
shares of Common Stock. The option price per share and the expiration date were
determined by the Board of Directors at the date of grant. Incentive stock
options were granted at not less than their fair value as of the date of grant
and the options generally vested ratably over a five-year period and expire ten
years after the date of grant.
11. INCOME TAXES
A reconciliation of the Company's effective tax rate to the statutory federal
rate for the years ended January 31 is as follows:
53
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
1995 1996 1997
-------- -------- -------
Statutory federal rate (34.0)% (34.0)% 34.0)%
State income taxes, net of federal tax benefit --- --- ---
Research and development credit --- --- ---
Net losses without tax benefit 11.8 30.9 32.7
Permanent differences 22.2 3.1 1.3
Change in federal valuation allowance --- --- ---
-------- -------- -------
--- --- ---
======== ======== =======
Permanent differences are primarily due to non-deductible officer's life
insurance, business meals and entertainment expenses and the settlement of the
class action litigation.
The Company prospectively adopted the provisions of SFAS 109 as of February 1,
1993. Adoption did not have a material impact on the Company's results of
operations or financial position. Due to the uncertainty of realizing the
benefit of the deferred tax asset, a valuation allowance has been fully
provided.
Deferred tax assets at January 31, 1996 and 1997 consisted of:
1996 1997
------------- --------------
Assets:
Reserves $1,196,000 $1,325,000
Federal NOLs 16,909,000 18,495,000
Federal tax credit carryforwards 900,000 900,000
State NOLs and tax credits, net of federal benefit 1,398,000 1,398,000
------------- --------------
Total assets 20,403,000 22,118,000
Liabilities:
Capitalized software (796,000) (1,011,000)
------------- --------------
Net deferred tax asset 19,607,000 21,107,000
Valuation allowance (19,607,000) (21,107,000)
------------- --------------
Deferred tax balance $0 $0
============= ==============
At January 31, 1996 and 1997, the Company had federal net operating loss
carryforwards of approximately $49,000,000 and $54,000,000, respectively. In
addition, at January 31, 1996 and 1997, the Company had federal tax credit
carryforwards of approximately $900,000. The net operating loss carryforwards
expire during the years 1998 through 2010 and the tax credit carryforwards
expire during the years 1998 through 2010. Substantially all of the Company's
net
54
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
operating loss and tax credit carryforwards are subject to limitation under the
provisions of Section 382 of the Internal Revenue Code.
12. EMPLOYEE BENEFIT PLAN
Effective February 1, 1993, the Company established an elective employee savings
plan, the Kurzweil A.I. 401(k) Retirement Plan ("the Plan"). The Plan covers
substantially all employees. Contributions to the Plan are made by Plan
participants in the investments of their choice. The investments of the Plan
consist of mutual funds. Administrative costs paid by the Company were
approximately $6,900 and $3,600 in fiscal years 1996 and 1997, respectively. The
Company currently does not match employee contributions.
13. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash, investments and trade receivables. The
Company places its cash with high quality credit institutions. At times, cash
balances may be in excess of the FDIC insurance limit.
Marketable securities include low risk, non-equity corporate securities and U.S.
Government obligations. At January 31, 1996 and 1997, the Company had $501,000,
and $982,000 respectively, invested in highly liquid U.S. Government securities
and obligations. These securities are susceptible to market value depreciation
if certain changes in market conditions occur.
The Company performs on-going credit evaluations of its customers' financial
condition and generally does not require collateral. The Company maintains
reserves for potential credit losses.
55
KURZWEIL APPLIED INTELLIGENCE, INC.
NOTES TO FINANCIAL STATEMENTS
Schedule II - Valuation and Qualifying Accounts
Kurzweil Applied Intelligence, Inc.
--------------------------------------------------------------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
--------------------------------------------------------------------------------------------------------------------------------
Description Balance at Additions Deductions Balance at
End
-------------------------------------- of Period
Beginning of Period Charged to Costs Charged to Other
and Expenses Accounts
--------------------------------------------------------------------------------------------------------------------------------
Year Ended January 31, 1997
Allowance for doubtful
accounts $287,000 $75,000 $37,000 $325,000
Year Ended January 31, 1996
Allowance for doubtful
accounts $315,000 $105,000 $133,000 $287,000
Year Ended January 31, 1995
Allowance for doubtful
accounts $100,000 $231,000 $16,000 $315,000
--------------------------------------------------------------------------------------------------------------------------------
56
Item 9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure.
Reference is made to the Company's Report on Form 8-K and 8-K/A
Amendment No. 1, both dated January 9, 1995.
PART III
Item 10. Directors and Executive Officers of the Registrant ;Compliance
with Section 16(a) of the Exchange Act.
The information required by this item regarding the Company's
directors is included in the Company's Proxy Statement to be filed
pursuant to Schedule 14A in connection with the Company's 1997
Annual Meeting of Stockholders under the section captioned "Election
of Directors" and "Beneficial Ownership's Reporting Compliance" and
is incorporated herein by reference thereto. Information regarding
the Company's executive officers is set forth in Part I hereof,
above, under the caption "Executive Officers of the Registrant" and
is incorporated herein by reference thereto. The information
required by these items regarding compliance with Section 16(a) of
the Exchange Act is included in the Company's Proxy Statement to be
filed pursuant to Schedule 14A in connection with the Company 1997
Annual Meeting of Stockholders under the section "Section 16(a)
Beneficial Ownership Reporting Compliance" and is incorporated
herein by reference hereto.
Item 11. Executive Compensation.
The information required by this item is included in the Company's
Statement to be filed pursuant to Schedule 14A in connection with
the Company's 1997 Annual Meeting of Stockholders under the sections
captioned "Directors' Compensation" and "Executive Compensation" and
is incorporated herein by reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is included in the Company's
Statement to be filed pursuant to Schedule 14A in connection with
the Company's 1997 Annual Meeting of Stockholders under the section
captioned "Security Ownership of Certain Beneficial Owners and
Management" and is incorporated herein by reference thereto.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is included in the Company's
Statement to be filed pursuant to Schedule 14A in connection with
the Company's 1997 Annual Meeting of Stockholders under the sections
captioned "Compensation Committee Interlocks and Insider
Participation" and "Certain Relationships and Related Transactions
is incorporated herein by reference thereto.
57
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K.
(a) Documents Filed as Part of this Report.
1. Financial Statements
Report of Independent Accountants.
Balance Sheets at January 31, 1996 and 1997.
Statement of Operations for the years ended January 31, 1995, 1996 and
1997.
Statements of Changes in Stockholders' Equity for the years ended
January 31,1995, 1996 and 1997.
Statements of Cash Flows for the years ended January 31, 1995, 1996 and
1997.
Notes to Financial Statements
2. Financial Statements Schedules for the fiscal years ended January 31,
1997, 1996, and 1995:
Schedule II - Valuation and Qualifying Accounts
Financial statement schedules other than the one listed above are
omitted because they are either not required, not applicable, or the
required information is shown in the financial statements or notes
thereto.
3. Exhibits
Exhibit
Number Description
------ -----------
2.1# Agreement and Plan of merger, dated April 14, 1997, by
and among Lernout & Hauspie Speech Products, N.V.,
Trappist Acquisition Corp. and the Registrant
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 24, 1997).
3.1# Amended and Restated Certificate of Incorporation of
the Registrant (incorporated by reference from the
Registrant's registration statement on Form S-1 (File
No. 33-48103)).
3.2# Amended and Restated Bylaws of the Registrant
(incorporated by reference from the Registrant's
registration statement on Form S-1 (File No.
33-48103)).
58
4.1# Form of Common Stock Certificate (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.1*# 1992 Stock Option Plan of the Registrant (incorporated
by reference from the Registrant's registration
statement on Form S-1 (File No. 33-48103)).
10.2*# 1990 Stock Option Plan of the Registrant (incorporated
by reference from the Registrant's registration
statement on Form S-1 (File No. 33-48103)).
10.3*# 1984 Stock Option Plan of the Registrant (incorporated
by reference from the Registrant's registration
statement on Form S-1 (File No. 33-48103)).
10.4+# Distribution Agreement, dated September 30, 1992, by
and between Registrant and EMSA Limited Partnership
(incorporated by reference from the Registrant's
registration statement on Form S-1 (File No.
33-48103)).
10.5# Lease Agreement as amended, dated September 2, 1983, by
and between the Registrant and Duffy Brothers
Construction, Inc. as amended on October 1, 1989,
October 14, 1988 and November 30, 1990 (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.6# Form of Invention, Non-Disclosure and Non-Competition
Agreement (incorporated by reference from the
Registrant's registration statement on Form S-1 (File
No. 33-48103)).
10.7# Form of System Maintenance Agreement (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.8# Form of Terms and Conditions of Sale (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.9# Form of Software License Agreement (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.10+# Agreement with a contract period between April 1, 1993
and March 31, 1994, by and between the Registrant and
the General Services Administration (incorporated by
reference from the Registrant's registration statement
on Form S-1 (File No. 33-48103)).
10.11# Amendment No. 4, dated December 1, 1992, to Lease
Agreement, dated September 2, 1983, as amended, by and
between the Registrant and Duffy Brothers Construction
Inc. (incorporated by reference from the Registrant's
registration statement on Form S-1 (File No.
33-48103)).
10.12# Stock Purchase Warrant of Xerox Corporation to purchase
621,592 shares of Series B Convertible Preferred Stock,
dated September 10, 1991 (incorporated by reference
from the Registrant's registration statement on Form
S-1 (File No. 33-48103)).
59
10.13# Stock Purchase Warrant of Phemus Corporation to
purchase 371,060 shares of Series B Convertible
Preferred Stock, dated September 10, 1991 (incorporated
by reference from the Registrant's registration
statement on Form S-1 (File No. 33-48103)).
10.14# Settlement and Patent Cross-License Agreement between
Kurzweil Applied Intelligence, Inc. and Dragon Systems,
Inc. dated September 23, 1993 (incorporated by
reference from the Registrant's Quarterly Report on
Form 10-Q for the Quarter ended October 31, 1993).
10.15# Agreement on Licensing of Certain Patents of Dragon
Systems, Inc. and Cross-Licensing of Future Patents of
Dragon Systems, Inc. and the Registrant between the
Registrant and Dragon Systems, Inc. dated September 23,
1993 (incorporated by reference from the Registrant's
Quarterly Report on Form 10-Q for the Quarter ended
October 31, 1993).
10.16* Employment Agreement dated November 1, 1994 between the
Registrant and Thomas E. Brew, Jr. (incorporated by
reference from the Registrant's Annual Report on Form
10-K for the fiscal year ended January 31, 1995).
10.17* Placement Agent Agreements, Warrant Purchase
Agreements, Financial Consulting Agreement (from 1996
Private Placement incorporated by reference from the
Registrant's Quarterly Report on Form 10-Q for the
Quarter ended July 31, 1996)
10.18* Letter Agreement dated March 24, 1997 between the
Registrant and Thomas E. Brew, Jr.
10.19* Change in Control Agreement dated February 14, 1997
between the Registrant and Thomas B. Doherty.
10.20* Change in Control Agreement dated February 14, 1997
between the Registrant and Mark Flanagan.
10.21 Stock Option Agreement dated April 14, 1997 between the
Registrant and Lernout & Hauspie Speech Products, N.V.
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 24, 1997).
10.22 Loan Agreement dated April 14, 1997 between the
Registrant and Lernout & Hauspie Speech Products. N. V.
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 24, 1997).
60
10.23 Common Stock Purchase Warrant dated April 14, 1997
issued by the Registrant to Lernout & Hauspie Speech
Products, n. V. (incorporated by reference from the
Registrant's Current Report on Form 8-K dated April 24,
1997)
10.24 Promissory Note in the amount of $1,500,000 dated April
14, 1997 (incorporated by reference from the
Registrant's Current Report on Form 8-K dated April 24,
1997).
10.25 Security Agreements dated April 14, 1997 between the
Registrant and Lernout 7 Hauspie Speech Products, N.V.
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 24, 1997).
11++ Computation of Earnings Per Share.
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young LLP
99.1# Press Release of the Registrant dated April 19, 1995
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 19, 1995).
99.2# Press Release of the Registrant dated April 27, 1995
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 27, 1995).
99.3# Press Release of the Registrant dated April 15, 1997
(incorporated by reference from the Registrant's
Current Report on Form 8-K dated April 24, 1997).
----------------------
++Filed herewith.
* This exhibit is a compensatory plan or arrangement in which one or more
executive officers or directors of the Registrant participate.
# Incorporated herein by reference as noted.
+ Confidential treatment granted as to certain portions.
-------------------------------------------
61
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the Company's fourth fiscal
quarter ended January 31, 1997.
VoiceMED(R), VoiceEM(R), VoiceRAD(R), and VoicePATH(R) are registered trademarks
and VoiceCATH(TM), VoiceDIALYSIS(TM), Kurzweil VOICE(TM), Kurzweil VOICE(TM) for
Windows, Kurzweil VoiceReport(TM), VoiceEM(R)/Nursing, VoiceORTHO(TM),
VoiceGI(TM), VoiceBI(TM), and VoiceMRI(TM), and KBEdit(TM) are trademarks of the
Company.
MS-DOS(R) and Windows(R) are trademarks of Microsoft(R) Corporation,
WordPerfect(R) is a trademark of Novell, Inc., Pentium(TM) is a trademark of
Intel Corporation and RS/6000(TM) is a trademark of International Business
Machines Corporation.
62
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.
Kurzweil Applied Intelligence, Inc.
(Registrant)
By: /s/ Thomas E. Brew. Jr.
-----------------------
Thomas E. Brew, Jr.
President & Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears
below constitutes and appoints each of Thomas E. Brew, Jr., Thomas B. Doherty
and Roger M. Barzun jointly and severally his true and lawful attorneys-in-fact
and agent with full powers of substitution for him and in his name, place and
stead in any and all capacities to sign on his behalf, individually and in each
capacity stated below and to file any and all amendments to this Annual Report
on Form 10-KSB with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents and each of them full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises as fully as he might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or any of them, or
their substitute or substitutes may lawfully do or cause to be done by virtue
thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Title/Capacity Date
Chairman of the Board, Chief Executive Officer
/s/ Thomas E. Brew, Jr. (principal executive officer) April 30, 1997
-------------------------------- and Director
Thomas E. Brew, Jr.
/s/ Thomas B. Doherty Vice President, Treasurer & Chief Financial Officer April 30, 1997
-------------------------------- (principal financial and accounting officer)
Thomas B. Doherty
/s/ Raymond C. Kurzweil Chief Technical Officer and Director April 30, 1997
--------------------------------
Raymond C. Kurzweil
/s/ Steven F. Kaplan Director April 30, 1997
--------------------------------
Steven F. Kaplan
63
/s/ William R. Lonergan Director April 30, 1997
--------------------------------
William R. Lonergan
/s/ David R. A. Steadman Director April 30, 1997
--------------------------------
David R. A. Steadman
/s/ James W. Storey Director April 30, 1997
--------------------------------
James W. Storey
64
[Kurzweil Applied Intelligence, Inc. Letterhead]
March 24, 1997
Thomas E. Brew, Jr.
72 Ferncroft Road
Waban, Massachusetts 02168
Dear Tom:
This letter will serve to confirm and clarify the terms of your employment
agreement dated as of November 1, 1994 and your stock option agreements dated
October 19, 1994 and May 13, 1996 with respect to a Change in Control (as that
term is defined in the 1995 Non-Employee Stock Option Plan of the Company)
occurring while you are an employee of the Company ("the Change in Control.")
The Company will pay you on the effective date of the Change in Control a lump
sum equal to one year of your salary as in effect on the effective date of the
Change in Control and will provide to you the continuation of benefits as
described in the employment agreement for a period of one year after the
effective date of the Change in Control.
You will provide to the Company your services as an employee during the 90-day
period immediately following the Change in Control at the rate of $1,528 for
each business day or any portion of a business day that you render services to
new management of the Company (to the extent that they so request) during the
90-day period.
For a period of one year after the effective date of the Change in Control, you
will provide new management with informal telephone consulting services. These
services will relate to the operations and management of the Company, but shall
not be so time-consuming as to prevent or interfere with your seeking or
engaging in full-time employment or full-time consulting for a third party.
In the event of the Change in Control, the vesting of your options that are then
outstanding will be accelerated so that all shares covered by those options will
be or will become exercisable in full immediately prior to the effective date of
the Change in Control.
If the foregoing accurately confirms and clarifies the terms of your employment
and option agreements, please so indicate by signing and returning a copy of
this letter.
Very truly yours, ACCEPTED AND AGREED:
/s/ David R. A. Steadman
David R. A. Steadman /s/ Thomas E. Brew, Jr.
Chairman, Compensation Committee --------------------------
Thomas E. Brew, Jr.
CHANGE-IN-CONTROL AGREEMENT
KURZWEIL APPLIED INTELLIGENCE, INC. & THOMAS B. DOHERTY
THIS CHANGE-IN-CONTROL AGREEMENT (this "Agreement") is made as of the 14th day
of February 1997 by and between Kurzweil Applied Intelligence, Inc. (hereinafter
sometimes referred to as the "Company") and Thomas B. Doherty (hereinafter
referred to as "Mr. Doherty").
1 Consideration. The parties are entering into this Agreement for and in
consideration of the mutual covenants contained herein and other good and
valuable consideration, the receipt and sufficiency of which are hereby
acknowledged.
2 Background. Mr. Doherty is an executive officer of the Company and as
such, his title, responsibilities and status within the Company are
dependent in large part upon the continued incumbency of the current
management of the Company, including its Board of Directors. The Company
wishes to retain the services of Mr. Doherty and therefore wishes to make
provision for Mr. Doherty in the event that a Change in Control (as that
term is defined in the 1995 Non-Employee Director Stock Option Plan of the
Company) occurs.
3 Change in Control. In the event of a Change of Control while Mr. Doherty
is employed by the Company--
(a) The Company shall pay Mr. Doherty in a lump sum $68,000 on the
effective date of the Change in Control.
(b) Mr. Doherty shall provide to the Company his services as an employee
during the 90-day period immediately following a Change in Control
to assist in the transition to new management at the rate of $594
for each business day or any portion of a business day that Mr.
Doherty renders services to new management of the Company (to the
extent that they so request) during the 90-day period.
(c) For a period of one year after the effective date of a Change in
Control, Mr. Doherty will provide new management with informal
telephone consulting services, provided however, that such
consulting shall not be so time-consuming as to prevent or interfere
with Mr. Doherty seeking or engaging in full-time employment or
full-time consulting.
(d) The Company shall provide to Mr. Doherty at Company expense until
the first anniversary of the effective date of a Change in Control
the same health benefits as are made available to other officers of
the Company during such period.
4 Not an Employment Agreement. This Agreement is not and shall not be
construed as an agreement by the Company to employ Mr. Doherty for any
particular period of time or on any terms and conditions that are not
contained herein or in any Other Agreement (as defined below).
5 Other Agreements. This Agreement is in addition to any other agreements
between Kurzweil Applied Intelligence, Inc. and Mr. Doherty (each an
"Other Agreement") and shall not be construed or interpreted as
superceding or amending any such agreements.
6 Breach and Termination. This Agreement shall automatically expire and be
of no further force or effect on the occurrence of any one or more of the
following events:
Page 1 of 3
Thomas B. Doherty Change-in-Control Agreement dated as of
February 14, 1997 - continued
-------------------------------------------------------------------------------
(a) Mr. Doherty's employment is terminated for any reason prior to a
Change in Control, unless such termination was demonstrably in
contemplation of a particular Change in Control.
(b) Mr. Doherty breaches any material term or condition of any Other
Agreement.
7 Definition. The "Company" shall mean Kurzweil Applied Intelligence, Inc.
(as indicated in the preface to this Agreement) or if Kurzweil Applied
Intelligence, Inc. shall cease to be a legal entity, the "Company" shall
mean any entity that acquires substantially all of the business or assets
of Kurzweil Applied Intelligence, Inc.
8 Severability. If any provision or part of a provision of this Agreement
is finally declared to be invalid by any tribunal of competent
jurisdiction, such part shall be deemed automatically adjusted, if
possible, to conform to the requirements for validity, but, if such
adjustment is not possible, it shall be deemed deleted from this Agreement
as though it had never been included herein. In either case, the balance
of any such provision and of this Agreement shall remain in full force and
effect. Notwithstanding the foregoing, however, no provision shall be
severed if it is clearly apparent under the circumstances that either or
both of the parties would not have entered into this Agreement without
such provision.
9 Miscellaneous.
(a) This Agreement contains the entire understanding of the parties on
the subject matter hereof except as otherwise expressly contemplated
herein; shall not be amended except by written agreement of the
parties signed by each of them; shall be binding upon and inure to
the benefit of the parties and their successors personal
representatives and permitted assigns; may be executed in one or
more counterparts each of which shall be deemed an original hereof,
but all of which shall constitute but one and the same agreement;
and because the obligations of Mr. Doherty are personal, shall not
be assignable by Mr. Doherty.
(b) The words "herein," "hereof," "hereunder," "hereby," "herewith" and
words of similar import when used in this Agreement shall be
construed to refer to this Agreement as a whole. The word
"including" shall mean including, but not limited to any enumerated
items.
(c) Each party and its counsel has reviewed this Agreement. Accordingly,
the normal rule of construction that any ambiguities and
uncertainties are to be resolved against the party preparing an
agreement will not be employed in the interpretation of this
Agreement; rather this Agreement shall be construed as if all
parties had jointly prepared it.
(d) No representation, affirmation of fact, course of prior dealings,
promise or condition in connection herewith not expressly
incorporated herein shall be binding on the parties.
(e) The failure to insist upon strict compliance with any term, covenant
or condition contained herein shall not be deemed a waiver of such
term, nor shall any waiver or relinquishment of any right at any one
or more times be deemed a waiver or relinquishment of such right at
any other time or times.
(f) The captions of the paragraphs herein are for convenience only and
shall not be used to construe or interpret this Agreement.
Page 2 of 3
Thomas B. Doherty Change-in-Control Agreement dated as of
February 14, 1997 - continued
--------------------------------------------------------------------------------
10 Governing Law. This Agreement shall be governed by and construed in
accordance with the domestic laws of The Commonwealth of Massachusetts
without giving effect to any choice of law or conflict of law provision or
rule (whether of The Commonwealth of Massachusetts or of any other
jurisdiction) that would cause the application hereto of the laws of any
jurisdiction other than The Commonwealth of Massachusetts.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of
the day and year first above written.
Kurzweil Applied Intelligence, Inc.
By: /s/ David R. A. Steadman /s/ Thomas B. Doherty
------------------------------------ ------------------------------
David R. A. Steadman Thomas B. Doherty
Chairman, Compensation Committee
Page 3 of 3
Mark D. Flanagan Change-in-Control Agreement dated as of
February 14, 1997 - continued
--------------------------------------------------------------------------------
CHANGE-IN-CONTROL AGREEMENT
KURZWEIL APPLIED INTELLIGENCE, INC. & MARK D. FLANAGAN
THIS CHANGE-IN-CONTROL AGREEMENT (this "Agreement") is made as of the 14th day
of February 1997 by and between Kurzweil Applied Intelligence, Inc. (hereinafter
sometimes referred to as the "Company") and Mark D. Flanagan (hereinafter
referred to as "Mr. Flanagan").
1 Consideration. The parties are entering into this Agreement for and in
consideration of the mutual covenants contained herein and other good and
valuable consideration, the receipt and sufficiency of which are hereby
acknowledged.
2 Background. Mr. Flanagan is an executive officer of the Company and as
such, his title, responsibilities and status within the Company are
dependent in large part upon the continued incumbency of the current
management of the Company, including its Board of Directors. The Company
wishes to retain the services of Mr. Flanagan and therefore wishes to make
provision for Mr. Flanagan in the event that a Change in Control (as that
term is defined in the 1995 Non-Employee Director Stock Option Plan of the
Company) occurs.
3 Change in Control. In the event of a Change of Control while Mr. Flanagan
is employed by the Company--
(a) The Company shall pay Mr. Flanagan in a lump sum $225,000 on the
effective date of the Change in Control.
(b) Mr. Flanagan shall provide to the Company his services as an
employee during the 90- day period immediately following a Change in
Control to assist in the transition to new management at the rate of
$983 for each business day or any portion of a business day that Mr.
Flanagan renders services to new management of the Company (to the
extent that they so request) during the 90-day period.
(c) For a period of one year after the effective date of a Change in
Control, Mr. Flanagan will provide new management with informal
telephone consulting services, provided however, that such
consulting shall not be so time-consuming as to prevent or interfere
with Mr. Flanagan seeking or engaging in full-time employment or
full-time consulting.
(d) The Company shall provide to Mr. Flanagan at Company expense until
the first anniversary of the effective date of a Change in Control
the same health benefits as are made available to other officers of
the Company during such period.
4 Not an Employment Agreement. This Agreement is not and shall not be
construed as an agreement by the Company to employ Mr. Flanagan for any
particular period of time or on any terms and conditions that are not
contained herein or in any Other Agreement (as defined below).
5 Other Agreements. This Agreement is in addition to any other agreements
between Kurzweil Applied Intelligence, Inc. and Mr. Flanagan (each an
"Other Agreement") and shall not be construed or interpreted as
superceding or amending any such agreements.
6 Breach and Termination. This Agreement shall automatically expire and be
of no further force or effect on the occurrence of any one or more of the
following events:
Page 1 of 3
Mark D. Flanagan Change-in-Control Agreement dated as of
February 14, 1997 - continued
-------------------------------------------------------------------------------
(a) Mr. Flanagan's employment is terminated for any reason prior to a
Change in Control, unless such termination was demonstrably in
contemplation of a particular Change in Control.
(b) Mr. Flanagan breaches any material term or condition of any Other
Agreement.
7 Definition. The "Company" shall mean Kurzweil Applied Intelligence, Inc.
(as indicated in the preface to this Agreement) or if Kurzweil Applied
Intelligence, Inc. shall cease to be a legal entity, the "Company" shall
mean any entity that acquires substantially all of the business or assets
of Kurzweil Applied Intelligence, Inc.
8 Severability. If any provision or part of a provision of this Agreement is
finally declared to be invalid by any tribunal of competent jurisdiction,
such part shall be deemed automatically adjusted, if possible, to conform
to the requirements for validity, but, if such adjustment is not possible,
it shall be deemed deleted from this Agreement as though it had never been
included herein. In either case, the balance of any such provision and of
this Agreement shall remain in full force and effect. Notwithstanding the
foregoing, however, no provision shall be severed if it is clearly
apparent under the circumstances that either or both of the parties would
not have entered into this Agreement without such provision.
9 Miscellaneous.
(a) This Agreement contains the entire understanding of the parties on
the subject matter hereof except as otherwise expressly contemplated
herein; shall not be amended except by written agreement of the
parties signed by each of them; shall be binding upon and inure to
the benefit of the parties and their successors personal
representatives and permitted assigns; may be executed in one or
more counterparts each of which shall be deemed an original hereof,
but all of which shall constitute but one and the same agreement;
and because the obligations of Mr. Flanagan are personal, shall not
be assignable by Mr. Flanagan.
(b) The words "herein," "hereof," "hereunder," "hereby," "herewith" and
words of similar import when used in this Agreement shall be
construed to refer to this Agreement as a whole. The word
"including" shall mean including, but not limited to any enumerated
items.
(c) Each party and its counsel has reviewed this Agreement. Accordingly,
the normal rule of construction that any ambiguities and
uncertainties are to be resolved against the party preparing an
agreement will not be employed in the interpretation of this
Agreement; rather this Agreement shall be construed as if all
parties had jointly prepared it.
(d) No representation, affirmation of fact, course of prior dealings,
promise or condition in connection herewith not expressly
incorporated herein shall be binding on the parties.
(e) The failure to insist upon strict compliance with any term, covenant
or condition contained herein shall not be deemed a waiver of such
term, nor shall any waiver or relinquishment of any right at any one
or more times be deemed a waiver or relinquishment of such right at
any other time or times.
(f) The captions of the paragraphs herein are for convenience only and
shall not be used to construe or interpret this Agreement.
Page 2 of 3
Mark D. Flanagan Change-in-Control Agreement dated as of
February 14, 1997 - continued
-------------------------------------------------------------------------------
10 Governing Law. This Agreement shall be governed by and construed in
accordance with the domestic laws of The Commonwealth of Massachusetts
without giving effect to any choice of law or conflict of law provision or
rule (whether of The Commonwealth of Massachusetts or of any other
jurisdiction) that would cause the application hereto of the laws of any
jurisdiction other than The Commonwealth of Massachusetts.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of
the day and year first above written.
Kurzweil Applied Intelligence, Inc.
By: /s/ David R. A. Steadman /s/ Mark D. Flanagan
---------------------------------------- ---------------------------
David R. A. Steadman Mark D. Flanagan
Chairman, Compensation Committee
Page 3 of 3
Consent of Independent Accountants
As independent public accountants, we hereby consent to the incorporation by
reference in this Registration Statement on Form S-3 for Kurzweil Applied
Intelligence, Inc. of our report dated March 21, 1997 (except with respect to
the matter discussed in Note 3 as to which the date is April 14, 1997) included
in the Annual Report on Form 10-KSB of Kurzweil Applied Intelligence, Inc. for
the fiscal year ended January 31, 1997, and to all references to our Firm
included in this Registration Statement.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
May 1, 1997
Independent Auditors' Consent
We consent to the incorporation by reference in this Registration Statement on
Form S-3 of Kurzweil Applied Intelligence, Inc. of our report dated March 29,
1996 except for Note 3, as to which the date is May 9, 1996 with respect to the
balance sheet at January 31, 1996 and the related statements of operations,
stockholders' equity, and cash flows for the years ended January 31, 1996 and
1995 included in the Annual Report on Form 10-KSB of Kurzweil Applied
Intelligence, Inc. for the fiscal year ended January 31, 1997.
/s/ Ernst & Young LLP
Boston, Massachusetts
April 30, 1997
====================================================================================
FORM 10-KSB/A
(Amendment No. 1)
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended January 31, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ____________________ to________________________
Commission file number: 0-20256
KURZWEIL APPLIED INTELLIGENCE, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-2815079
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
411 Waverley Oaks Road
Waltham, Massachusetts 02154
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (617) 893-5151
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, $0.01 par value per share
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-B 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. [X]
Issuer's revenues for its most recent fiscal year: $8,547,000
At April 15, 1997 the aggregate market value of the voting stock held by non-
affiliates of the registrant was $25,907,330.
At April 15, 1997, the registrant had 9,085,760 shares of its common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
Page No. 1 of 11
PART III
Item 10. Directors And Executive Officers of The Registrant
The following sets forth the name and age of each director and executive officer
of the Company, his positions and offices with the Company, his period of
service with the Company and his business experience for at least the past five
years, and with respect to directors, their present principal occupation and
other directorships held in public companies.
Directors
The Bylaws of the Company provide that the number of directors shall be
determined from time to time by the stockholders or the Board of Directors, but
that there shall be no less than three directors. There are currently six
directors.
Name Age Director Since
---- --- --------------
Thomas E. Brew, Jr. ................................. 54 1994
Steven F. Kaplan..................................... 41 1995
Raymond C. Kurzweil.................................. 49 1982
William R. Lonergan.................................. 72 1984
David R. A. Steadman................................. 59 1995
James W. Storey...................................... 63 1995
--------
Mr. Brew. Mr. Brew served as Acting Co-Chief Executive Officer and President
of the Company from May 1994 until November 1994 when he was elected President,
Chief Executive Officer and a director. In June 1995 he was elected Chairman of
the Board of Directors. Prior to joining the Company, Mr. Brew was a founder and
had served since 1988 as Executive Vice President of Argus Management
Corporation, a firm which provides interim management services in crisis
situations.
Mr. Kaplan. Mr Kaplan has been Executive Vice President and Chief Financial
Officer of The Coleman Company, Inc., a diversified manufacturer of outdoor
recreation and hardware products, since August 1996. From 1993 to August 1996
he was an independent financial and strategy consultant, assisting companies,
buy-out firms and venture capital firms to identify, assess, structure and
negotiate mergers, acquisitions, strategic investments and divestitures as
well as helping firms develop and implement business plans and financial
strategies. During 1994, Mr. Kaplan served as Chief Financial Officer of
Marcam Corporation, a software company, and from 1990 to 1992, he was
Executive Vice President, Chief Financial Officer and Chief Strategic Officer
of AM International, Inc., a graphics art equipment and supplies company.
Prior thereto, Mr. Kaplan was Senior Vice President, Chief Strategic Officer
of AM International and President of Harris Graphics Web Group, a
manufacturing division of AM International. Before joining AM International,
Mr. Kaplan was a Vice President and partner of the Boston Consulting Group.
Mr. Kurzweil. Mr. Kurzweil is a founder of the Company and has been Chief
Technology Officer since its inception in 1982. From 1982 until 1995 he was
also Chairman of the Board of Directors. He served as Chief Executive Officer
from 1982 to 1991 and as Co-Chief Executive Officer from 1991 to November
1994. Mr. Kurzweil serves as a director of Wang Laboratories, Inc. and as
Chairman of its Strategy and Technology Committee.
Mr. Lonergan. Mr. Lonergan was a general partner of Oxford Partners, a
venture capital partnership, from 1983 to 1995. Prior to 1983, he was with
Xerox Corporation for eight years, most recently as Vice President Business
Development. Mr. Lonergan serves as a director of Zitel Corporation, a memory
systems company, Dataware Technologies, Inc. a CD ROM software company and
Medical Sterilization, Inc.
Mr. Steadman. Mr. Steadman has been President of Atlantic Management
Associates, Inc., a management services firm since 1988. From 1990 to 1994,
Mr. Steadman served as President and Chief Executive Officer of Integra--A
Hotel and Restaurant Company, and from 1987 to 1988, as Chairman and Chief
Executive Officer of GCA Corporation, a manufacturer of automated
semiconductor capital equipment. From 1980 to 1987 Mr. Steadman was a Vice
President of Raytheon Company, a defense electronics manufacturer, and served
in various management positions, most recently as President of its venture
capital division. Mr. Steadman is Chairman of the Board of Directors of
Technology Service Group, Inc., a manufacturer of high technology pay
telephone components and Wahlco Environmental Systems, Inc., a manufacturer of
environmental conditioning systems. He is also a director of Aavid Thermal
Technologies, Inc., which manufactures thermal management products and
produces computational fluid dynamics software, and Vitronics Corporation, a
manufacturer of reflow soldering ovens.
Mr. Storey. Mr. Storey has been a business consultant and investment manager
since 1993. From 1987 to 1992, Mr. Storey was President of Wellingsley
Corporation, a private investment company. From 1981 to 1986, Mr. Storey was
President and Chief Executive Officer of Codex Corporation, a manufacturer of
data communications equipment, and a Vice President of its parent company,
Motorola, Inc. Mr. Storey is a director of Progress Software Corporation and
Westerbeke Corporation, a manufacturer of marine engines and generator sets.
Executive Officers
-2-
Executive Officers are elected by the Board of Directors and serve until they
resign or are removed by the Board. The Company's executive officers who served
as such during fiscal 1997 are as follows:
Name Age Position
---- --- --------
Thomas E. Brew, Jr. .............. 54 Chairman of the Board of Directors
President, Chief Executive Officer
Thomas B. Doherty................. 38 Chief Financial Officer, Vice President
of Finance and Treasurer
Mark D. Flanagan.................. 44 Executive Vice President
W. Francis Ganong................. 44 Vice President, Research
Raymond C. Kurzweil............... 49 Chief Technology Officer
John J. Scarcella................. 42 Vice President of Sales
The business experience of Messrs. Brew and Kurzweil is set forth above under
the listing of directors of the Company.
Mr. Doherty. Mr. Doherty became the Company's Vice President of Finance,
Treasurer and Chief Financial Officer on November 1, 1994. He had been serving
as Acting Chief Financial Officer of the Company since May 23, 1994. Prior
thereto, Mr. Doherty had been a financial consultant at Argus since 1988.
Mr. Flanagan. Mr. Flanagan joined the Company in January 1993 and was elected
Vice President of Business Development in May 1993. Mr. Flanagan was elected
Executive Vice President in June 1994. Prior to joining the Company, Mr.
Flanagan served as President and Chief Executive Officer of Lotus Publishing
Corporation, a subsidiary of International Data Group, Inc. from 1991 to 1992.
Mr. Flanagan also worked at Lotus Development Corporation from 1988 to 1991 in
various positions including President of Lotus Publishing Corporation and Vice
President of Corporate Marketing from 1988 to 1989.
Mr. Ganong. Mr. Ganong joined the Company in 1982 and became Vice President,
Research in May 1993. Mr. Ganong was formerly Director of Research. Mr. Ganong
holds a Ph.D. and is a graduate of MIT and Harvard.
Mr. Scarcella. Mr. Scarcella joined the Company in 1985 as a Sales Manager for
its Mid-Atlantic territory. Prior to being elected Vice President of Sales in
September 1995, he served as Vice President of National Accounts and Government
Operations.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than 10% of a registered class
of the Company's equity securities ("Insiders") to file reports of ownership and
certain changes in ownership with the Securities and Exchange Commission and to
furnish the Company with copies of those reports.
Based solely on a review of those reports and amendments thereto furnished
to the Company during its most recent fiscal year or written representations by
Insiders that no Forms 5 were required to be filed, the Company believes that
during the fiscal year ended January 31, 1997, all Section 16(a) filing
requirements applicable to Insiders were satisfied.
-3-
Item 11. Executive Compensation.
This item contains information about compensation, stock options grants,
employment arrangements and other matters concerning certain of the executive
officers and the directors of the Company.
Summary Compensation Table
The following table sets forth the compensation the Company paid or accrued
for services rendered in fiscal years ended January 31, 1997, 1996 and 1995 by
the Chief Executive Officer and the four other most highly compensated executive
officers of the Company whose compensation exceeded $100,000 in fiscal 1997 and
who were serving at the end of the 1997 fiscal year.
Long Term Compensation
Annual Compensation Awards
---------------------------------------- -----------------------
Securities
Other Annual Underlying All Other
Name and Principal Fiscal Salary(1) Bonus Compensation(2) Options Compensation
Position Year ($) ($) ($) (#)(3) ($)
- ------------------ ------ --------- ------- --------------- ---------- ------------
Thomas E. Brew, Jr.(4).. 1997 300,000 50,000 -- 300,000 --
Chairman, President & 1996 250,000 100,000 -- -- --
Chief Executive Officer 1995 62,500 25,000 -- 250,000 --
Thomas B. Doherty(5).... 1997 136,500 -- -- 80,000 --
Vice President, Chief 1996 134,394 -- -- 10,000 --
Financial Officer & 1995 32,500 -- -- 50,000 --
Treasurer
Mark D. Flanagan(6)..... 1997 175,000 50,000 -- 80,000 --
Executive Vice 1996 175,000 50,000 -- 10,000 --
President 1995 160,833 38,333 -- 20,000 --
Raymond C. Kurzweil(7).. 1997 103,984 -- -- 50,000 --
Chief Technology 1996 172,791 -- -- -- --
Officer 1995 180,999 -- -- -- --
John J. Scarcella(8).... 1997 193,828 -- -- 34,520 --
Vice President, Sales 1996 171,300 -- -- 31,000 --
- --------
(1) Includes sales commissions.
(2) Excludes perquisites and other personal benefits if the aggregate amount
of such items of compensation is less than the lesser of either $50,000 or
10% of the total annual salary and bonus of the named executive officer.
(3) Effective July 31, 1996 the Compensation Committee voted to reduce the
exercise price per share of employee stock options, the exercise price of
which was in excess of the per share market value of the Company's common
stock ("Common Stock") on that date ($2.437) to that per share market value
if the optionee agreed to amend each of his or her option agreements so that
the portion of the re-priced option that was vested at April 30, 1996 would
cease to be vested and would then vest in two substantially equal
installments on July 31, 1997 and July 31, 1998. Under the rules and
regulations of the Securities and Exchange Commission, the re-priced option
shares are deemed to have been granted on the date of the re-pricing. See
"Report on Ten Year Option Re-Pricings."
(4) Mr. Brew joined the Company in the fourth quarter of fiscal 1995. Of the
number of shares shown as underlying options granted in fiscal 1997,
250,000 shares are covered by options granted in prior years which were
re-priced in July 1996 (see footnote 3, above).
(5) Mr. Doherty joined the Company in the fourth quarter of fiscal 1995. Of the
number of shares shown as underlying options granted in fiscal 1997,
60,000 shares are covered by options granted in prior years which were re-
priced in July 1996 (see footnote 3, above).
(6) Of the number of shares shown as underlying options granted in fiscal
1997, 60,000 shares are covered by options granted in prior years which
were re-priced in July 1996 (see footnote 3, above).
(7) Mr. Kurzweil's salary in fiscal 1997 reflects employment on a 35% basis
and in fiscal 1996 and fiscal 1995 reflects employment on a 75% basis. The
number of shares shown as underlying options granted in fiscal 1997 are
shares covered by options granted in prior years which were re-priced in
July 1996 (see footnote 3, above).
(8) Mr. Scarcella became an executive officer of the Company in fiscal 1996. The
number of shares shown as underlying options granted in fiscal 1997 are
shares covered by options granted in prior years which were re-priced in
July 1996 (see footnote 3, above).
Option Grants In The Last Fiscal Year
The following table sets forth certain information with respect to stock
options granted to each of the Company's executive officers named in the Summary
Compensation Table during the fiscal year ended January 31, 1997. For purposes
of this table, options re-priced on July 31, 1996 are considered under
Securities and Exchange Commission regulations to have been re-granted on that
date. Accordingly, the information under the columns entitled "Number of
Securities Underlying Options," "Percent of Total Options Granted to Employees
in FY 1997," and "Potential Realizable Value at Assumed Annual Rates of Stock
Price Appreciation for Option Term" are all computed on that basis. The
expiration dates of the re-priced options were not affected by the re-pricing.
Individual Grants
-------------------------------------------
Potential Realizable
Percent Of Value At Assumed
Total Annual Rates Of Stock
Options Price Appreciation For
Number Of Granted To Option Term(3)
Securities Employees In Exercise -----------------------
Underlying FY 1997(1) Price(2) Expiration 5% 10%
Name Options (%) ($) Date ($) ($)
---- ---------- ------------ -------- ---------- ------- -------
Thomas E. Brew, Jr. 250,000* 24.6 2.437 10/19/04 300,567 724,300
**(4).................. 50,000 4.9 2.437 10/19/04 60,113 144,860
Thomas B. Doherty 50,000* 4.9 2.437 10/19/04 60,113 144,860
**(5).................. 10,000* 1.0 2.437 04/18/05 12,913 31,553
20,000 1.9 2.437 05/13/06 29,818 75,097
Mark D. Flanagan **(6).. 30,000* 2.9 2.437 06/21/03 29,214 67,880
20,000* 1.9 2.437 10/19/04 24,045 57,944
10,000* 1.0 2.437 04/18/05 12,913 31,553
20,000 1.9 2.437 05/13/06 29,818 75,097
Raymond F. Kurzweil(7).. 50,000* 4.9 2.437 12/18/02 44,525 102,052
John J. Scarcella(8).... 3,520* 0.3 2.437 12/31/02 3,154 7,238
6,000* 0.6 2.437 04/18/05 7,748 18,932
25,000* 2.4 2.437 09/07/05 34,070 84,165
- --------
-4-
* These options were granted in prior years, but were re-priced in July 1996.
See footnote 2, below.
** In the event of a change in control of the Company the options of Messrs.
Brew, Doherty and Flanagan become exercisable in full. A change in control
for purposes of the option agreements will occur if the Merger is
consummated. See Item 1. "General" and "Employment Agreements, Termination
of Employment and Change-in-Control Arrangements," below.
(1) Based on a total of 1,012,646 shares of which (i) 322,000 shares are subject
to options granted to employees in the fiscal year ended January 31, 1997,
plus (ii) 690,646 shares subject to options granted in prior years that were
re-priced in July 1996. See footnote 2, below.
(2) The original exercise price per share of each option was equal to the
market value on the date of grant. Effective July 31, 1996, the exercise
price per share was reduced to $2.437, the closing price per share of
Common Stock on the Nasdaq National Market on that date. These re-pricings
were part of a Company-wide re-pricing of options authorized by the
Compensation Committee of the Board of Directors on July 31, 1996. Optionees
who elected the re-pricing of their options were required, in consideration,
to agree to the amendment of their re-priced options so that shares vested
as of April 30, 1996 would cease to be so vested and instead would vest in
two substantially equal installments on July 31, 1997 and July 31, 1998. See
"Report on Ten-Year Option Re-Pricings," below.
(3) The potential realizable value is calculated based on the term of the option
at its date of grant (or in the case of re-priced options, the date of re-
pricing) by assuming that the stock price on the date of grant appreciates
at the indicated annual rate compounded annually for the entire term of the
option. However, the optionee will not actually realize any benefit from the
option unless the market value of Common Stock exceeds the option exercise
price at the time of exercise.
(4) The option to purchase 50,000 shares was granted to Mr. Brew in May 1996
pursuant to his November 1994 Employment Agreement to offset the
percentage dilutive effects of the shares issued in connection with the
settlement of stockholder litigation pending against the Company in 1994.
See "Employment Agreements, Termination of Employment and Change-in-Control
Arrangements," below. As a result of the re-pricing of options in July 1996
(see footnote 2, above), Mr. Brew's options to purchase 150,000 shares vest
in equal quarterly installments on the last day of each calendar quarter,
commencing June 30, 1996, and options to purchase 150,000 shares vest in two
equal installments on July 31, 1997 and July 31, 1998.
(5) As a result of the re-pricing of options in July 1996 (see footnote 2,
above), Mr. Doherty's options to purchase 53,000 shares vest in equal
quarterly installments on the last day of each fiscal quarter, commencing
July 31, 1996, and options to purchase 27,000 shares vest in two equal
installments on July 31, 1997 and July 31, 1998.
(6) As a result of the re-pricing of options in July 1996 (see footnote 2,
above), Mr. Flanagan's options to purchase 52,285 shares vest in equal
quarterly installments on the last day of each fiscal quarter, commencing
July 31, 1996, and options to purchase 27,715 shares vest in two equal
installments on July 31, 1997 and July 31, 1998.
(7) As a result of the re-pricing of options in July 1996 (see footnote 2,
above), Mr. Kurzweil's options to purchase 15,000 shares vest in equal
quarterly installments on the last day of each fiscal quarter, commencing
July 31, 1996, and options to purchase 35,000 shares vest in two equal
installments on July 31, 1997 and July 31, 1998.
(8) As a result of the re-pricing of options in July 1996 (see footnote 2,
above), Mr. Scarcella's options to purchase 1,056 shares vest in equal
quarterly installments on the last day of each calendar quarter,
commencing June 30, 1996; options to purchase 30,053 shares vest in equal
quarterly installments on the last day of each fiscal quarter, commencing
July 31, 1996; and options to purchase 3,411 shares vest in two equal
installments on July 31, 1997 and July 31, 1998.
Aggregated Option Exercises In The Last Fiscal Year And Fiscal Year-End Option
Values
The following table sets forth for each of the Company's executive officers
named in the Summary Compensation Table certain information regarding stock
options held at January 31, 1997. No executive officer named in the Summary
Compensation Table exercised any options during fiscal 1997. The "Value of
Unexercised In-the-Money Options at Fiscal Year End" is the difference between
the closing market price of the Common Stock as reported on the Nasdaq
National Market on January 31, 1997 ($3.875 per share) and the option exercise
price.
Number Of Securities Value Of Unexercised
Underlying Unexercised In-The-Money
Options At Fiscal Year End Options At Fiscal Year End($)
------------------------------ --------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ------------- -------------- -------------- ---------------
Thomas E. Brew, Jr. .... 75,000 225,000 107,850 323,550
Thomas B. Doherty....... 14,000 66,000 20,132 94,908
Mark D. Flanagan........ 11,857 68,143 17,050 97,989
Raymond F. Kurzweil..... 158,768 42,500 370,046 61,115
John J. Scarcella....... 7,266 29,919 12,946 43,042
-5-
Report On Ten-Year Option Re-Pricings
The following table sets forth all re-pricings of options held by current
executive officers of the Company since August 1993 when the Company became a
reporting company pursuant to Section 13(a) or 15(d) of the Exchange Act. In
all cases, the new exercise price was equal to the price set forth under the
column entitled "Market Price of Underlying Securities At Time of Re-Pricing."
Length Of
Original Option
Number Of Market Price Term
Securities Of Underlying Remaining At
Underlying Securities At Exercise Price At Date Of Re-
Date Of Re- Options Re- Time Of Re- Time Of Re- Pricing
Name And Position Pricing Priced(#) Pricing($) Pricing($) (In Years)(#)
----------------- ----------- ----------- ------------- ----------------- ---------------
Thomas E. Brew, Jr. .... 07/31/96(1) 250,000 2.437 4.125 8.2
Chairman, President & 50,000 2.437 4.500 8.2
Chief Executive Officer
Raymond C. Kurzweil..... 10/19/94(2) 50,000 4.125 9.00 8.2
Chief Technology 07/31/96 50,000 2.437 4.125 6.4
Officer
Thomas B. Doherty....... 07/31/96 50,000 2.437 4.125 8.2
Vice President, Chief 10,000 2.437 5.125 8.7
Financial Officer & 20,000 2.437 4.500 9.8
Treasurer
Mark D. Flanagan........ 10/19/94(2) 30,000 4.125 9.00 8.7
Executive Vice 07/31/96 30,000 2.437 4.125 6.9
President 20,000 2.437 4.125 8.2
10,000 2.437 5.125 8.7
20,000 2.437 4.500 9.8
John J. Scarcella....... 10/19/94(2) 3,520 4.125 9.00 8.2
Vice President, Sales 07/31/96 3,520 2.437 5.125 6.4
6,000 2.437 5.125 8.7
25,000 2.437 4.125 9.1
W. Francis Ganong....... 10/19/94(2) 4,800 4.125 9.00 8.2
Vice President, 07/31/96 4,800 2.437 4.125 6.4
Research 10,000 2.437 5.125 8.7
7,500 2.437 4.500 9.8
- --------
(1) The option re-pricing of July 31, 1996 was carried out in connection with
the sale of approximately 2.24 million aggregate shares of Common Stock
pursuant to two private placements in May 1996 and July 1996, which
the Compensation Committee believes had a dilutive effect on the Company's
stock price. Optionees who elected the re-pricing of their options were
required, in consideration, to agree to the amendment of their re-priced
options so that shares vested as of April 30, 1996 would cease to be so
vested and instead would vest in two substantially equal installments on
July 31, 1997 and July 31, 1998. All but nine eligible employees elected
to re-price some or all of their options.
(2) The option re-pricing of October 19, 1994 was carried out in connection
with the formation of a new management team in late 1994. At that time
the Company was suffering from the actions of certain members of prior
management (all of whom have left the Company) that had resulted in the
improper recording of revenues and the erroneous recording of
capitalization costs. In anticipation of Messrs. Brew and Doherty
commencing full-time employment with the Company and the granting of options
to them in that connection, the Compensation Committee decided that it was
appropriate to re-price all options with an exercise price of $9.00 per
share (held by a total of 52 optionees) as an inducement to them to remain
with the Company and to assist it in achieving a financial recovery.
The Compensation Committee: David R. A. Steadman
William R. Lonergan
James W. Storey
Employment Agreements, Termination Of Employment And Change-In-Control
Arrangements
Mr. Brew is employed pursuant to an employment agreement dated as of November
1, 1994, as amended in March, 1997, which provides for (i) the payment of a
salary of $250,000, $300,000 and $350,000 for the twelve-month periods ending
November 1, 1995, 1996 and 1997, respectively; (ii) the payment of bonuses of
$100,000 and $50,000 for the twelve-month periods ending November 1, 1995 and
1996, respectively; and (iii) the granting in 1994 of a ten-year option vesting
in quarterly installments over a five-year period to purchase 250,000 shares of
Common Stock and an additional option grant to offset the percentage dilutive
effects of shares issued in connection with the settlement of stockholder
litigation then pending against the Company. In May 1996 the Company granted to
Mr. Brew this offset option to purchase 50,000 shares of Common Stock with the
same vesting schedule and expiration date as the option granted in 1994. The
employment agreement also provides that in the event of the termination of Mr.
Brew's employment by reason of the expiration of the agreement on November 1,
1997, or if prior to expiration of the agreement his employment is terminated
without cause, or a change in control of the Company occurs, the Company will
pay Mr. Brew one year's salary in a lump sum on the effective date of such
termination, expiration or change in control and provide him current benefits
until November 1, 1997 or for one year from the date of such termination,
-6-
expiration or change in control, whichever period is longer. In addition, in the
event of a change in control Mr. Brew's options become fully exercisable. A
change in control will occur for purposes of these agreements if the Merger
described in Item 1. under the heading "General" is consummated.
Messrs. Doherty and Flanagan have entered into agreements with the Company
providing that in the event of a change in control the Company will pay Mr.
Doherty $68,000 and Mr. Flanagan $225,000, respectively, in a lump sum on the
effective date of the change in control and will continue to provide each of
them with current benefits for a period of one year thereafter. In addition,
their stock options by their terms become fully exercisable in the event of a
change in control. A change in control will occur for purposes of these
agreements if the Merger described in Item 1. under the heading "General" is
consummated.
In addition, all unexercised options held by non-employee directors of the
Company immediately vest in the event the Merger is consummated.
Report Of The Compensation Committee On Executive Compensation
This report has been prepared by the Compensation Committee (the "Committee")
of the Board of Directors and addresses the Company's compensation policies with
respect to the Chief Executive Officer and executive officers in general for the
fiscal year ended January 31, 1997. Each member of the Committee is a non-
employee director.
Compensation Policy
The overall intent of the Committee in respect of executive officers is to
establish levels of compensation that provide appropriate incentives in order to
command high levels of individual performance and thereby increase the value of
the Company to its stockholders, and that are sufficiently competitive to retain
and attract the skills required for the success and profitability of the
Company. The principal components of executive compensation are salary, bonus
and stock options. During fiscal 1997, the Company did not have a formal
compensation or bonus plan.
Chief Executive Officer's Compensation
The Chief Executive Officer's compensation for fiscal 1997 was based on a
written employment agreement that was negotiated and entered into in November
1994 and subsequently amended in March, 1997. See "Employment Agreements,
Termination of Employment and Change-in-Control Arrangements," above. The Chief
Executive Officer's compensation was determined to be appropriate by the members
of the Committee at such time based on the financial and legal difficulties that
the Company had experienced; the expertise and responsibility that the position
requires; the Chief Executive Officer's management experience in prior
employment, particularly with respect to troubled companies; and the subjective
judgment of the Committee members of a reasonable compensation level.
Other Executive Officers
Salary. During fiscal 1997, the salary of each executive officer other than
the Chief Executive Officer was based on prior salary level (in the case of
long-term employees), any increase during the year in responsibilities, and
the subjective judgment of the members of the Committee as to the value of the
executive's past contribution and potential future contribution to the
profitability of the business. In the case of Mr. Doherty, Vice President,
Chief Financial Officer and Treasurer, who joined the Company in November 1994,
salary was based on his prior financial and accounting experience, (in
particular his experience with financially troubled companies), and on terms
designed to induce him to join the Company as a full-time employee. In all
cases, Committee members exercised their subjective judgment as to what
constitutes a compensation level that is fair and calculated to retain the
executive in the Company's employ.
Bonuses. Kurzweil has no formal bonus program. A bonus was paid to one
executive officer (other than the Chief Executive Officer) based on an
informal agreement with the officer made in 1994.
Stock Options. The Committee believes that stock ownership by executive
officers is important in aligning management's and stockholders' interests in
the enhancement of stockholder value over the long term. The exercise price of
stock options is equal to the market price of the Common Stock on the date of
grant. The stock option grants made to executive officers in fiscal 1997
were made based on the subjective judgment of the Committee members of the
appropriate recognition for services to the Company during the 1997 fiscal year
and prior years. For a discussion of the decision by the Committee in fiscal
1997 to offer optionees, including executive officers, the opportunity to
reduce the price of their options, see "Report on Ten-Year Option Re-Pricings,"
above.
Compliance with Internal Revenue Code Section 162(m). Section 162(m) of the
Internal Revenue Code (enacted in 1993) generally disallows a tax deduction to
public companies for compensation over $1 million paid to its chief executive
officer and its four other most highly compensated executives. The Company's
compensation payable to any one executive officer (including potential income
from outstanding stock options) in any one tax year is unlikely to reach that
threshold. Qualifying, performance-based compensation will not be subject to
the deduction limit if certain requirements are met. The Committee currently
intends to structure stock option grants to executive officers in a manner
that complies with the performance-based requirements of the statute.
The Compensation Committee: David R. A. Steadman
William R. Lonergan
James W. Storey
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Compensation Committee Interlocks And Insider Participation
Decisions concerning executive compensation are made by the Compensation
Committee of the Board of Directors, which during fiscal 1997 consisted of
Messrs. Steadman, Lonergan and Storey, none of whom is or was an officer or
employee of the Company or any of its subsidiaries. During fiscal 1997, no
executive officer of the Company served as a director or member of a
compensation committee of any entity with which any director of the Company had
any relationship as a director or officer.
Performance Graph
The following graph assumes an investment of $100 on August 17, 1993 (the date
the Common Stock was first registered under Section 12 of the Exchange Act) and
compares yearly changes thereafter through January 31, 1997 with (i) the Nasdaq
Market Index for U.S. Companies (a broad market index) and (ii) the Nasdaq
Computer and Data Processing Services Stocks (a published industry index).
[PERFORMANCE GRAPH APPEARS HERE]
August 17, 1993 January 31, 1994 January 31, 1995 January 31, 1996 January 31, 1997
Kurzweil Applied Intelligence, Inc $100.00 $130.00 $53.00 $38.00 $38.75
Nasdaq Computer & Data Processing
Service Stocks $100.00 $110.00 $124.00 $198.00 $265.00
Nasdaq Market Index $100.00 $109.00 $104.00 $146.00 $191.00
The performance of the indices is shown on a total return (dividend
reinvestment) basis; however, the Company paid no dividends during the period
shown. The graph lines connect the beginning and end of the measuring periods
and do not reflect fluctuations between those dates. The price of the Common
Stock during the period shown is not necessarily indicative of its future
performance.
The Performance Graph and the Report of the Compensation Committee on
Executive Compensation in this Annual Report on Form 10-KSB are not and shall
not be deemed incorporated by reference into any filings of the Company with the
Securities and Exchange Commission by implication or by any reference in any
such filings to this Annual Report on Form 10-KSB.
Directors' Compensation
Directors who are employees of the Company receive no compensation for
services as members of the Board. Directors who are not employees of the Company
receive $1,000 in the aggregate for Board and committee meetings they attend on
a given day. All directors are reimbursed for out-of-pocket expenses incurred in
attending meetings.
Nonemployee directors of the Company also receive "formula" stock option
grants under the Company's 1995 Nonemployee Director Stock Option Plan (the
"Director Plan") approved by stockholders on June 20, 1995. Each non-employee
director serving at that date received a fully-vested option to purchase 10,000
shares of Common Stock (the "Initial Grants") and is automatically granted an
additional option to purchase 3,000 shares of Common Stock on each anniversary
of that date so long as he is then serving as a non-employee director. Each non-
employee director first elected to the Board of Directors after June 20, 1995
automatically receives an option to purchase 3,000 shares of Common Stock on the
date of his or her election and, so long as he or she is then serving as a non-
employee director, an additional option to purchase 3,000 shares of Common Stock
on each anniversary of that date. All options under the Director Plan are
granted at an exercise price per share equal to the market value of a share of
Common Stock on the date of grant. Except for the Initial Grants, all options
vest as to one-half the shares six months after the grant date, and as to an
additional one-quarter of the shares at nine months and twelve months after the
grant date.
Item 12. Security Ownership of Certain Beneficial Holders and Management.
The following tables set forth certain information regarding beneficial
ownership of the Company's common stock ("Common Stock") at April 15, 1997 (i)
by each person known by the Company to own beneficially more than 5% of the
outstanding Common Stock; (ii) by each director; (iii) by the executive officers
named in the Summary Compensation Table in Item 11. above; and (iv) by all
directors and executive officers as a group. The numbers and percentages are
based on 9,085,760 shares of Common Stock outstanding on April 15, 1997 and
assume, for each person or group listed, the exercise of all warrants and stock
options held by such person or group that are exercisable within 60 days of
April 15, 1997, in accordance with Rule 13d-3(d)(1) of the Exchange Act, but not
the exercise of such stock options or warrants owned by any other person. Except
as otherwise indicated in the footnotes, the Company believes that the
beneficial owners of Common Stock listed below, based on information furnished
by such owners, have sole investment and voting power with respect to the shares
of Common Stock shown as beneficially owned by them.
-8-
Security Ownership Of Certain Beneficial Holders
Number Of
Name And Address Shares Of Percentage
Of Beneficial Owner Common Stock Of Class
------------------- ------------ ----------
Special Situations Fund, L.P. ..................... 1,445,050(1) 15.90%
153 East 53rd Street
New York, NY 10020
Xerox Corporation.................................. 876,121(2) 9.60%
800 Long Ridge Road
Stamford, Connecticut 06904
WisdomTree Capital Management, Inc. ............... 737,200(3) 8.11%
WisdomTree Offshore, Ltd.
WisdomTree Associates, L.P.
1633 Broadway, 38th Floor
New York, NY 10019
Security Ownership Of Management
Number Of Shares
Name Of Beneficial Owner Of Common Stock Percentage Of Class
------------------------ ---------------- -------------------
Thomas E. Brew, Jr. ..................... 101,000(4) 1.10%
Thomas B. Doherty........................ 19,866(5) *
Mark D. Flanagan......................... 15,809(6) *
Raymond C. Kurzweil...................... 167,934(7) 1.82%
John J. Scarcella........................ 9,420(8) *
Steven F. Kaplan......................... 12,250(9) *
William R. Lonergan...................... 12,250(9) *
David R. A. Steadman..................... 12,250(9) *
James W. Storey.......................... 18,250(10) *
All Directors and Executive Officers as a
Group (10 Persons)...................... 396,254(11) 4.19%
- --------
* Represents holdings of less than one percent.
(1) Special Situations Fund L.P. purchased 1,320,050 of these shares on
May 9, 1996 and the balance on April 15, 1997.
(2) Excludes 168,222 shares owned by Fuji Xerox Co., Ltd. as to which Xerox
disclaims beneficial ownership, and includes 53,143 shares issuable on
the exercise of currently exercisable warrants to purchase Common Stock.
(3) According to a Form 13D dated February 4, 1997 and filed by WisdomTree
Capital Management, Inc., WisdomTree Offshore, Ltd. and WisdomTree
Associates, L.P., WisdomTree Capital Management, Inc. has shared voting
and dispositive power as to 475,700 of these shares, and WisdomTree
Offshore, Ltd. has shared voting and dispositive power as to 261,500 of
these shares. The foregoing entities may be deemed to be a group under
applicable securities laws, but the entities disclaim group membership.
(4) Includes 100,000 shares subject to purchase under stock options
exercisable within 60 days of April 15, 1997 at a price of $2.437 per
share.
(5) Includes 18,666 shares subject to purchase under stock options
exercisable within 60 days of April 15, 1997 at a price of $2.437 per
share.
(6) These shares are subject to purchase under stock options exercisable
within 60 days of April 15, 1997 at a price of $2.437 per share.
(7) Includes 161,268 shares subject to purchase under stock options
exercisable within 60 days of April 15, 1997 at prices ranging from $1.50
to $2.437 per share. Mr. Kurzweil disclaims beneficial ownership of the
following shares included in this number: (i) 466 shares held in an
irrevocable trust (of which Mr. Kurzweil is a trustee and has sole voting
and investment power) for the benefit of Mr. Kurzweil's children, mother,
sister and his sister's children; (ii) 1,066 shares held in an
irrevocable trust for the benefit of Mr. Kurzweil's children; (iii) 2,133
shares held in a separate irrevocable trust for the benefit of Mr.
Kurzweil's wife; (iv) 133 shares held in a separate irrevocable trust for
the benefit of Mr. Kurzweil's sister; and (v) 1,066 shares held directly
by Mr. Kurzweil's wife.
(8) Includes 9,320 shares subject to purchase under stock options exercisable
within 60 days of April 15, 1997 at prices ranging from $1.50 to $2.437
per share.
(9) These shares are subject to purchase under stock options exercisable
within 60 days of April 15, 1997 at prices ranging from $2.875 to $4.375
per share.
(10) Includes 12,250 shares subject to purchase under stock options
exercisable within 60 days of April 15, 1997 at prices ranging from
$2.875 to $4.375 per share.
(11) Includes 378,356 shares subject to purchase under stock options
exercisable within 60 days of April 15, 1997 at prices ranging from $1.50
to $4.375 per share.
-9-
Item 13. Certain Relationships and Related Transactions.
On May 9, 1996, the Company sold 1,320,050 shares of its common stock at a
purchase price of $2.00 per share in a private placement to Special Situations
Fund, L.P., which thereby became a 5% or greater stockholder of the Company
yielding net proceeds to the Company of approximately $2,376,000. See Item 12.,
above.
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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.
KURZWEIL APPLIED INTELLIGENCE, INC.
Date: May 29, 1997 By: /s/ Thomas E. Brew, Jr.*
------------------------------
Thomas E. Brew, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signatures Title Date
/s/ Thomas E. Brew, Jr.* Chairman of the Board of Directors May 29, 1997
- ---------------------------- President & Chief Executive Officer
Thomas E. Brew, Jr.
Chief Financial Officer May 29, 1997
Vice President of Finance &
/s/ Thomas B. Doherty* Treasurer (principal accounting and
- ---------------------------- financial officer)
Thomas B. Doherty
/s/ Raymond C. Kurzweil* Chief Technology Officer May 29, 1997
- ---------------------------- Director
Raymond C. Kurzweil
/s/ Steven F. Kaplan * May 29, 1997
- ---------------------------- Director
Steven F. Kaplan
/s/ William R. Lonergan* May 29, 1997
- ---------------------------- Director
William R. Lonergan
/s/ David R. A. Steadman* May 29, 1997
- ---------------------------- Director
David R. A. Steadman
/s/ James W. Storey * May 29, 1997
- ---------------------------- Director
James W. Storey
*By: /s/ Roger M. Barzun
------------------------
Roger M. Barzun
Attorney-in-fact