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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
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.
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.
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 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 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.
Dave Earl Claims
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.
Thomason General Hospital
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
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.
VoicePAD 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.
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May 2, 1997