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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.
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%
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
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.
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.
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.
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May 2, 1997