<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
Current Report Pursuant
to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) June 7, 2000
-------------------------------------------------------------
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.
--------------------------------------
(Exact Name Of Registrant As Specified In Its Charter)
The Kingdom of Belgium
----------------------
(State or Other Jurisdiction of Incorporation)
0-27296 N/A
------------------------------
(Commission File Number) (I.R.S. Employer Identification No.)
52 Third Avenue, Burlington, Massachusetts 01803
----------------------------------------------------
(Address of Principal Executive Offices in the U.S.) (Zip Code)
(781) 203-5000
--------------
(Registrant's Telephone Number, Including Area Code)
----------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
<PAGE>
Item 7. Financial Statements and Exhibits.
------ ---------------------------------
(a) Financial Statements of business acquired:
Audited consolidated balance sheets of Dragon Systems, Inc. and
subsidiaries as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the three years in the
period ended December 31, 1999.**
(b) Pro Forma financial information:
Unaudited pro forma condensed consolidated statements of
operations of Lernout & Hauspie Speech Products N.V. for the
year ended December 31, 1999 and the six months ended June 30,
2000 giving effect to the acquisitions of Brussels Translation
Group N.V., Dictaphone Corporation and Dragon Systems, Inc.**
(c) Exhibits:
2.1 Agreement and Plan of Merger, dated as of March 27, 2000, by
and among the Registrant, L&H Holdings USA, Inc., a Delaware
corporation and a direct, wholly owned subsidiary of the
Registrant, Dragon Systems, Inc., a Delaware corporation, and
the principal stockholders of Dragon.*
2.2 Amendment No. 1, dated as of May 25, 2000, to the Agreement and
Plan of Merger dated as of March 27, 2000, by and among the
Registrant, L&H Holdings USA, Inc., a Delaware corporation and
a direct, wholly owned subsidiary of the Registrant, Dragon
Systems, Inc., a Delaware corporation, and the principal
stockholders of Dragon.*
4.1 Registration Rights Agreement, dated as of June 7, 2000, by and
among the Registrant, L&H Holdings USA, Inc., Dragon Systems,
Inc., Janet M. Baker and Seagate Technology, Inc.*
4.2 Stockholders' Agreement, dated as of June 7, 2000, by and among
the Registrant, JKBaker LLC, JMBaker LLC, Seagate, LLC, Roth
Special LLC, CFB Gilbert LLC, RGB Rumpole LLC (each a Delaware
limited liability company), James K. Baker, Janet M. Baker,
Robert Roth, Seagate Technology, Inc., the Paul G. Bamberg
Trust, the Cherry F. Bamberg Trust, LEHA, a Netherlands
foundation, L&H Holding N.V., a Belgian corporation, L&H
Holding III, a Luxembourg corporation, Oldco N.V., a Belgian
corporation, and L&H Investment Company, a Belgian
corporation.*
23.1 Consent of Arthur Andersen LLP.**
* Incorporated herein by reference from the Current Report on Form 8-K of the
Registrant filed on June 22, 2000.
** Filed herewith.
<PAGE>
SIGNATURE
---------
Pursuant to the requirements 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.
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.
Dated: August 21, 2000
By: /s/ Carl Dammekens
----------------------
Carl Dammekens, Chief Financial Officer
and Senior Vice President of Finance
<PAGE>
Report of Independent Public Accountants
To Dragon Systems, Inc.
We have audited the accompanying consolidated balance sheets of Dragon Systems,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1999
and the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 1999. These consolidated financial statements are the
responsibility of Dragon Systems, Inc.'s management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Dragon Systems, Inc.
and subsidiaries as of December 31, 1998 and 1999 and the results of their
operations and their cash flows for each of the three years ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 25, 2000 (except with respect to the matters
discussed in Note 1, as to which the date is
June 7, 2000.)
1
<PAGE>
DRAGON SYSTEMS, INC.
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
ASSETS
Years Ended December 31,
1998 1999
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 4,911 $ 6,193
Investments, available for sale 3,932 321
Accounts receivable, net of allowance for bad debt of $925 and $656, respectively 11,714 8,554
Unbilled revenue 352 133
Inventories 7,827 4,323
Refundable income taxes 3,983 2,858
Prepaid expenses and other current assets 683 611
Deferred tax assets 2,326 -
----------- ------------
Total current assets 35,728 22,993
----------- ------------
Property and Equipment, net 1,994 2,280
Other Assets 207 -
----------- ------------
Total assets $ 37,929 $ 25,273
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Line of credit $ - $ 3,000
Accounts payable 7,979 3,013
Accrued expenses 7,552 11,345
Income taxes payable 10 101
Current portion of deferred revenue 581 2,339
----------- ------------
Total current liabilities 16,122 19,798
----------- ------------
Deferred Revenue, net of current portion - 3,112
Convertible Note Payable to Stockholder - 3,500
Commitments and Contingencies (Note 9)
Stockholders' Equity (Deficit):
Convertible preferred stock, $.04 par value-
Authorized--5,000,000 shares
Issued and outstanding--3,238,951 shares, (preference in liquidation-$64,779) 130 130
Common stock, $.04 par value-
Authorized--45,000,000 shares
Issued and outstanding--13,635,805 and 13,823,920 shares, respectively
(preference in liquidation-$18,801) 545 553
Additional paid-in capital 31,041 31,352
Accumulated deficit (9,992) (31,819)
Accumulated other comprehensive income (loss) 83 (1,353)
----------- ------------
Total stockholders' equity (deficit) 21,807 (1,137)
----------- ------------
Total liabilities and stockholders' equity (deficit) $ 37,929 $ 25,273
=========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
DRAGON SYSTEMS, INC.
Consolidated Statements of Operations
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1997 1998 1999
<S> <C> <C> <C>
Net Revenue:
Software licenses $ 19,506 $ 63,667 $ 55,570
Development contracts 7,315 5,732 4,434
------------ ----------- ------------
Total net revenue 26,821 69,399 60,004
------------ ----------- ------------
Cost of Revenue:
Cost of software licenses 5,394 18,586 29,131
Cost of development contracts 4,993 3,275 2,772
------------ ----------- ------------
Total cost of revenue 10,387 21,861 31,903
------------ ----------- ------------
Gross profit 16,434 47,538 28,101
------------ ----------- ------------
Operating Expenses:
Research and development 9,577 14,056 18,851
Selling and marketing 9,350 26,002 27,947
General and administrative 2,485 4,378 6,692
------------ ----------- ------------
Total operating expenses 21,412 44,436 53,490
------------ ----------- ------------
Operating income (loss) (4,978) 3,102 (25,389)
Interest, net 511 629 117
------------ ----------- ------------
Income (loss) from continuing operations before income
taxes (4,467) 3,731 (25,272)
Provision for (Benefit from) Income Taxes (2,190) 1,104 (1,194)
------------ ----------- ------------
Income (loss) from continuing operations (2,277) 2,627 (24,078)
------------ ----------- ------------
Gain on Discontinued Operations:
Loss from operations (3,019) (2,142) -
Gain on sale, net of taxes of $0, $1,420 and $1,500,
respectively - 6,782 2,251
Gain on discontinued operations (3,019) 4,640 2,251
------------ ----------- ------------
Net income (loss) $ (5,296) $ 7,267 $ (21,827)
============= =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
DRAGON SYSTEMS, INC.
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended December 31, 1999 and 1998
(in thousands, except share data)
<TABLE>
<CAPTION>
Convertible Preferred Stock Common Stock Additional
Number of Number of Paid-in
Shares Par Value Shares Par Value Capital
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996: 2,847,349 $ 114 11,966,120 $ 479 $ 18,135
Exercise of stock options and units 510 - 5,010 - 4
Issuance of convertible preferred stock
and common stock 359,739 14 1,511,990 60 11,926
Issuance of subsidiary stock - - - - 910
Net loss - - - - -
Foreign currency translation adjustment - - - - -
------------- ------------- ------------- ------------- -------------
Comprehensive income
Balance, December 31, 1997 3,207,598 128 13,483,120 539 30,975
Exercise of stock options and units 31,353 2 152,685 6 66
Net income - - - - -
Unrealized gain on investments,
available-for-sale - - - - -
Foreign currency translation adjustment - - - - -
------------- ------------- ------------- ------------- -------------
Comprehensive income
Balance, December 31, 1998 3,238,951 130 13,635,805 545 31,041
Exercise of stock options - - 188,115 8 311
Net loss - - - - -
Unrealized loss on investments
available-for-sale - - - - -
Foreign currency translation adjustment - - - - -
------------- ------------- ------------- ------------- -------------
Comprehensive loss
Balance, December 31, 1999 3,238,951 $ 130 13,823,920 $ 553 $ 31,352
============= ============= ============= ============= =============
<CAPTION>
Accumulated Total
Other Stockholders'
Accumulated Comprehensive Equity Comprehensive
Deficit Income (Loss) (Deficit) Income (Loss)
<S> <C> <C> <C> <C>
Balance, December 31, 1996: $ (11,963) $ (14) $ 6,751 $
Exercise of stock options and units - - 4
Issuance of convertible preferred stock
and common stock - - 12,000
Issuance of subsidiary stock - - 910
Net loss (5,296) - (5,296) (5,296)
Foreign currency translation adjustment - (56) (56) (56)
------------- ------------- ------------- -------------
Comprehensive income $ (5,352)
=============
Balance, December 31, 1997 (17,259) (70) 14,313
Exercise of stock options and units - - 74
Net income 7,267 - 7,267 7,267
Unrealized gain on investments,
available-for-sale - 179 179 179
Foreign currency translation adjustment - (26) (26) (26)
------------- ------------- ------------- -------------
Comprehensive income $ 7,420
=============
Balance, December 31, 1998 (9,992) 83 21,807
Exercise of stock options - - 319
Net loss (21,827) - (21,827) (21,827)
Unrealized loss on investments
available-for-sale - (1,423) (1,423) (1,423)
Foreign currency translation adjustment - (13) (13) (13)
------------- ------------- ------------- -------------
Comprehensive loss $ (23,263)
=============
Balance, December 31, 1999 $ (31,819) $ (1,353) $ (1,137)
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
DRAGON SYSTEMS, INC.
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1998 1999
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income (loss) $ (5,296) $ 7,267 $ (21,827)
Adjustments to reconcile net income (loss) to net cash used in
operating activities- - -
Depreciation and amortization 970 890 1,402
Gain on sale of discontinued operations - (6,782) (2,251)
Deferred income taxes (2,594) 483 826
Changes in operating assets and liabilities-
Accounts receivable (1,503) (9,213) 3,160
Unbilled revenue 333 616 219
Inventories (1,681) (5,665) 3,504
Refundable income taxes 836 (3,413) 1,125
Prepaid expenses and other current assets (38) (201) 72
Accounts payable 1,902 5,364 (4,966)
Accrued expenses 307 4,807 3,702
Deferred revenues 24 16 4,870
Income taxes payable 418 (1,864) 91
Discontinued operations (140) 1,719 -
---------------- --------------- ---------------
Net cash used in operating activities (6,462) (5,976) (10,073)
--------------- --------------- ---------------
Cash Flows from Investing Activities:
Purchases of property and equipment (1,003) (1,515) (1,688)
Maturities and sales of investments, available-for-sale, net (4,131) 5,240 2,188
Cash from sale of discontinued operations - 2,230 4,035
Other assets 17 (14) (1)
--------------- --------------- ---------------
Net cash provided by investing activities (5,117) 5,941 4,534
--------------- --------------- ---------------
Cash Flows from Financing Activities:
Proceeds from issuance of options and units 12,004 74 319
Proceeds from convertible note payable 910 - 3,500
Proceeds from line of credit, net - - 3,000
--------------- --------------- ---------------
Net cash provided by financing activities 12,914 74 6,819
--------------- --------------- ---------------
Foreign Exchange Impact on Cash and Cash Equivalents (57) (22) 2
--------------- --------------- ---------------
Net Increase in Cash and Cash Equivalents 1,278 17 1,282
Cash and Cash Equivalents, beginning of period 3,616 4,894 4,911
--------------- --------------- ---------------
Cash and Cash Equivalents, end of period $ 4,894 $ 4,911 $ 6,193
=============== =============== ===============
Supplemental Disclosure of Cash Flows:
Cash paid for (refunds received from) income taxes, net $ (872) $ 5,909 $ (3,575)
=============== =============== ===============
Cash paid for interest $ - $ 12 $ 373
=============== =============== ===============
Supplemental Disclosure of Noncash Investing Activities:
fonix stock received from sale of discontinued operations $ - $ 1,759 $ -
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(1) THE COMPANY
Dragon Systems, Inc. (the Company) is a leading developer and provider of
advanced speech recognition products and related speech technologies that
humanize the way people communicate with computers and other electronic
devices. The Company's products and technologies enable electronic devices
to understand speech.
On June 7, 2000, the Company was acquired by Lernout & Hauspie Speech
Products NV (L&H). L&H issued 10,011,236 shares of common stock to former
stockholders of the Company and reserved for issuance 1,569,402 shares of
common stock for the Company's former stock option holders. The Company's
stock options have been converted into options to acquire L&H common stock
on the same basis as the Company's stock was converted into the right to
receive shares of L&H common stock. Of the shares of L&H common stock
issued to the former stockholders of the Company on closing, approximately
12% will be subject to vesting over a 4-year period.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation.
At September 2, 1998, the Company owned approximately 38% of the
outstanding voting shares of Articulate Systems, Inc. (Articulate).
The financial statements of Articulate have been reflected in the
consolidated financial statements of the Company as discontinued
operations (see Note 3).
(b) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets
and liabilities as at the date of the financial statements and the
reported amounts of income and expenses during the reporting period.
Actual results could differ from these estimates.
(c) Revenue Recognition
The Company sells its products predominantly through major
distributors to retail channel accounts and Value-Added Resellers
(VARs) and directly to Original Equipment Manufacturers (OEMs) and
ISVs. The Company recognizes revenue and the related receivable from
software license revenue to distributors at the time the products are
delivered by the distributor to the retail accounts and VARs, and
collectibility is deemed probable. The Company recognizes revenue from
products sold directly to end users at the time of shipment. Purchases
of the Company's products are evidenced by
6
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
purchase orders. Shipments by distributors to VARs, retail accounts
and end users are reported to the Company monthly by the principal
distributors. Based on its historical experience, the Company
estimates future credits and returns and records a related allowance
at the time revenue is recognized. The distributors do not
specifically identify the period of sale to which product returns from
the retail channel relate; therefore, for reserve purposes, any
returns are first attributed to deferred revenue, which represents
inventory at the distributor.
Revenue from royalty fees is recognized upon the shipment of units by
the OEMs.
Revenue received under development contracts and government funded
research is recognized using the percentage-of-completion method.
Losses, if any, are provided for at the time that management
determines that development costs will exceed related fees. Payments
received under development contracts prior to completion of the
related work and attainment of milestones are recorded as deferred
revenue. Unbilled revenue represents revenue recognition in excess of
amounts billed.
The Company has historically provided customers with free technical
support services for a 90-day period, which it is not contractually
obligated to provide. A provision is made at the time of sale for the
cost of such free services. Accrued product support expenses are
included in accrued expenses in the accompanying consolidated
financial statements.
(d) Foreign Currency
Assets and liabilities of the Company's foreign operations are
translated into U.S. dollars at the exchange rate in effect as of the
consolidated balance sheet date and revenue and expenses are
translated at average exchange rates during the period. The resultant
translation adjustment is reflected as a separate component of
accumulated other comprehensive income. Net gains and losses resulting
from foreign exchange transactions are reflected in the consolidated
statements of operations and were not material in all periods
presented.
(e) Research and Development and Software Development Costs
Software development costs for new software and for enhancements to
existing software are charged to operations as incurred until
technological feasibility is established, using the working model as a
basis for this determination. Software development costs incurred
subsequent to the establishment of technological feasibility and prior
to general release of the product are capitalized and amortized to
cost of software licenses on a straight-line basis over the estimated
useful life of the related products, generally from one to two years.
7
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
For the years ended December 31, 1997, 1998 and 1999, no software
development costs were capitalized, as the amounts expended subsequent
to reaching technological feasibility were immaterial.
(f) Income Taxes
The Company utilizes the liability method of accounting for income
taxes, as set forth in Statement of Financial Accounting Standards
(SFAS) No. 109, Accounting for Income Taxes. SFAS No. 109 requires the
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the
Company's consolidated financial statements or tax returns. In
estimating future tax consequences, SFAS No. 109 generally considers
all expected future events, other than enactments of changes in the
tax law or rates. Deferred tax assets are recognized, net of any
valuation allowance, for deductible temporary differences and
operating loss and credit carryforwards, if any. Deferred tax expense
represents the change in the deferred tax asset or liability balances.
(g) Financial Instruments
The Company considers all highly liquid investments that are readily
convertible to cash and that have original maturity dates of three
months or less to be cash equivalents. Cash equivalents consist
primarily of money market funds. In accordance with the SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities,
investments in securities are classified as trading, available-for-
sale or held-to-maturity. The Company's investments are classified as
available-for-sale and are carried at fair market value on the
accompanying consolidated balance sheets. The investments available-
for-sale are as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------
1998 1999
Cost Market Cost Market
<S> <C> <C> <C> <C>
U.S. government and
government agency
securities $ 1,990 $ 1,990 $ - $ -
Corporate securities 198 198 - -
fonix Class A common stock 1,565 1,744 1,565 321
---------- ---------- ---------- ----------
Total investments $ 3,753 $ 3,932 $ 1,565 $ 321
========== ========== ========== ==========
</TABLE>
(h) Fair Value and Concentration of Credit Risks
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that disclosure be made of estimates of the fair value of
financial instruments. The Company's financial instruments consist
primarily of cash and cash equivalents, letters of credit, accounts
receivable and accounts
8
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
payable. The carrying amount of these instruments approximates fair
value due to their short-term nature.
The Company sells its products primarily to distributors, resellers,
government agencies and large corporate customers. The Company
performs ongoing evaluations of customers' financial condition, and,
generally, does not require collateral. In addition, the Company
maintains reserves for potential credit losses, and such losses, in
the aggregate, have not exceeded management's expectations.
(i) Major Customers
The Company's sales to its two largest distributors were approximately
41% and 23%, respectively, of net revenue for 1998 and 30% and 22%,
respectively, of net revenue for 1999. For the year ended December 31,
1997, no customer accounted for 10% or more of net revenue.
(j) Inventories
Inventories include component parts and finished goods and are stated
at the lower of cost or market, cost being determined on the first-in,
first-out method.
December 31,
1998 1999
Component parts $ 3,173 $ 2,258
Finished goods 4,654 2,065
--------------- ---------------
$ 7,827 $ 4,323
=============== ===============
9
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(k) Property and Equipment
Property and equipment is recorded at cost. The Company provides for
depreciation and amortization on the straight-line method. Charges are
made to operating expenses in amounts that are sufficient to amortize
the cost of the assets over their estimated useful lives. Property and
equipment are summarized as follows:
December 31, Depreciable
1998 1999 Life In Year
Furniture and fixtures $ 623 $ 773 3-5
Office and computer equipment 5,803 6,969 3-5
Leasehold improvements and other 3-10 or term of
697 924 lease
-------- --------
7,123 8,666
Less--Accumulated depreciation
and amortization 5,129 6,386
-------- --------
$ 1,994 $ 2,280
======== ========
(l) Stock-Based Compensation
In accordance with SFAS No. 123, Accounting for Stock-Based
Compensation, the Company has elected to continue to account for
employee stock options at intrinsic value under Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,
with disclosure of the effects of fair value accounting on the net
income and earnings per share on a pro forma basis (see Note 8).
(m) Advertising Expenses
Advertising expenses are charged to operations as incurred. Total
advertising expenses included in the accompanying consolidated
statements of operations were $1,486, $9,180 and $9,676 in 1997, 1998
and 1999, respectively.
10
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(n) Accrued Expenses
Accrued expenses consist of the following:
December 31,
1998 1999
Compensation $ 3,027 $ 2,865
Marketing costs 2,764 2,141
Rebates 1,120 4,564
Other 644 1,775
--------------- ---------------
$ 7,552 $ 11,345
=============== ===============
(o) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Statement, as amended, is effective for the year ended
December 31, 2000. SFAS No. 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. The Company does not expect
adoption of this statement to have a material impact on its
consolidated financial position or results of operations.
In December 1998, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 98-9,
Modification of SOP 97-2, Software Revenue Recognition, with Respect
to Certain Transactions. SOP 98-9 is effective for fiscal years
beginning after March 15, 1999. SOP 98-9 requires use of the residual
method for the recognition of revenue under certain multiple element
arrangements. The Company does not expect the adoption of SOP 98-9 to
have a material impact on its consolidated financial position or
results of operations.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation--an Interpretation
of Accounting Principles Board Opinion No. 25. The interpretation
clarifies the application of Accounting Principles Board (APB) Opinion
25 in certain situations, as defined. The interpretation is effective
July 1, 2000 but covers certain events occurring during the period
after December 15, 1998 but before the effective date. To the extent
that events covered by this interpretation occur during the after
December 15, 1998 but before the effective date, the effects of
applying this interpretation would be recognized on a prospective
basis from the effective date. Accordingly, upon initial application
of the final interpretation, (i) no adjustments would be made to the
financial statements for periods before the effective date and (ii) no
expense would be recognized for any additional compensation cost
measured that is attributable to periods before the effective date.
The Company expects that the adoption of this interpretation will
affect the accounting for stock options repriced during 1999 (see Note
8(b)) and is currently evaluating the impact.
11
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(p) Reclassifications
Certain prior-period amounts have been reclassified to conform with
the current year presentation.
(3) DISCONTINUED OPERATIONS
During 1995, the Company purchased 49.7% of the outstanding voting
securities of Articulate. Because of (a) the Company's ownership interest,
(b) its option held to purchase additional shares of Articulate, and (c)
the Company's ability to control the Articulate Board of Directors, the
financial statements of Articulate were consolidated by the Company.
Effective September 2, 1998, the Company sold its interest in Articulate,
which then represented 38% of Articulate's outstanding voting securities,
to fonix corporation (fonix). The results of Articulate are reflected in
the Company's consolidated financial statements as discontinued operations
for all periods presented. As consideration for the sale, the Company
received $2,230 of cash, $4,035 of fonix demand notes, 1,260,988 shares of
unregistered fonix Class A common stock and 779,093 shares of unregistered
fonix Class B common stock. The common stock received was valued in the
aggregate amount of $1,759 and represented approximately 3.5% of the
outstanding common stock of fonix as of September 30, 1998. Due to the
significant uncertainty regarding collectibility of the notes, the Company
had fully reserved the value of the notes as part of the gain on sale from
the Articulate stock. During 1999, the Company received payment in full on
the notes, which is included in gain on discontinued operations. See also
Note 9(b) for discussion of the Company's agreement with fonix related to
certain outstanding litigation.
The following is a summary of the results of discontinued operations for
the years ended December 31:
1997 1998
Net sales $ 770 $ 329
Loss before income taxes (3,019) (2,142)
Loss from discontinued operations (3,019) (2,142)
(4) LINE OF CREDIT
In December 1998, the Company entered into an agreement with a bank
providing for a domestic credit facility of up to $3,000, as amended. This
credit facility can be used for revolving loans and letters of credit
through June 2000. This credit facility is secured by a guarantee of one of
the Company's stockholders and bears interest at the bank's prime rate of
interest (8.5% at December 31, 1999). There was $3,000 outstanding on the
credit facility at December 31, 1999.
(5) CONVERTIBLE NOTE PAYABLE TO STOCKHOLDER
On December 10, 1999, the Company entered into an agreement with one of its
stockholders, whereby the stockholder issued an unsecured $5,000 promissory
note (the Note) to the Company. The Note matures on December 10, 2002 and
interest is
12
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
payable quarterly at the prime rate (8.5% at December 31, 1999)
through the term of the Note. As of December 31, 1999, the Company had
$3,500 outstanding and $1,500 available for future borrowings under the
Note.
The Note is convertible at $12 per common share at the option of the
stockholder and automatically upon the closing of an initial public
offering (IPO) that results in aggregate proceeds of at least $30,000 and a
per share price of at least $15. The Company has reserved 416,667 shares of
common stock for conversion of the Note.
(6) INCOME TAXES
The provision for income taxes consists of the following:
1997 1998 1999
Current provision-
Federal $ 341 $ 3,438 $ (3,120)
State 35 585 -
Foreign 28 37 100
-------- ---------- ----------
Total current 404 4,060 (3,020)
-------- ---------- ----------
Deferred provision-
Federal (2,205) (2,513) 1,477
State (389) (443) 349
Foreign - - -
-------- ---------- ----------
Total deferred (2,594) (2,956) 1,826
-------- ---------- ----------
Total tax provision (benefit) $ (2,190) $ 1,104 $ (1,194)
======== ========== ==========
Reconciliation of the United States federal statutory rate to the Company's
effective tax rate is as follows for the two years ending December 31:
1997 1998 1999
U.S. federal statutory rate 34.0% 34.0% 34.0%
State income taxes, net of
federal income tax effect 6.0 6.0 6.0
Change in valuation allowance - (3.9) (38.3)
Tax credits generated 7.6 (9.9) 3.6
Other, net 1.4 3.4 (0.5)
-------- ---------- ----------
Effective tax rate 49.0% 29.6% 4.7%
======== ========== ==========
13
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
The temporary differences and carryforwards that created the deferred tax
assets and liabilities are as follows:
December 31,
1998 1999
Deferred tax assets-
Net operating loss and credit carryforward $ - $ 4,189
Deferred revenues 410 2,120
Nondeductible reserves and accruals 3,546 4,698
Other 208 521
-------- ---------
Total deferred tax assets 4,164 11,528
Valuation allowance (1,838) (11,528)
-------- ---------
Net deferred taxes $ 2,326 $ -
======== =========
The net tax benefits have been reduced by a valuation allowance, as they do
not satisfy the recognition criteria set forth in SFAS No. 109. Of the
valuation allowance at December 31, 1998, approximately $84 will be reduced
directly to equity when realized related to stock option benefits.
As of December 31, 1999, the Company had operating loss carryforwards and
credit carryforwards available for federal or state income taxes as
follows:
State operating loss $ 15,746
Federal operating loss 5,851
AMT credits 296
Research and development 900
These carryforwards expire through 2019 and are subject to the review and
possible adjustment by the Internal Revenue Service. In addition, the
occurrence of certain events, including significant changes in ownership
interests, may limit the amount of net operating loss carryforwards
available to be used in any given year.
(7) STOCKHOLDERS' EQUITY
(a) Convertible Preferred Stock
At December 31, 1999, the Company has, issued and outstanding, a total
of 3,238,951 shares of Convertible Preferred Stock, convertible into a
total of 16,194,755 shares of common stock. All shares of Convertible
Preferred Stock are required to be converted into common stock upon
the closing of an IPO of the Company's common stock, yielding
aggregate gross proceeds to the Company of at least $10,000.
In the event of any liquidation, dissolution or winding up of the
Company, the holders of Convertible Preferred Stock shall be entitled
to receive $20 per share, plus any declared and unpaid dividends.
After such payment to the
14
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
holders of Convertible Preferred Stock, the remaining assets available
for distribution shall first be distributed to the holders of the
common stock at a rate of $1.36 per share, plus all declared and
unpaid dividends, and the remaining assets, if any, shall be
distributed pro rata among the holders of common stock and the holders
of Convertible Preferred Stock (on an as-converted basis).
The holders of Convertible Preferred Stock are entitled to the number
of notes equal to the number of shares of common stock into which the
shares of Convertible Preferred Stock can be converted.
Convertible Preferred Stock is entitled to receive a noncumulative,
annual dividend of $1.60 per share, when and if declared by the Board
of Directors. No cash dividends may be paid on common stock during any
year unless the annual dividend on Convertible Preferred Stock has
been paid or declared during such year.
(b) Common Stock
At December 31, 1999, the Company had 23,449,432 shares of its common
stock reserved for issuance upon conversion of Convertible Preferred
Stock, convertible notes payable and the exercise of all stock options
available under the Company's stock option plans.
On December 1, 1998, the Company effected a five-for-one stock split
of its common stock in the form of a stock dividend of four shares for
each share then outstanding. In addition, the Company increased the
number of common stock authorized to 45,000,000 shares. The
accompanying consolidated financial statements and notes thereto, have
been retroactively adjusted to reflect the stock split.
(8) EMPLOYEE BENEFIT PLANS
(a) Stock Option Plans
In 1994, the Company adopted the 1994 Stock Option Plan (the 1994
Plan). Each plan provides for the granting of incentive stock options
and nonqualified stock options to employees, consultants and directors
of the Company. In June 1997, the Company adopted the 1997 Dragon
Systems UK Company Share Option Plan (the 1997 Plan), which provides
for the granting of options for UK employees. In December 1998, the
Company approved the 1999 Stock Incentive Plan (Incentive Plan). The
Incentive Plan provides for the granting of an aggregate of 3,000,000
shares issuable pursuant to incentive stock options, nonqualified
stock options, restricted stock awards and other stock based awards.
Under the plans, the Board of Directors determines the term of each
option, option price, number of shares for which options are granted
and the vesting period, which ranges from three to four years. The
exercise price per share for incentive stock options and nonqualified
options granted may not be less than 100% and 90%, respectively, of
the fair market value per share of the underlying common stock on the
date granted. The term of the options
15
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
granted cannot exceed 10 years. No options have been granted under the
1984 Plan since its expiration in 1994.
The activity under the Company's stock option plans is as follows:
<TABLE>
<CAPTION>
Outstanding Options
Weighted
Average
Reserved Exercise
Shares Number Price
<S> <C> <C> <C>
Outstanding, December 31, 1996 3,299,910 1,832,750 $ 1.38
Granted - 871,250 3.03
Exercised (2,865) (2,865) 1.35
Terminated - (106,185) 1.55
--------- --------- -----------
Outstanding, December 31, 1997 3,297,045 2,594,950 1.91
Increase in plan size 750,000 - -
Granted - 775,000 15.28
Exercised (20,925) (20,925) 2.78
Terminated - (107,941) 2.45
--------- --------- -----------
Outstanding, December 31, 1998 4,026,120 3,241,084 5.12
Increase in plan size 3,000,000 - -
Granted - 1,922,809 7.46
Exercised (188,110) (188,110) 1.70
Terminated - (311,580) 4.22
--------- --------- -----------
Outstanding, December 31, 1999 6,838,010 4,664,203 $ 6.28
========= ========= ===========
</TABLE>
The above table reflects options for common stock. In addition, at
December 31, 1995, the Company had 6,625 options that allowed the
holder to acquire units. Each unit consisted of approximately six
shares of common stock and seven shares of preferred stock, at an
exercise price per share of $10. The number of shares issued relating
to options to acquire units was 16,387 preferred shares and 68,895
common shares in 1996; 510 preferred shares and 2,145 shares in 1997;
and 31,353 preferred shares and 131,760 common shares in 1998. At
December 31, 1999, all options to acquire units had been exercised.
16
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
As of December 31, 1999, the status of the Company's outstanding
and exercisable options was as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life (Years) Price Exercisable Price
<S> <C> <C> <C> <C> <C>
$ 1.36-$1.50 1,451,612 6.05 $ 1.38 1,280,223 $ 1.37
$ 2.30-$3.18 588,934 7.59 3.15 281,292 3.15
$ 3.50-$3.50 12,500 7.61 3.50 6,250 3.50
$ 7.20-$8.80 2,050,157 9.54 8.01 130,026 7.98
$ 16.00 561,000 8.38 16.00 162,000 16.00
----------- ------------ -------- ----------- --------
$ 1.36-$16.00 4,664,203 8.21 $ 6.28 1,859,791 $ 3.38
=========== ============ ======== =========== ========
</TABLE>
Had compensation costs for the stock option plans been determined
using the fair value method, the Company's net income (loss) would
have changed to the following for the three years ended December
31, 1999:
1997 1998 1999
As reported $ (5,296) $ 7,267 $ (21,827)
Pro forma (5,524) 6,520 (23,167)
Consistent with SFAS No. 123, pro forma net loss has not been
calculated for options granted prior to January 1, 1995. Pro forma
compensation may not be representative of that to be expected in
future years.
The weighted average fair value of options granted was $0.90, $4.21
and $2.36 for options granted during 1997, 1998 and 1999,
respectively. The values were estimated on the date of grant using
the minimum value method and the following weighted average
assumptions for grants for the three years ended December 31:
1997 1998 1999
Risk-free interest rate 6.09% 5.51% 5.80-6.19%
Expected life 6 years 6 years 6 years
Volatility factor - - -
Expected dividend yield - - -
(b) Repricing
In December 1999, the Company's Board of Directors authorized the
repricing of options to purchase 170,000 shares of common stock at
$8 per share. The price per share was less than fair market value
on the date of the repricing and, accordingly, the Company has
recorded compensation expense in the related statement of
operations. As discussed in Note 2(n), these options will be
subject to variable plan accounting, as defined in Interpretation
No. 44.
17
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(c) Employee Stock Purchase Plan
The Company's 1999 Employee Stock Purchase Plan (the Purchase Plan)
was adopted by the Board of Directors in December 1998. The Purchase
Plan authorizes the issuance of up to a total of 500,000 shares of
common stock to eligible participating employees, as defined. As of
December 31, 1999, no shares were issued under the purchase plan.
(d) Other Compensation Plans
The Company has a profit sharing and bonus plan, which provides for
the distribution of a percentage of pretax profits to Company
employees. The Company also has a 401(k) plan for its employees.
Eligible employees may make voluntary contributions to the 401(k) plan
through a salary reduction contract up to the statutory limit or 12%
of their annual compensation. The Company matches employees' voluntary
contributions to the plan, up to certain prescribed limits. These
Company contributions vest over a two-year period commencing upon
enrollment in the Plan. The total charge to expense under these plans
was $762, $2,615 and $1,373 in 1997, 1998 and 1999, respectively.
(9) REPORTABLE SEGMENTS
The Company's reportable segments include its software licensing segment
and development contract segment. The software licensing segment produces
voice recognition software products for sale to end users through
distributors, OEMs and resellers. The development contract segment provides
contractual software development services to commercial and government
securities.
Each reportable segment is a strategic business unit that offers different
products and services to end users. Each segment is separately managed
because its end users are very different, thus requiring different
technology and marketing strategies.
(a) Measurement of Reportable Segments
The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. The
Company evaluates the performance of each reportable segment based on
the segment's contribution towards selling, marketing, general and
administrative costs. Intersegment sales or transfers are immaterial,
as each segment has different products and services.
18
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
(b) Financial Information
The following table reflects certain financial information relating to
each reportable segment for the three years ended December 31:
<TABLE>
<CAPTION>
Segment Data 1997 1998 1999
<S> <C> <C> <C>
Net revenue from external customers:
Software licensing $ 19,506 $ 63,667 $ 55,570
Development contracts 7,315 5,732 4,434
------------ ------------ ------------
Total net revenue $ 26,821 $ 69,399 $ 60,004
============ ============ ============
</TABLE>
Contribution towards selling, marketing, general and administrative for
the three years ended December 31:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Software licensing $ 4,535 $ 33,023 $ 7,588
Development contracts 2,322 2,457 1,662
--------------- --------------- ---------------
Total contribution $ 6,857 $ 35,480 $ 9,250
=============== =============== ===============
</TABLE>
Depreciation and amortization expense included in the determination of
contribution for the three years ended December 31:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Software licensing $ 442 $ 253 $ 321
Development contracts 110 56 47
--------------- --------------- ---------------
Total depreciation
and amortization $ 532 $ 309 $ 368
=============== =============== ===============
</TABLE>
The total contribution differs from the pretax income from continuing
operations by the amount of total selling, marketing, general and
administrative expenses and net interest income, which are not allocated
by segment. Segment assets are not reviewed by the chief operating
decision maker. Assets specifically identifiable with each reportable
segment are as follows:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Software licensing $ 4,368 $ 20,281 $ 12,050
Development contracts 1,538 857 660
Unallocated assets 17,280 16,791 12,563
--------------- --------------- ---------------
Total assets $ 23,186 $ 37,929 $ 25,273
=============== =============== ===============
</TABLE>
19
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, execept share data)
(c) Geographic Data
Net revenue from external customers for the three years ended December
31:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
United States $ 22,750 $ 60,326 $ 47,484
Rest of world 4,071 9,073 12,520
--------------- --------------- ---------------
Total net revenue $ 26,821 $ 69,399 $ 60,004
=============== =============== ===============
United States $ 22,816 $ 37,542 $ 23,650
Rest of world 370 387 1,623
--------------- --------------- ---------------
Total assets $ 23,186 $ 37,929 $ 25,273
=============== =============== ===============
</TABLE>
Net revenue from external customers has been attributed to a geographical area
based on the location of the customer.
(10) COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments
The Company has operating lease commitments for certain facilities and
equipment. The Company's minimum lease payments as of December 31, 1999
are as follows:
2000 $ 1,623
2001 1,598
2002 1,818
2003 1,782
2004 and thereafter 1,034
----------
Total minimum lease payments $ 7,855
==========
Total rent expense for years ended December 31, 1997, 1998 and 1999
was $1,053, $1,166 and $1,415, respectively.
(b) Contingencies
In February 1996, Articulate, a former investment of the Company,
sued Apple Computer, Inc. (Apple) for patent infringement in
Massachusetts. Apple then sued Articulate in May 1996 in California
alleging that Articulate's PowerSecretary product infringed four
Apple patents. In September 1996, Apple added the Company, which
then owned a minority interest in Articulate and distributed
PowerSecretary, as a defendant to its suit in California. In a
separate proceeding in October 1997, Apple sued the Company and one
of its customers, MetroBook, in Virginia, alleging that the
Company's Dragon NaturallySpeaking product infringed three Apple
patents.
20
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, execept share data)
Articulate's initial suit in Massachusetts is still pending. Previous
to Articulate being purchased by fonix in September of 1998, Dragon
was obligated to pay Articulate's fees in the Massachusetts case.
Subsequent to that sale, Dragon had no further involvement in that
case.
In Apple's California suit, the court has granted a summary judgment
motion in favor of Articulate and the Company on all claims. Apple has
filed an appeal with the U.S. Court of Appeals for the Federal
Circuit. Apple's Virginia suit has been transferred to California and
the court has granted summary judgment in favor of the Company and
MetroBook with respect to one of Apple's patents. The remainder of the
case (with respect to the final two Apple patents) is still in
discovery. The Company believes that its Dragon PowerSecretary and
Dragon NaturallySpeaking products do not infringe any of Apple's
patents, but there can be no assurance that the Company will prevail
in these matters. The Company believes it has substantial defenses in
each case, but the outcome cannot be predicted. The legal costs of
Articulate relating to this litigation included in discontinued
operations were approximately $1,749 in 1997, $774 in 1998 and $91 in
1999.
In connection with the Articulate sale to fonix, the Company has
agreed to jointly defend the pending lawsuit in California involving
the Company and Articulate. This agreement commits the Company to pay
one half of the legal cost incurred to defend the lawsuit and one half
of any settlement.
On January 26, 1999, Voice Recognition Systems, Inc. of Annapolis,
Maryland, filed a lawsuit against the Company which alleges breach of
contract, misappropriation of trade secret, conversion, unjust
enrichment and fraud. The plaintiff is seeking injunctive relief and
damages.
On February 12, 1999, AllVoice Computing Plc of Devon, England, filed
a lawsuit against the Company which alleges infringement by the
Company of one of AllVoice's patents and violation of the unfair trade
practices statute in Massachusetts. AllVoice is seeking injunctive
relief and unspecified damages, including treble damages.
Because these two lawsuits have only recently commenced, the Company
is unable to give any assurance that the Company will prevail.
However, based on the Company's preliminary review of the plaintiffs'
allegations, the Company believes that the Company has meritorious
defenses in each case and that these lawsuits will not have a material
adverse effect on the financial condition or operations of the
Company, although an unfavorable outcome could adversely affect the
operating results for the quarter in which the unfavorable outcome
would occur.
The Company is not a party to any other material legal proceedings.
(11) Patent Settlement
In September 1993, the Company and Kurzweil Applied Intelligence (Kurzweil)
settled pending litigation by entering into two settlement and cross-
license
21
<PAGE>
DRAGON SYSTEMS, INC.
Notes to Consolidated Financial Statements
(in thousands, except share data)
agreements. Pursuant to one of these agreements, each party granted
the other an irrevocable, worldwide, nonexclusive, nontransferable license
to use patents and patent applications of the other party. Kurzweil was
subsequently acquired by Lernout in 1997. As a result of this acquisition,
no license grants were made under the agreement after the date of such
acquisition; however, each party maintains its rights in the patents and
applications previously granted under the agreement.
In consideration for the license, the Company recorded software license
revenue in the amounts of $970, $1,096 and $1,301 during the years ended
December 31, 1997, 1998 and 1999, respectively. In addition, Kurzweil is
required to pay $1,470 and $1,662 during the years ended December 31, 2000
and 2001, respectively.
Kurzweil has the option to continue its license by continuing to make such
payments to the Company through June 1, 2006, at which time its license
would be fully paid. If Kurzweil were to elect to renew its license each
year, the settlement agreement provides that the Company would receive
approximately $12,238 from 2000 through 2006.
22
<PAGE>
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
In June 1999, Lernout & Hauspie Speech Products N.V. (the "Company") acquired
Brussels Translation Group N.V. ("BTG"), a Belgian corporation, for
approximately $42.3 million, including acquisition costs. In May 2000, the
Company acquired Dictaphone Corporation ("Dictaphone") for approximately $533.4
million, including 9,384,198 shares of Lernout & Hauspie common stock,
approximately $31.5 million in cash and approximately $12.4 million in
acquisition costs. In June 2000, the Company acquired Dragon Systems, Inc.
("Dragon") for approximately $444.0 million, consisting of 10,011,236 shares of
Lernout & Hauspie common stock and acquisition costs.
Dragon is a developer and provider of advanced speech recognition products and
related speech technologies that humanize the way people communicate with
computers and other electronic devices. The Company intends to keep the
operations of Dragon substantially unchanged.
Concurrently with the acquisition of Dragon, a Dragon shareholder converted a
note payable in the amount of $3.5 million into 291,666 shares of Dragon common
stock. Also concurrently with the acquisition, all outstanding shares of Dragon
convertible preferred stock were converted into 16,194,755 shares of Dragon
common stock. In addition, all outstanding vested and unvested employee options
to purchase Dragon common stock were exchanged for equivalent options to
purchase Lernout & Hauspie common stock. The total purchase price of $444.0
million consists of 10,011,236 shares of Lernout & Hauspie common stock, valued
at $39.27 per share; the fair value of the exchanged stock options; and
acquisition costs of approximately $7.8 million.
The Unaudited Pro Forma Condensed Consolidated Statements of Operations of the
Company for the year ended December 31, 1999 and the six months ended June 30,
2000 (the "Pro Forma Statements of Operations") give effect to these
acquisitions as if they had occurred on January 1, 1999. The Pro Forma
Statements of Operations are based on the historical results of operations of
the Company, of BTG for the six months ended June 30, 1999, of Dictaphone for
the year ended December 31, 1999 and the four months ended April 30, 2000, and
of Dragon for the year ended December 31, 1999 and the period from January 1,
2000 to June 7, 2000. The Pro Forma Statements of Operations and the
accompanying notes should be read in conjunction with and are qualified by the
consolidated financial statements and related notes and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included in the
Company's 1999 annual report on Form 10-K and June 30, 2000 quarterly report on
Form 10-Q.
The Pro Forma Statements of Operations have been prepared in accordance with
generally accepted accounting principles in the United States ("US GAAP") and
give effect to the acquisitions of BTG, Dictaphone and Dragon using the purchase
method of accounting. In accordance with US GAAP, the purchase price is
allocated to the assets and liabilities of the respective companies based on
their fair values at the respective dates of acquisition.
The Pro Forma Statements of Operations are intended for informational purposes
only and are not necessarily indicative of the future results of operations of
the consolidated company after the acquisitions of BTG, Dictaphone and Dragon,
or of the results of operations of the consolidated company that would have
actually occurred had the acquisitions of BTG, Dictaphone and Dragon been
effected as of January 1, 1999.
<PAGE>
LERNOUT & HAUSPIE SPEECH PRODUCTS NV AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
DICTAPHONE
HISTORICAL HISTORICAL HISTORICAL BUSINESS TO ADJUSTED
THE COMPANY BTG DICTAPHONE BE DISPOSED DICTAPHONE
<S> <C> <C> <C> <C> <C>
Revenues:
Technologies and solutions $ 138,660 $ - $103,702 $ - $103,702
Applications 113,693 - 205,744 - 205,744
Consulting and services 91,884 - - - -
Contract manufacturing sales - - 44,288 44,288 -
------------ -------- -------- -------- --------
Total revenues 344,237 - 353,734 44,288 309,446
------------ -------- -------- -------- --------
Cost of revenues:
Technologies and solutions 19,634 - 51,936 - 51,936
Applications 18,988 - 99,557 - 99,557
Consulting and services 55,633 - - - -
Contract manufacturing sales - - 37,702 37,702 -
------------ -------- -------- -------- --------
Total cost of revenues 94,255 - 189,195 37,702 151,493
Selling, general and administrative 101,641 10 111,308 912 110,396
Research and development, net 49,621 1,978 9,761 - 9,761
Amortization of goodwill and other
business acquisition intangibles 32,439 - 11,369 2,723 8,646
------------ -------- -------- -------- --------
Total operating expenses 277,956 1,988 321,633 41,337 280,296
------------ ------- -------- -------- --------
Operating income (loss) 66,281 (1,988) 32,101 2,951 29,150
Other expenses (income):
Interest and other financing expenses 1,684 538 40,062 3,677 36,385
Interest income (7,949) - - - -
Foreign exchange gains and losses, net (2,479) - - - -
Share in losses of unconsolidated affiliates 1,633 - - - -
Other - - (55) - (55)
------------ -------- -------- -------- --------
Total other expenses (income) (7,111) 538 40,007 3,677 36,330
------------ -------- -------- -------- --------
Income before income taxes and minority interests 73,392 (2,526) (7,906) (726) (7,180)
Provision for income taxes (benefit) 27,150 - 1,037 - 1,037
------------ -------- -------- -------- --------
Income before minority interests 46,242 (2,526) (8,943) (726) (8,217)
Minority interests 4,500 - - - -
------------ -------- -------- -------- --------
Net income (loss) 41,742 (2,526) (8,943) (726) (8,217)
Dividends on preferred stock - - 5,815 - 5,815
------------ -------- -------- -------- --------
Net income (loss) applicable to common stock $ 41,742 $(2,526) $(14,758) $ (726) $(14,032)
============ ======== ======== ======== ========
Basic net income (loss) per common share $ 0.37
============
Diluted net income (loss) per common share $ 0.35
============
Basic weighted average number of
shares outstanding 113,109,456
============
Diluted weighted average number of
shares outstanding 119,423,724
============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
DRAGON ADJUSTMENTS PRO FORMA
<S> <C> <C> <C>
Revenues:
Technologies and solutions $ - $ - $ 242,362
Applications 60,004 (1,301) c 378,140
Consulting and services - (1,978) a 89,906
Contract manufacturing sales - - -
-------- --------- ------------
Total revenues 60,004 (3,279) 710,408
-------- --------- ------------
Cost of revenues:
Technologies and solutions - - 71,570
Applications 31,903 (1,582) c 148,866
Consulting and services - (781) b 54,852
Contract manufacturing sales - - -
-------- --------- ------------
Total cost of revenues 31,903 (2,363) 275,288
Selling, general and administrative 34,639 (8,720) e 237,966
Research and development, net 18,851 (1,978) a 98,494
781 b
15,360 e
4,120 f
Amortization of goodwill and other
business acquisition intangibles - 2,070 d 202,292
(8,646) e
79,879 e
87,904 f
-------- --------- ------------
Total operating expenses 85,393 168,407 814,040
-------- --------- ------------
Operating income (loss) (25,389) (171,686) (103,632)
Other expenses (income):
Interest and other financing expenses 275 207 g 43,294
(12,553) h
(23) i
17,411 j
(630) l
Interest income (392) 1,163 k (7,178)
Foreign exchange gains and losses, net - - (2,479)
Share in losses of unconsolidated affiliates - - 1,633
Other - - (55)
-------- --------- ------------
Total other expenses (income) (117) 5,575 35,215
-------- --------- ------------
Income before income taxes and minority interests (25,272) (177,261) (138,847)
Provision for income taxes (benefit) (1,194) (6,420) m 20,573
-------- --------- ------------
Income before minority interests (24,078) (170,841) (159,420)
Minority interests - - 4,500
-------- --------- ------------
Net income (loss) (24,078) (170,841) (163,920)
Dividends on preferred stock - (5,815) n -
-------- --------- ------------
Net income (loss) applicable to common stock $(24,078) $(165,026) $ (163,920)
======== ========= ============
Basic net income (loss) per common share $ (1.24)
============
Diluted net income (loss) per common share $ (1.24)
============
Basic weighted average number of
shares outstanding o 132,504,890
============
Diluted weighted average number of
shares outstanding o 132,504,890
============
</TABLE>
<PAGE>
LERNOUT & HAUSPIE SPEECH PRODUCTS NV AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2000
<TABLE>
<CAPTION>
DICTAPHONE
HISTORICAL HISTORICAL BUSINESS TO ADJUSTED
THE COMPANY DICTAPHONE BE DISPOSED DICTAPHONE
<S> <C> <C> <C> <C>
Revenues:
Technologies and solutions $ 137,790 $ 35,297 $ - $ 35,297
Applications 78,433 50,772 - 50,772
Consulting and services 49,378 - - -
Contract manufacturing sales - 12,502 (12,502) -
------------ ---------- ----------- ----------
Total revenues 265,601 98,571 (12,502) 86,069
------------ ---------- ----------- ----------
Cost of revenues:
Technologies and solutions 19,551 20,767 - 20,767
Applications 23,587 36,501 - 36,501
Consulting and services 29,141 - - -
Contract manufacturing sales - 10,849 (10,849) -
------------ ---------- ----------- ----------
Total cost of revenues 72,279 68,117 (10,849) 57,268
Selling, general and administrative 87,225 39,672 (221) 39,451
Research and development, net 40,090 2,492 - 2,492
Amortization of goodwill and other business
acquisition intangibles 46,620 2,945 (768) e 2,177
Write-off of in-process research and development 8,600 - - -
------------ ---------- ----------- ----------
Total operating expenses 254,814 113,226 (11,838) 101,388
------------ ---------- ----------- ----------
Operating income (loss) 10,787 (14,655) (664) (15,319)
Other expenses (income):
Interest and other financing expenses 8,540 14,025 (1,295) 12,730
Interest income (3,953) - - -
Foreign exchange gains and losses, net (9,372) - - -
Share in losses of unconsolidated affiliates 5,465 - - -
Other 2,276 62 - 62
------------ ---------- ----------- ----------
Total other expenses (income) 2,956 14,087 (1,295) 12,792
------------ ---------- ----------- ----------
Income before income taxes and minority interests 7,831 (28,742) 631 (28,111)
Provision for income taxes (benefit) 23,428 (521) - (521)
------------ ---------- ----------- ----------
Income before minority interests (15,597) (28,221) 631 (27,590)
Minority interests 1,622 - - -
------------ ---------- ----------- ----------
Net income (loss) (17,219) (28,221) 631 (27,590)
Dividends on preferred stock - 2,210 - 2,210
------------ ---------- ----------- ----------
Net loss applicable to common stock $ (17,219) $ (30,431) $ 631 $ (29,800)
============ ========== =========== ==========
Net loss per common share-basic and diluted $ (0.14)
============
Weighted average number of shares
outstanding-basic and diluted 124,968,811
============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
DRAGON ADJUSTMENTS PRO FORMA
<S> <C> <C> <C>
Revenues:
Technologies and solutions $ - $ - $ 173,087
Applications 20,366 (3,674) c 145,897
Consulting and services - - 49,378
Contract manufacturing sales - - -
----------- ------------- ------------
Total revenues 20,366 (3,674) 368,362
----------- ------------- ------------
Cost of revenues:
Technologies and solutions - - 40,318
Applications 10,949 (692) c 70,345
Consulting and services - - 29,141
Contract manufacturing sales - - -
----------- ------------- ------------
Total cost of revenues 10,949 (692) 139,804
Selling, general and administrative 24,240 (3,903) e 147,013
Research and development, net 11,503 5,120 e 60,922
1,717 f
Amortization of goodwill and other business
acquisition intangibles - 27,319 e 110,565
(2,177) e
36,626 f
Write-off of in-process research and development - - 8,600
----------- ------------- ------------
Total operating expenses 46,692 (64,010) 466,904
----------- ------------- ------------
Operating income (loss) (26,326) (67,684) (98,542)
Other expenses (income):
Interest and other financing expenses 268 104 g 21,610
(5,315) h
(139) i
5,804 j
(382) l
Interest income (52) - (4,005)
Foreign exchange gains and losses, net - - (9,372)
Share in losses of unconsolidated affiliates - - 5,465
Other 347 - 2,685
----------- ------------- ------------
Total other expenses (income) 563 72 16,383
----------- ------------- ------------
Income before income taxes and minority interests (26,889) (66,305) (113,474)
Provision for income taxes (benefit) 225 (1,335) m 21,797
----------- ------------- ------------
Income before minority interests (27,114) (65,304) (135,605)
Minority interests - - 1,622
----------- ------------- ------------
Net income (loss) (27,114) (65,304) (137,227)
Dividends on preferred stock - (2,210) n -
----------- ------------- ------------
Net loss applicable to common stock $ (27,114) $ (63,094) $ (137,227)
=========== ============= ============
Net loss per common share-basic and diluted $ (0.98)
============
Weighted average number of shares outstanding-basic and diluted o 140,211,646
============
</TABLE>
<PAGE>
Continued
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V.
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Adjustments have been made to the unaudited pro forma condensed consolidated
statements of operations to reflect the following (amounts in thousands, except
where indicated):
(a) In March 1997, the Company entered into a software development and
commercialization agreement with BTG (the "BTG Agreement") in which the
Company agreed to provide engineering services for the development of the
Machine Translation Software. The Company completed its work under the BTG
Agreement in early 1999.
During the six months ended June 30, 1999, BTG paid the Company
approximately $2 million for engineering work performed under the BTG
Agreement. The pro forma adjustment reflects the combined operations in
which intercompany revenues and expenses are eliminated.
(b) The costs of engineering associated with the BTG Agreement for the six
months ended June 30, 1999 were $781,000 and were included in cost of
language technologies and cost of consulting and services. The pro forma
adjustment reflects the reclassification of these costs to research and
development expense, reflecting a full year of combined operations.
(c) In September 1993, a subsidiary of the Company and Dragon entered into a
license agreement whereby each party was granted the right to use the
patents and patent applications of the other party. During the year ended
December 31, 1999 and the six months ended June 30, 2000, Dragon recorded
revenues and the Company recorded cost of revenues in connection with this
license agreement. The pro forma adjustments reflect the combined
operations in which intercompany revenues and expenses are eliminated.
(d) To reflect the amortization of goodwill associated with the BTG acquisition
over an estimated useful life of 15 years.
(e) To reflect the elimination of the historical amortization of goodwill and
capitalized technology costs of Dictaphone, and the amortization of the
goodwill and other intangibles in connection with the Dictaphone
acquisition as follows:
<TABLE>
<CAPTION>
Year ended Four months
December 31, ended April 30,
1999 2000
---- ----
<S> <C> <C>
Dictaphone historical amortization:
Goodwill $ 8,646 $ 2,945
Capitalized technology 8,720 3,903
------ -------
$17,366 $ 6,848
======= =======
<CAPTION>
Year ended Six months
December 31, ended June 30,
1999 2000
---- ----
<S> <C> <C>
Pro forma amortization:
Goodwill $56,116 $19,403
Customer lists 16,513 5,504
Tradenames 2,950 980
Workforce 4,300 1,432
------- -------
79,879 27,319
Capitalized technology 15,360 5,120
------- -------
$95,239 $32,439
======= =======
</TABLE>
The pro forma amortization has been calculated using the following estimated
useful lives (in years):
<TABLE>
<S> <C>
Goodwill.................................................................................. 10
Customer lists............................................................................ 8
Tradenames................................................................................ 10
Workforce................................................................................. 5
Capitalized technology.................................................................... 5
</TABLE>
<PAGE>
(f) To reflect the amortization of the goodwill and other intangibles in
connection with the Dragon acquisition using an estimated useful life of
five years as follows:
<TABLE>
<CAPTION>
Year ended Six months
December 31, ended June 30,
1999 2000
---- ----
<S> <C> <C>
Goodwill $ 81,784 $ 34,077
Workforce 1,460 608
Trademarks 380 158
Non-compete and other agreements 3,380 1,408
Favorable leases 900 375
-------- --------
87,904 36,626
Capitalized technology and in-process research and development 4,120 1,717
-------- --------
$ 92,024 $ 38,343
======== ========
</TABLE>
(g) To reflect the amortization of the deferred financing costs related to the
Revolving Credit Facility over 5 years.
(h) To reflect the reduction in interest expense related to the Dictaphone
long-term debt repaid on the date of acquisition.
(i) To reflect the reduction in interest expense related to the Dragon note
payable converted into Dragon common stock concurrently with the
acquisition.
(j) To reflect the increase in interest expense related to the borrowings under
the Revolving Credit Facility utilized in funding a portion of the
Dictaphone acquisition (assuming an interest rate of 7.57%).
(k) To reflect the reduction in interest income related to cash balances
utilized in funding a portion of the BTG acquisition (assuming an interest
rate of 5.5%).
(l) To reflect the reduction of Dictaphone's historical amortization of
deferred financing costs related to long-term debt repaid on the date of
acquisition.
(m) The pro forma adjustment reflects the income tax benefit that would have
been recorded by the Company in its consolidated statements of operations
related to the historical losses of Dragon for the comparable periods
presented and the income tax effect of the pro forma adjustments, primarily
the adjustments related to the reduction in foreign taxes due to an
increase in interest expense related to the borrowings under the Revolving
Credit Facility (see (j)) and a reduction in interest income related to
cash balances utilized in the funding of BTG (see (k)).
(n) To reflect the reduction in stock dividends of Dictaphone preferred stock
retired and not assumed by the Company.
(o) The following information reconciles the number of shares used to compute
historical and pro forma earnings (loss) per common share:
<TABLE>
<CAPTION>
For the period ended
--------------------
December 31, 1999 June 30, 2000
----------------- -------------
Basic Diluted Basic Diluted
----- ------- ----- -------
<S> <C> <C> <C> <C>
Lernout & Hauspie historical 113,109,456 119,423,724 124,968,811 124,968,811
Common shares issued in Dictaphone 9,384,198 9,384,198 6,496,755 6,496,755
acquisition
Common shares issued in Dragon acquisition 10,011,236 10,011,236 8,746,080 8,746,080
Elimination of Lernout & Hauspie stock
options--antidilutive on a pro forma
basis -- (6,176,982) -- --
Elimination of Lernout & Hauspie warrants--
antidilutive on a pro forma basis -- (137,286) -- --
------------ ------------ ------------ ------------
132,504,890 132,504,890 140,211,646 140,211,646
============ ============ ============ ============
</TABLE>
