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For purposes of this Form 10-QSB, all references to "Fiscal 1998" mean the fiscal year of Kurzweil Applied Intelligence, Inc. (the "Company") ending January 31, 1998. All references to "Fiscal 1997" mean the Company's fiscal year ended January 31, 1997.
The accompanying condensed unaudited financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Item 310 of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results of operations for the fiscal year. For further information, refer to the financial statements and footnotes thereto included in the Company's 1997 Annual Report on Form 10-KSB for the fiscal year ended January 31, 1997.
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 pursuant to which the L&H subsidiary 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.
Pursuant to the terms of a Loan Agreement dated April 14, 1997 (the "Loan Agreement"), a subsidiary of L&H ("the L&H subsidiary") 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 Systems, Inc. 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 a rate of 8.5% per annum. On May 2, 1997, the Company drew down the full amount of the loan. All outstanding principal and interest under the Note is due and payable in full on October 31, 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 the L&H subsidiary 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 the earlier occurrence of the consummation of the merger or April 14, 2002.
Litigation
On September 11, 1995, one of the Company's shareholders who
elected not to be included in the shareholder class action litigation against
the Company, which was subsequently settled in April of 1995, filed a complaint
in Dallas County, Texas against the Company and certain of its current and
former directors and officers. The matter is entitled Caffey v. Kurzweil Applied
Intelligence, Inc. et.al. The complaint asserts that the defendants committed
fraud and violated Texas state law and unnamed federal securities laws. The
shareholder seeks $1,500,000 in damages as a result of his purchase of 1,000
shares of the Company's Common Stock.
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 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 in Massachusetts, Civil Action No. 96-07037, asserting claims against the Company and the Lexington Insurance Company ("Lexington"), an insurer that issued an insurance policy as to the directors and officers of Kurzweil. 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 and unspecified amount of damages.
On January 13, 1997, Lexington filed and 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.
Nasdaq Regulatory Requirements At April 30, 1997, the Company was not in compliance with the Nasdaq net worth requirements for the continued listing of the Company's Common Stock on the Nasdaq National Market. On May 28, 1997, the Nasdaq Stock Market notified the Company that the Company's Common Stock would be delisted from the Nasdaq National Market effective with the opening of business on June 4, 1997. The Company requested an oral hearing from Nasdaq to reconsider such determination and the Company's Common Stock will continue to be listed and traded on the Nasdaq National Market pending the outcome of the hearing or if the merger is consummated prior to such hearing. On June 11, 1997, Nasdaq notified the Company that a hearing will be held on July 17, 1997. If the merger is not consummated and as a result of the hearing Nasdaq determines to delist the Company's Common Stock from the Nasdaq National Market, the Company may not again qualify for listing on the Nasdaq National Market 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 thereof.
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 agreement, 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 April 30, 1997:
| June 1, 1997 | $1,019,460 |
| June 1, 1998 | 1,151,523 |
| Total | $2,170,983 |
The Company expensed $1,107,600 during fiscal year 1997, and will amortize the remaining asset of $92,300 on a straight-line basis through May 31, 1997, at which time the Company will decide whether or not to extend the license for a 1 year term. The Company expensed $276,900 relating to the Dragon agreement for the three months ended April 30, 1997. According to the agreement, the Company, if it chooses not to extend the license, has use of the licensed technology through June 28, 1997. The final payment will then be made in Fiscal 1999.
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 annual payments increasing at a rate of 13% per year 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.
On April 14, 1997, the Company entered into a Loan Agreement with the L&H subsidiary. In consideration for the commitment to make the Loan, the Company issued to the L&H subsidiary 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 the earlier occurrence of the consummation of the merger or April 14, 2002.
The Company's total revenues consist of revenue from the sale and licensing of Company products and revenue from maintenance contracts.
Cost of product, license 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.
Sales and marketing expenses include the costs for marketing, selling and supporting the Company's products.
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 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, license and maintenance revenue.
General and Administrative Expenses
General and administrative expenses include
those costs associated with general corporate needs and administrative
functions.
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 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.
Liquidity and Capital Resources
At April 30, 1997, the Company's principal source of liquidity was cash and cash equivalents of $824,000, as compared to cash and cash equivalents of $1,439,000 at January 31, 1997.
The Company's operating activities used cash of $64,000 for the three months ended April 30, 1997. The Company will be required to pay $1,019,000 to Dragon by June 30, 1997 as part of the patent cross license agreement.
At April 30, 1997 the Company had a working capital deficit of $493,000 as compared to a working capital deficit of $97,000 at January 31, 1997. The increase in the deficit is primarily the result of the Company's need to fund its continued operating losses and other commitments.
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 pursuant to which the L&H subsidiary 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.
Pursuant to the terms of a Loan Agreement dated April 14, 1997 (the "Loan Agreement"), a subsidiary of L&H ("the L&H subsidiary") 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 a rate of 8.5% per annum. On May 2, 1997, the Company drew down the full amount of the loan.. All outstanding principal and interest under the Note is due and payable in full on October 31, 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.
The longer term financial stability of the Company is dependent on its ability to consummate the merger, achieve profitable operations and, if necessary, obtain additional financing. The Company's future capital requirements will depend on many factors, including the progress and scope of its research and development programs and the level and profitability of sales. 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. There is no assurance that the Company can obtain such additional financing. If the Company requires additional financing, or additional financing is not obtained, or the Company fails to consummate the merger, the Company will likely be required to restructure its operations, curtail its spending in research and development, or attempt a merger or other strategic alliance with another company. 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 is likely to result in dilution of the Company's existing stockholders.
At April 30, 1997, the Company was not in compliance with the Nasdaq net worth requirements for the continued listing of the Company's Common Stock on the Nasdaq National Market. On May 28, 1997, the Nasdaq Stock Market notified the Company that the Company's Common Stock would be delisted from the Nasdaq National Market effective with the opening of business on June 4, 1997. The Company requested an oral hearing from Nasdaq to reconsider such determination and the Company's Common Stock will continue to be listed and traded on the Nasdaq National Market pending the outcome of the hearing or if the merger is consummated prior to such hearing. On June 11, 1997, Nasdaq notified the Company that a hearing will be held on July 17, 1997. If the merger is not consummated and as a result of the hearing Nasdaq determines to delist the Company's Common Stock from the Nasdaq National Market, the Company may not again qualify for listing on the Nasdaq National Market 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 thereof.
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 adoption and learning. 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 Company 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 revenues in any quarter are substantially dependent on orders booked and shipped in that quarter. The timing of revenue receipts 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 revenues can cause significant fluctuations in operating results from quarter to quarter and may result in anticipated quarterly earnings shortfalls 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 risk and uncertainties. In particular, statements contained herein, 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.
Kurzweil AI Q1 FY 1998 Statement of Operations
Kurzweil AI Q1 FY 1998 Balance Sheet
Kurzweil AI Q1 FY 1998 Cash Flow
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