<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 4, 1999
REGISTRATION NO. 333-69211
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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DRAGON SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C>
DELAWARE 7372 04-2764754
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
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320 NEVADA STREET
NEWTON, MA 02460
(617) 965-5200
(ADDRESS INCLUDING ZIP CODE, AND TELEPHONE NUMBER INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
JANET M. BAKER
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
DRAGON SYSTEMS, INC.
320 NEVADA STREET
NEWTON, MA 02460
(617) 965-5200
(NAME, ADDRESS INCLUDING ZIP CODE AND TELEPHONE
NUMBER INCLUDING AREA CODE, OF AGENT FOR SERVICE)
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COPIES TO:
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PAUL P. BROUNTAS, ESQ. JOHN A. MELTAUS, ESQ.
HALE AND DORR LLP TESTA, HURWITZ & THIBEAULT, LLP
60 STATE STREET 125 HIGH STREET
BOSTON, MASSACHUSETTS 02109 BOSTON, MASSACHUSETTS 02110
TELEPHONE: (617) 526-6000 TELEPHONE: (617) 248-7000
TELECOPY: (617) 526-5000 TELECOPY: (617) 248-7100
</TABLE>
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date hereof.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS (Subject to Completion)
Issued March , 1999
Shares
DRAGON SYSTEMS LOGO
COMMON STOCK
------------------------
DRAGON SYSTEMS, INC. IS OFFERING SHARES OF ITS COMMON STOCK.
THIS IS OUR INITIAL
PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS FOR OUR SHARES.
WE ANTICIPATE THAT
THE INITIAL PUBLIC OFFERING PRICE WILL BE BETWEEN $ AND $
PER SHARE.
------------------------
WE HAVE FILED AN APPLICATION FOR THE COMMON STOCK TO BE QUOTED ON THE
NASDAQ NATIONAL MARKET UNDER THE SYMBOL "DRGN."
------------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 4.
------------------------
PRICE $ A SHARE
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<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS COMPANY
-------- ------------- -----------
<S> <C> <C> <C>
Per Share........................... $ $ $
Total............................... $ $ $
</TABLE>
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
Dragon's founders and some of its other key employees have granted the
underwriters the right to purchase up to shares to cover
over-allotments. Morgan Stanley & Co. Incorporated expects to deliver the shares
to purchasers on , 1999.
------------------------
MORGAN STANLEY DEAN WITTER
HAMBRECHT & QUIST
SG COWEN
, 1999
<PAGE> 3
[gatefold artwork]
Description of Gatefold
Two page insert
Text: Dragon Systems was the first company to introduce general purpose,
large vocabulary continuous speech recognition. The company has a 16
year history of developing and providing advanced speech technologies,
worldwide. These technologies "humanize" the way people communicate
with computers, telephones, industrial systems and mobile devices.
SPEECH, PRODUCTS & TECHNOLOGY
Graphic: Picture of six company products on bottom half of page
Picture depicting various people using Dragon products on right side
of page
Company logo and a collage of international flags on bottom margin of
page.
<PAGE> 4
TABLE OF CONTENTS
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PAGE
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Prospectus Summary................... 3
Risk Factors......................... 4
Special Note Regarding
Forward-Looking Statements......... 10
Use of Proceeds...................... 10
Dividend Policy...................... 10
Capitalization....................... 11
Dilution............................. 12
Selected Consolidated Financial
Data............................... 13
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 14
</TABLE>
<TABLE>
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PAGE
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Business............................. 23
Management........................... 39
Certain Transactions................. 47
Principal and Selling Stockholders... 48
Description of Capital Stock......... 50
Shares Eligible for Future Sale...... 52
Underwriters......................... 54
Legal Matters........................ 56
Experts.............................. 56
Where You Can Find More Information... 56
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
------------------------
We are a Delaware corporation. Our principal executive offices are located
at 320 Nevada Street, Newton, MA 02460. Our telephone number is (617) 965-5200.
In this prospectus, "Dragon," "we," and "our" refer to Dragon Systems, Inc. and
its subsidiaries.
Until , 1999, (25 days after the date of this prospectus) all
dealers that buy, sell or trade in our common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This is
in addition to the dealers' obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
The Dragon logo, DragonDictate, Dragon Systems and PhoneQuery are
registered trademarks of Dragon. BestMatch, NaturallyMobile, NaturallyOrganized,
NaturallySpeaking, The Natural Speech Company, Point & Speak, Select-and-Say,
Vocabulary Builder and VoiceTool are trademarks of Dragon. All other trade names
and trademarks referred to in this prospectus are the property of their
respective owners.
------------------------
Except as set forth in the Consolidated Financial Statements or as
otherwise indicated, all information in this prospectus:
- assumes no exercise of the underwriters' over-allotment option;
- reflects the conversion of all outstanding shares of our convertible
preferred stock into shares of common stock;
- reflects the filing, as of the closing of the offering, of our amended
and restated certificate of incorporation and the adoption of our amended
and restated by-laws implementing certain provisions described below
under "Description of Capital Stock -- Delaware Law and Certain Charter
and By-Law Provisions; Anti-Takeover Effects," and the receipt of
stockholder approval therefor;
- reflects a 5-for-1 stock split of our common stock effected on December
1, 1998. See "Description of Capital Stock," "Underwriters" and Note 6 of
Notes to Consolidated Financial Statements.
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PROSPECTUS SUMMARY
The following summary is qualified by the more detailed information and
Consolidated Financial Statements and Notes appearing elsewhere in this
Prospectus.
THE COMPANY
We are 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. Our products and
technologies enable electronic devices to understand speech, the most natural
and effective means of communication. As a result, users of our products can
interact with electronic devices faster and more intuitively than with other
input methods such as the keyboard or computer mouse, thereby increasing
productivity. We market a variety of speech products worldwide, including our
Dragon NaturallySpeaking family of continuous dictation software products.
Dragon NaturallySpeaking products are currently available in six languages:
American-English, British-English, French, German, Italian and Spanish, with
Japanese and Mandarin versions scheduled for release in 1999. Since 1997, we and
our Dragon NaturallySpeaking products have received over 70 industry awards
worldwide.
We were the first to introduce products incorporating built-in PC speech
recognition (1984), large vocabulary, general purpose, discrete dictation
(1990), and software-only dictation compatible with most Windows programs
(1993). In June 1997, we achieved an important milestone by introducing Dragon
NaturallySpeaking 1.0, the world's first large vocabulary, general purpose,
continuous speech dictation product. We are currently applying our technologies
beyond PC-based products to such products as hand-held and mobile devices, and
are developing advanced applications for emerging speech markets such as
consumer electronics and telephony. We are also collaborating with major
corporations and federal agencies to enable their existing hardware and software
to recognize speech.
Our end-users include individuals and companies that use our leading-edge
speech products and technologies for a wide range of applications, including
general purpose dictation, legal and medical dictation, inventory management and
in-bound customer telephone interactions. These end-users include Bank of
America FSB, The Boeing Company, the Los Angeles Police Department, Peugeot
S.A., and Wells Fargo & Company. We sell our products worldwide predominantly
through major distributors to retail channel accounts and value-added resellers.
THE OFFERING
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Common stock offered by us in this offering................ shares
Common stock to be outstanding after this offering......... shares
Use of proceeds............................................ For working capital and general corporate purposes,
including capital expenditures, potential acquisitions and
geographic expansion. See "Use of Proceeds."
Proposed Nasdaq National Market symbol..................... DRGN
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
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YEAR ENDED DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue................................................. $14,138 $16,887 $17,038 $26,821 $71,397
Gross profit................................................ 9,369 10,207 9,991 16,434 49,536
Operating income (loss)..................................... (1,246) (3,498) (5,335) (4,978) 7,404
Income (loss) from continuing operations.................... (579) (2,092) (4,251) (2,277) 5,646
Net income (loss)........................................... (579) (5,162) (5,957) (5,296) 10,286
Earnings per share:
Income (loss) from continuing operations:
Basic................................................... $ (.06) $ (.18) $ (.36) $ (.18) $ .42
Diluted................................................. $ (.06) $ (.18) $ (.36) $ (.18) $ .18
Net income (loss):
Basic................................................... $ (.06) $ (.43) $ (.50) $ (.43) $ .76
Diluted................................................. $ (.06) $ (.43) $ (.50) $ (.43) $ .32
Weighted average shares outstanding:
Basic..................................................... 9,355 11,897 11,922 12,460 13,624
Diluted................................................... 9,355 11,897 11,922 12,460 31,964
</TABLE>
The following table presents our summary consolidated balance sheet at
December 31, 1998, which has been adjusted for the conversion of our preferred
stock outstanding as of December 31, 1998 into shares of common stock and
our sale of shares of common stock in this offering at an assumed price of
$ per share and the application of the estimated net proceeds. See "Use of
Proceeds" and "Capitalization."
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
------------------------
ACTUAL AS ADJUSTED
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CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments........... $ 8,843
Working capital............................................. 23,166
Total assets................................................ 38,425
Long-term obligations, net of current maturities............ --
Total stockholders' equity.................................. 25,367
</TABLE>
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RISK FACTORS
You should consider carefully the risks described below before you decide
to buy our common stock. The risks and uncertainties described below are not the
only ones facing us. If any of the following risks actually occur, our business,
financial condition or results of operations would likely suffer. In such case,
the trading price of our common stock could fall, and you may lose all or part
of the money you paid to buy our common stock.
OUR RECENT HISTORY OF OPERATING LOSSES
Although we have been profitable for a majority of our 16 years, including
1998, we incurred losses from continuing operations of approximately $579,000 in
1994, $2.1 million in 1995, $4.3 million in 1996 and $2.3 million in 1997. The
major portion of our losses for those years was principally attributable to
increased expenses in developing and marketing a continuous speech recognition
product. We cannot assure you that we can sustain or increase our profitability
in the future.
WE EXPECT OUR QUARTERLY RESULTS TO FLUCTUATE
Historically, our operating results have been volatile and hard to predict
and will continue to vary from period to period for a number of reasons
including the following:
- we sell more products during the fourth calendar quarter, which is marked
by increased holiday shopping and, to a certain extent, by the practice
of corporate customers to defer purchase decisions until the end of the
year.
- our order backlog at the beginning of any quarter generally does not
represent a significant portion of that quarter's expected revenue
because we ship shortly after we receive orders. As a result, product
revenue in any given quarter largely depends on orders booked and shipped
through the distribution channel in that quarter. This makes it difficult
for us to predict revenue for any future quarter with any degree of
certainty.
- we may sell a significant number of products earlier than we expect,
causing our operating results for subsequent quarters to be lower than
expected. Any shortfall in our revenue as a result of these factors would
directly impact our results of operations and net income, and such
fluctuations in quarterly results could affect the market price of our
common stock in a manner unrelated to our long-term operating
performance.
- sales in Europe have historically declined during the summer months. If
our sales in Europe increase as a percentage of net revenue, this
seasonal effect will have a greater impact on our overall sales.
Our operating expenses, which include product development costs, and
selling, marketing, general and administrative expenses, are based on our
expectation of future orders and sales of our products. If we sell fewer
products or otherwise have lower revenue than we expect, we may not be able to
quickly reduce our spending in response. We may also choose to reduce prices or
increase spending in response to competition or to pursue new market
opportunities. In particular, our operating margins in the future may be
adversely affected if we invest more money in research and development or sales
and marketing efforts, or pursue more international market opportunities in
order to compete with new products introduced by our competitors.
WE FACE INTENSE COMPETITION FROM MAJOR COMPANIES
The emerging market for speech recognition products is relatively new,
intensely competitive and subject to rapid technological change. We expect
competition to persist and intensify in the future. Our principal current
competitors for PC applications include International Business Machines
Corporation, Lernout & Hauspie Speech Products N.V. and Philips Electronics N.V.
In addition, we face significant potential competition for PC applications from
Microsoft Corporation, particularly if Microsoft incorporates its competing
speech recognition software into Windows. See "Business -- Competition" for more
information concerning the potential competition posed by Microsoft. As we
expand our presence in the telephony market,
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we will also face competition from various companies including AT&T Corp., GTE
Internetworking, a division of GTE Corporation, Lucent Technologies Inc., Nuance
Communications Inc., Philips, SpeechWorks International Inc., (formerly Applied
Language Technologies, Inc.) and Voice Control Systems, Inc.
WE MAY NOT BE ABLE TO OBTAIN SUFFICIENT SUPPLY OF DIGITAL RECORDERS
Our Dragon NaturallyMobile product includes a hand-held digital recorder
that we purchase exclusively from another company. Recently, because of that
company's financial problems, we were not able to obtain a sufficient supply of
these recorders and that adversely affected our sales. We cannot assure you that
this sole source supplier will be able to meet our needs for digital recorders
and that may cause our sales to be lower than we anticipate. To date, we have
not been able to identify an alternative source for this digital recorder and we
cannot assure you that we will find an acceptable alternative.
OUR SUCCESS DEPENDS ON THE DRAGON NATURALLYSPEAKING PRODUCT FAMILY
Sales of the Dragon NaturallySpeaking product family accounted for
approximately 42% of our net revenue in 1997 and 79% of our net revenue during
1998. We expect that we will continue to depend principally on revenue from our
Dragon NaturallySpeaking product family for the foreseeable future. Any decline
in demand for these products, whether as a result of new competitive products,
price competition, technological change or other factors, could materially and
adversely affect our future financial results.
WE MUST INCREASE OUR SALES AND DISTRIBUTION CAPABILITIES
We must increase distribution of our products by expanding our share of the
mass market segment of the retail channel and increasing sales in the
value-adder reseller, or VAR, independent software vendor, or ISV and original
equipment manufacturer, or OEM, channels. We cannot assure you that we will be
successful in these efforts. We will sell fewer products if we cannot attract or
retain distributors, VARs and OEMs that can market our products effectively or
that will provide timely and cost-effective customer support. In addition, sales
of our products will drop if we fail to manage conflicts that might arise in our
distribution channels. Our two largest distributors are Ingram Micro Inc. and
Tech Data Product Management, Inc. Ingram Micro accounted for approximately 5%
of our net revenue in 1997 and 22% in 1998. Tech Data accounted for
approximately 9% of our net revenue in 1997 and 40% in 1998.
WE MUST MAINTAIN OUR EXISTING DISTRIBUTION RELATIONSHIPS
We compete with an increasing number of companies for access to the
distribution channels we use, and our arrangements with our distributors and
retailers generally may be terminated by either party at any time. We cannot
guarantee that distributors and retailers will continue to purchase our products
or provide us with adequate levels of shelf space and promotional support. Any
termination or significant disruption of our relationship with any of our major
distributors or retailers, or a significant reduction in sales volume
attributable to any of our principal resellers, could adversely affect our
day-to-day operating performance and future financial results.
OUR PERFORMANCE WILL DEPEND ON THE GROWTH OF THE SPEECH INDUSTRY
Because the speech industry is relatively new and rapidly evolving, it is
difficult to accurately predict demand and market acceptance for our recently
introduced products. The speech industry currently has a limited number of
proven products and applications. Popular perceptions about the use of speech
recognition products (including reliability, cost, ease-of-use and quality) may
impact the growth of the market for such products, particularly for speech
products other than PC-based applications. We cannot guarantee that the market
for speech recognition products will grow significantly or that our products
will become widely accepted. Therefore, it is difficult to predict the size and
future growth rate, if any, of this market. In addition, our existing and future
products may become obsolete and unmarketable if competing products based on new
technologies are introduced to the market. From time to time, we and our
competitors may announce new products, capabilities or technologies that have
the potential to replace or limit the usefulness of our existing product
offerings. As a result, customers may refrain from purchasing any of our
existing products. If the
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market for our products does not develop as quickly as we expect, or becomes
more competitive, or if our new products do not achieve market acceptance, our
future financial results will be adversely affected.
WE MAY BE UNABLE TO PROPERLY MANAGE GROWTH
We have recently experienced substantial expansion of our operations. This
rapid expansion has placed a significant strain on our management and
operational resources. As of December 31, 1998, we had approximately 316
employees located in the United States, England, France and Germany compared to
approximately 185 employees in three locations on January 1, 1997. We have tried
to assess and address the costs and risks associated with our recent and planned
future expansion, but our systems, procedures and controls may not support our
current or future operations. In addition, it may be difficult to simultaneously
manage our planned expansion and successfully exploit the market opportunity for
our products in a timely and cost-effective manner. If we fail to manage our
planned expansion effectively, our business could suffer significantly.
WE MAY BE ADVERSELY AFFECTED IF WE LOSE DR. JANET BAKER, JOHN SHAGOURY OR OTHER
KEY PERSONNEL
Our future success depends on the continued services of a number of key
officers, including our co-founder, Chairman and Chief Executive Officer, Dr.
Janet M. Baker, and our President, John D. Shagoury. We do not have an
employment contract with any of our key personnel other than Mr. Shagoury. If
Dr. Janet Baker left our Company, the loss of her technological knowledge and
industry expertise could seriously impede our development of new products.
Moreover, the loss of one or a group of our key employees, particularly to a
competitor, and any resulting loss of customers to any such competitor, could
adversely affect our future financial results. After undergoing back surgery in
October 1998, our other co-founder, Dr. James K. Baker, our former Chairman and
Chief Executive Officer and the husband of Dr. Janet M. Baker, resigned as a
director, officer and employee of Dragon, effective December 1, 1998. During his
16 years with Dragon, he and his wife led the development of our speech
technology and current products. Dr. James K. Baker has agreed to serve as
Chairman of our Technical Advisory Board. See "Management -- Technical Advisory
Board."
WE MUST COMPETE FOR SKILLED TECHNICAL PERSONNEL
Our future performance also depends upon our ability to attract and retain
highly-qualified scientific, technical, sales, marketing and managerial
personnel. There is intense competition for such personnel, particularly in the
field of software engineering. If we do not succeed in retaining our personnel
or in attracting new employees, our business could suffer significantly.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR TECHNOLOGY
We believe that our success depends, in large part, on protecting our
intellectual property in the United States and in foreign countries by doing the
following:
- obtaining patent protection for our technology;
- defending our patents against any infringement;
- preserving our trade secrets and trademarks;
- operating without infringing the patents and intellectual property rights
of others; and
- requiring that each employee, consultant or advisor sign a
confidentiality agreement to prevent the unauthorized use or disclosure
of confidential information.
However, we cannot guarantee that these measures will be adequate to protect our
intellectual property rights.
We may experience additional difficulty in protecting our intellectual
property rights because we derive a major portion of our sales from licensing
our products under standardized "shrink wrap" agreements that our licensees do
not sign. If any of these agreements were deemed to be unenforceable, our
licensees could use our technology free of charge and without appropriate
limitations. Moreover, we have not embedded any copy protection in our software
because we do not believe that these mechanisms are practical or cost-effective.
At
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the same time, current United States laws that prohibit software copying provide
only limited protection from software "pirates," and the laws of many other
countries provide almost no protection against unauthorized copying. Policing
unauthorized use of our technology is difficult, expensive, and time-consuming.
We expect software piracy to be a persistent problem and anticipate that our
revenue, especially overseas, may be adversely affected as a result of this
problem.
OTHERS HAVE AND COULD CLAIM THAT WE INFRINGE THEIR INTELLECTUAL PROPERTY
We are defendants in two recently commenced lawsuits involving, among other
things, allegations of patent infringement and misappropriation of intellectual
property. For more information regarding these and other pending litigation, see
"Business -- Legal Proceedings." We may also be subject to future litigation to
defend our intellectual property rights from claims of infringement made by
others. We believe that we have all rights necessary to use the intellectual
property employed in our business. However, an adverse legal decision affecting
our intellectual property, or the use of significant resources to defend against
such a claim, could adversely affect our operating results.
WE MAY BE ADVERSELY IMPACTED BY SOFTWARE DEFECTS
Our software products may contain errors or defects, especially when first
implemented, that may be very costly to correct. Additionally, we regularly
introduce new releases and periodically develop new versions of our software
products. If any of our products contain defects or errors, our business could
also suffer significantly from potential adverse customer reaction, negative
publicity regarding our products and harm to our reputation.
WE EXPECT OUR REVENUE FROM OPERATIONS OUTSIDE NORTH AMERICA TO BE SIGNIFICANT,
WHICH EXPOSES US TO INTERNATIONAL BUSINESS RISKS
We are exposed to a number of risks customary for international operations,
including the following:
- difficulties relating to global administration of our business;
- difficulty in staffing and managing our foreign operations;
- currency fluctuations;
- limitations on sending the earnings of our foreign operations back to the
United States;
- the burdens of complying with a wide variety of foreign laws;
- the uncertainty of laws and enforcement in certain countries relating to
the protection of intellectual property rights;
- reductions in business activity during the summer months in Europe and
certain other parts of the world;
- export controls;
- multiple and possibly overlapping tax structures;
- changes in import/export duties and quotas;
- introduction of tariff or nontariff barriers; and
- economic or political changes in international markets.
Net revenue from customers located outside North America accounted for
approximately 29% in 1996, 15% in 1997 and 12% in 1998 of our net revenue for
such periods. Over time, we expect revenue from international operations,
principally in Europe, to increase as a percentage of our net revenue.
We also expect to be exposed to fluctuations in the foreign exchange rates
between the United States dollar and foreign currencies because a substantial
portion of our international operating expenses are denominated in United States
dollars while we anticipate an increasing amount of our international revenue
will be generated in foreign currencies. To date, we have not used risk
management techniques or "hedged" the risks associated with fluctuations in
foreign exchange rates. Our business could suffer significantly from the
realization of any of these risks.
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WE MAY BE ADVERSELY IMPACTED BY THE YEAR 2000
We believe we do not have any significant exposure to the Year 2000 issue
because our products and information systems accept four digit entries into
their year code fields. In addition, we believe that the information systems of
our distributors, OEMs, VARs and ISVs (as they relate to our business) comply
with Year 2000 requirements. However, if the information systems of any of our
customers or suppliers fail to comply with Year 2000 requirements, then the
operation of our information systems could be adversely affected. Furthermore,
customers may be forced to allocate greater resources to comply with Year 2000
requirements and as a result purchase fewer products from us, causing a
significant reduction in our net revenue. For additional information addressing
our exposure to the Year 2000 issue, please see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000
Compliance."
OUR EXISTING PRINCIPAL STOCKHOLDERS WILL CONTROL OVER 70% OF OUR OUTSTANDING
COMMON STOCK
Following this offering, Drs. Janet and James Baker, will hold an aggregate
of approximately % of the outstanding shares of our common stock ( % if
the underwriters' over-allotment option is exercised in full), and Seagate
Technology, Inc. will hold approximately %. As a result, these three
stockholders acting together will be able to take any of the following actions
without the approval of our public stockholders:
- amend our charter in certain respects or approve a merger, sale of assets
or other major corporate transaction;
- defeat any non-negotiated takeover attempt that may be beneficial to our
public stockholders;
- determine the amount and timing of dividends paid to themselves and to
our public stockholders; and
- otherwise control our management and operations and the outcome of all
matters submitted for a stockholder vote, including the election of
directors, that could conflict with the interests of our public
stockholders.
YOU WILL FACE A NUMBER OF MARKET RISKS TYPICALLY ASSOCIATED WITH INITIAL PUBLIC
OFFERINGS
Before this offering, there was no public market for our common stock. The
underwriters and we have determined the initial public offering price of our
common stock based on negotiations among us concerning the valuation of our
common stock. The public market may not agree with or accept the valuation the
underwriters and we have arrived at. After this offering, therefore, you may not
be able to resell your shares at or above the initial public offering price due
to this and a number of other factors, including:
- actual or anticipated fluctuations in our operating results;
- changes in securities analysts' financial estimates;
- changes in expectations as to our future financial performance;
- announcements of new technological innovations and alliances by
competitors; and
- the operating and stock price performance of our competitors and other
comparable companies.
In addition, the stock market in general has experienced extreme volatility
that often has been unrelated to the operating performance of particular
companies. These broad market and industry fluctuations may adversely affect the
trading price of our common stock, regardless of our actual operating
performance. You should read the "Underwriters" section of this Prospectus for a
more complete discussion of the factors that the underwriters and we considered
in determining the initial public offering price.
8
<PAGE> 11
FUTURE SALES BY EXISTING STOCKHOLDERS COULD DEPRESS THE MARKET PRICE OF OUR
COMMON STOCK
Sales of a substantial number of shares of common stock after the offering
could adversely affect the market price of our common stock by introducing a
large number of sellers into a volatile market, thus driving down the price of
our common stock. This could impair our ability to raise new capital through the
sale of additional common stock. After this offering, we will have
shares of common stock outstanding and will have reserved an additional
shares of common stock for issuance pursuant to our stock option plans
and stock purchase plan. We intend to register for resale the shares of common
stock reserved for issuance under our stock option plans and stock purchase plan
after the date of this Prospectus. The federal securities laws impose certain
restrictions on the ability of stockholders to resell their shares.
We have entered into a registration rights agreement with Seagate
Technology which permits Seagate, subject to certain conditions, to include
shares of common stock it holds in certain offerings of common stock made by us
in the future. Certain Dragon stockholders, including Seagate, and certain
holders of options to purchase our common stock have agreed that, for a period
of 180 days from the date of this Prospectus, they will not sell their shares
without the prior written consent of Morgan Stanley & Co. Incorporated.
Accordingly, on , shares of our common stock held by Seagate
will be available for immediate resale (subject to certain volume restrictions
imposed on Seagate by the federal securities laws).
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR
INVESTMENT
The initial public offering price of our common stock is substantially
higher than the pro forma net tangible book value per share of the outstanding
common stock. Accordingly, if you purchase any shares of common stock in this
offering you will incur immediate dilution of approximately $ in the
pro forma net tangible book value per share of the common stock from the price
you pay for our common stock.
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER, BY-LAWS AND DELAWARE LAW COULD PREVENT
OR DELAY A CHANGE IN CONTROL OF DRAGON
Our restated certificate of incorporation and restated by-laws contain
anti-takeover provisions that could have the effect of delaying or preventing
changes in our management, even if such changes would benefit our public
stockholders. For example, following the closing of this offering, our Board of
Directors may issue up to 5,000,000 shares of preferred stock without any
further stockholder vote or action. The preferred stock could have voting,
liquidation, dividend and other rights superior to those of our common stock,
and, therefore, any issuance of preferred stock could adversely affect your
rights as a common stock holder. These factors could cause the market price of
the common stock to decrease.
9
<PAGE> 12
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve
substantial risks and uncertainties. You can identify these statements by
forward-looking words such as "anticipate," "believe," "could," "estimate,"
"expect," "intend," "may," "should," "will" and "would" or similar words. You
should read statements that contain these words carefully because they discuss
our future expectations, contain projections of our future results of operations
or of our financial position or state other "forward-looking" information. We
believe that it is important to communicate our future expectations to our
investors. However, there may be events in the future that we are not able to
accurately predict or control. The factors listed above in the section captioned
"Risk Factors," as well as any cautionary language in this prospectus, provide
examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking
statements. Before you invest in our common stock, you should be aware that the
occurrence of the events described in these risk factors and elsewhere in this
prospectus could have a material adverse effect on our business, results of
operations and financial position.
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the
shares of common stock will be approximately $ assuming an initial
public offering price of $ per share and after deducting estimated
underwriting discounts and commissions and estimated offering expenses payable
by us. If the over-allotment option is exercised in full, we will not receive
any proceeds from the sale of the common stock by the selling stockholders
granting the option.
The principal purposes of this offering are to establish a public market
for our common stock, to increase our visibility in the marketplace, to
facilitate future access to public capital markets, to provide liquidity to
existing stockholders and to obtain additional working capital.
We expect to use the net proceeds for anticipated working capital and
general corporate purposes, including capital expenditures, potential
acquisitions and geographic expansion. Although we may use a portion of the net
proceeds to acquire businesses, products or technologies that are complementary
to our business, we have no specific acquisitions planned. Pending such uses, we
plan to invest the net proceeds in investment grade, interest-bearing
securities.
DIVIDEND POLICY
We have never paid or declared any cash dividends on our common stock or
other securities and do not anticipate paying cash dividends in the foreseeable
future. We currently intend to retain all future earnings, if any, for use in
the operation of our business.
10
<PAGE> 13
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1998.
The pro forma information gives effect to the conversion of all of our
outstanding convertible preferred stock and assumes the filing of an amended and
restated certificate of incorporation immediately prior to the closing of this
offering authorizing 5,000,000 shares of preferred stock and 100,000,000 shares
of common stock. The pro forma as adjusted information reflects the issuance and
sale of the shares of common stock offered by us in this offering at an
assumed initial public offering price of $ per share and the application of
the estimated net proceeds we expect to receive from this offering. The
outstanding share information excludes: (1) 3,152,282 shares of common stock
issuable on exercise of outstanding options as of January 29, 1999, of which
options to purchase 1,212,541 shares were then exercisable and (2) 3,000,000
shares of common stock reserved for future issuance under our stock plans. See
"Management -- Benefit Plans" and Notes 5 and 6 of Notes to Consolidated
Financial Statements.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-----------------------------------
PRO PRO FORMA
ACTUAL FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA)
<S> <C> <C> <C>
Stockholders' equity:
Convertible preferred stock, $.04 par value; 5,000,000
shares authorized; 3,238,951 shares issued and
outstanding, actual; none issued and outstanding pro
forma and pro forma as adjusted..................... $ 130 $ -- $ --
Common stock, $.04 par value; 100,000,000 shares
authorized; 13,635,805 shares issued and
outstanding, actual; 29,830,560 shares issued and
outstanding pro forma; shares issued and
outstanding pro forma as adjusted................... 545 1,193
Additional paid-in capital............................. 31,041 30,523
Retained deficit....................................... (6,432) (6,432)
Accumulated other comprehensive income................. 83 83
------- ------- -------
Total stockholders' equity.......................... 25,367 25,367
------- ------- -------
Total capitalization.............................. $25,367 $25,367 $
======= ======= =======
</TABLE>
11
<PAGE> 14
DILUTION
Dragon's pro forma net tangible book value as of December 31, 1998, giving
effect to the conversion of all shares of convertible preferred stock
outstanding as of December 31, 1998 into common stock on the closing of this
offering, was approximately $25,367,000 or approximately $0.85 per share of
common stock. Pro forma net tangible book value per share represents our
tangible net worth (tangible assets less total liabilities) divided by the
29,830,560 shares of common stock outstanding after giving effect to the
conversion of the convertible preferred stock outstanding at December 31, 1998
into common stock. After giving effect to the issuance and sale of the
shares of common stock offered by Dragon in this offering (at an
assumed initial public offering price of $ per share)and the receipt and
application of the net proceeds from the sale of these shares, Dragon's pro
forma net tangible book value at December 31, 1998 would have been $ ,
or $ per share. This represents an immediate increase in pro forma net
tangible book value to existing stockholders of $ per share and an immediate
dilution to new investors of $ per share. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $
Pro forma net tangible book value per share before this
offering............................................... $ .85
Increase in pro forma net tangible book value per share
attributable to new investors..........................
-----
Pro forma net tangible book value per share after this
offering..................................................
-------
Dilution per share to new investors......................... $
=======
</TABLE>
The following table summarizes on a pro forma basis, giving effect to the
conversion of all outstanding shares of convertible preferred stock into common
stock on the closing of this offering, as of January 29, 1999, the difference
between the number of shares of common stock purchased from Dragon, the total
consideration paid to Dragon, and the average price per share paid by existing
stockholders and by new investors (at an assumed initial public offering price
of $ per share before deduction of estimated underwriting discounts and
commissions and estimated offering expenses payable by Dragon):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders............... 29,913,300 % $31,847,000 % $1.06
New investors....................... -- -- -- --
---------- ----- ----------- -----
Total..................... 100.0% 100.0% $
========== ===== =========== =====
</TABLE>
Sales by the selling stockholders (in the event the over-allotment option
is exercised in full) will reduce the number of shares held by existing
stockholders to , or % of the total number of shares of common stock
outstanding after this offering. These sales will also increase the number of
shares held by new investors to shares, or % of the total number of
shares of common stock outstanding after this offering. See "Principal and
Selling Stockholders."
The table above assumes no exercise of stock options outstanding at January
29, 1999, 1998. As of January 29, 1999, there were options outstanding to
purchase 3,152,282 shares of common stock at a weighted average exercise price
of $5.21 per share and 3,000,000 shares reserved for future grant or award under
Dragon's 1999 Stock Incentive Plan. To the extent any of these options are
exercised, there will be further dilution to new investors. To the extent all of
such outstanding options had been exercised as of January 29, 1999, net tangible
book value per share after this offering would be $ and total dilution
per share to new investors would be $ . See "Management -- Benefit
Plans," Note 7 of Notes to Consolidated Financial Statements, and "Risk
Factors -- Immediate and Substantial Dilution."
12
<PAGE> 15
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our Consolidated Financial Statements and the Notes thereto,
and with Management's Discussion and Analysis of Financial Condition and Results
of Operations, included elsewhere in this Prospectus. The selected consolidated
balance sheet data as of December 31, 1997 and 1998 and the consolidated
statement of operations data for the three years in the period ended December
31, 1998 set forth below are derived from Dragon's Consolidated Financial
Statements audited by Arthur Andersen LLP, independent public accountants, which
are included elsewhere in this Prospectus. The selected consolidated balance
sheet data at December 31, 1995 and 1996 and the consolidated statement of
operations data for the year ended December 31, 1995 is derived from Dragon's
Consolidated Financial Statements audited by Arthur Andersen LLP, independent
public accountants, which are not included in this Prospectus. The selected
consolidated financial data as of and for the year ended December 31, 1994 are
derived from Dragon's Consolidated Financial Statements audited by other
independent public accountants, which are not included in this Prospectus. For
an explanation of the determination of the number of shares used in computing
earnings per share, see Note 2(h) of Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net Revenue:
Software licenses......................................... $ 7,720 $12,171 $11,479 $19,506 $65,665
Development contracts..................................... 6,418 4,716 5,559 7,315 5,732
------- ------- ------- ------- -------
Total net revenue....................................... 14,138 16,887 17,038 26,821 71,397
------- ------- ------- ------- -------
Cost of revenue:
Cost of software licenses................................. 2,278 3,365 3,465 5,394 18,586
Cost of development contracts............................. 2,491 3,315 3,582 4,993 3,275
------- ------- ------- ------- -------
Total cost of revenue................................... 4,769 6,680 7,047 10,387 21,861
------- ------- ------- ------- -------
Gross profit............................................ 9,369 10,207 9,991 16,434 49,536
------- ------- ------- ------- -------
Operating expenses:
Research and development.................................. 6,311 6,688 7,983 9,577 14,056
Selling and marketing..................................... 3,022 4,825 5,403 9,350 23,698
General and administrative................................ 1,282 2,192 1,940 2,485 4,378
------- ------- ------- ------- -------
Total operating expenses................................ 10,615 13,705 15,326 21,412 42,132
------- ------- ------- ------- -------
Operating income (loss)..................................... (1,246) (3,498) (5,335) (4,978) 7,404
Interest income........................................... 313 760 520 511 629
------- ------- ------- ------- -------
Income (loss) from continuing operations before income
taxes................................................. (933) (2,738) (4,815) (4,467) 8,033
Provision for (benefit from) income taxes................... (354) (646) (564) (2,190) 2,387
------- ------- ------- ------- -------
Income (loss) from continuing operations................ (579) (2,092) (4,251) (2,277) 5,646
------- ------- ------- ------- -------
Gain (loss) on discontinued operations.................. -- (3,070) (1,706) (3,019) 4,640
------- ------- ------- ------- -------
Net income (loss)....................................... $ (579) $(5,162) $(5,957) $(5,296) $10,286
======= ======= ======= ======= =======
Earnings per share:
Income (loss) from continuing operations:
Basic................................................... $ (.06) $ (.18) $ (.36) $ (.18) $ .42
Diluted................................................. $ (.06) $ (.18) $ (.36) $ (.18) $ .18
Net income (loss):
Basic................................................... $ (.06) $ (.43) $ (.50) $ (.43) $ .76
Diluted................................................. $ (.06) $ (.43) $ (.50) $ (.43) $ .32
Weighted average shares outstanding:
Basic................................................... 9,355 11,897 11,922 12,460 13,624
Diluted................................................. 9,355 11,897 11,922 12,460 31,964
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short term investments........... $13,310 $ 9,582 $ 6,912 $ 12,321 $ 8,843
Working capital............................................. 16,135 11,136 5,936 13,481 23,166
Total assets................................................ 20,294 16,223 13,113 23,186 38,425
Long-term obligations, net of current maturities............ 43 43 -- -- --
Retained deficit............................................ (303) (5,465) (11,422) (16,718) (6,432)
Total stockholders' equity.................................. 18,402 13,230 7,292 14,854 25,367
</TABLE>
13
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
Dragon's Consolidated Financial Statements and related Notes included elsewhere
in this prospectus.
OVERVIEW
Dragon is a leading developer and provider of advanced speech recognition
products and related speech technologies. In 1997, we became the first company
to develop, produce and market large vocabulary, general purpose, continuous
speech technology for commercial applications through the introduction of our
Dragon NaturallySpeaking dictation product.
We have financed our activities through income from operations and proceeds
from the sale of equity securities to Seagate Technology in 1994 and 1997. At
January 29, 1999, Seagate owned approximately 38% of our outstanding common
stock on an as-converted basis. Although we have been profitable for a majority
of our 16 years of operation including 1998, during 1994, 1995, 1996 and 1997,
we incurred aggregate losses from continuing operations of approximately $9.2
million. These losses resulted principally from a significant increase in
operating expenses associated with developing and marketing the Dragon
NaturallySpeaking family of continuous speech products.
In 1995, we acquired an ownership interest in Articulate Systems, Inc. In
1998, we sold our then 38% interest in Articulate to fonix corporation for cash,
notes and fonix common stock valued in the aggregate at $4.0 million.
Accordingly, the results of operations of Articulate have been included as
discontinued operations in our Consolidated Financial Statements for all periods
presented. See Note 3 of Notes to Consolidated Financial Statements.
We derive our revenue primarily from the sale of software licenses through
distributors to retail channel accounts and VARs, as well as from royalty fees
from OEMs which license our software directly. We also derive revenue from
corporate development contracts and government-funded research. We recognize
revenue from software license sales at the time our products are delivered to
the retail channel accounts and VARs. We recognize revenue from OEM royalty fees
upon the shipment of units by the OEM. Revenue from corporate development
contracts and government-funded research is recognized on a percentage-of-
completion basis.
Since its introduction in June 1997, the Dragon NaturallySpeaking product
family has represented our principal source of revenue. We plan to expand our
existing product offerings through a series of new product introductions over
the next twelve months. We believe that our existing products, as well as the
new products we plan to introduce, will constitute the majority of our revenue
for the foreseeable future. Because our products range from lower-priced, mass
merchant software to higher-priced, professional software and related mobile
products (which combine microphones and recorders with our software), a shift in
the revenue mix of any of these products could have a material impact on our
gross margins in any given period.
We sell our products worldwide, with the majority of our net revenue coming
from North America. North American revenue accounted for approximately 85% of
our net revenue during 1997 and 88% during 1998. Revenue derived outside North
America declined as a percentage of net revenue in 1998 primarily due to the
substantial increase in revenue from our Dragon NaturallySpeaking product family
in North America. We expect that net revenue derived outside North America will
increase as a percentage of net revenue in 1999.
Sales to our two largest distributors constituted approximately 14% of net
revenue in 1997 and 62% of net revenue in 1998. We believe that these two
distributors will remain among our largest distributors. During 1998
approximately 74% of our net revenue was attributable to sales to retail channel
accounts through distribution. We plan to expand our OEM relationships in 1999
and therefore expect that our 1999 OEM-related revenue will increase
significantly as a percentage of net revenue as compared to 1998 levels.
At the time of sale, we provide for our expected sales returns, sales
commissions and post-sales support expense. In addition, we create reserves for
the collectability of accounts receivable. While we believe our
14
<PAGE> 17
provisions for sales returns, sales commissions, post-sales support, and the
collectability of accounts receivable are adequate, actual results could differ
from those estimates.
Our cost of software licenses primarily consists of expenses incurred by
Dragon to manufacture, package and distribute its products and related
documentation. These costs include expenses for hardware, literature and
packaging, technical support, fulfillment and shipping, and shrinkage. Any
significant change in material component prices, increase or decrease in bundled
hardware component prices, or increase or decrease in fulfillment and shipping
costs could have a material effect on our cost of software licenses. Our cost of
development contracts consists primarily of labor costs, other direct expenses
and related overhead associated with the performance of these contracts. Since
the beginning of 1997, we have not capitalized any software development costs as
such costs were immaterial. In addition, all research and development costs have
been charged to operations as incurred.
We have experienced seasonal fluctuations in our results of operations. We
began selling our products at retail in August 1997 and based on our 1997 and
1998 experience and software industry trends, we expect sales to increase during
the fourth quarter as a result of the holiday shopping season. In addition,
certain corporate customers tend to enter into sales contracts at or near
year-end resulting in higher demand during the fourth quarter. Due to this
seasonality, we expect to incur increased sales and marketing expenses
(principally advertising costs and promotional expenses) during the fourth
quarter and any shortfall from anticipated revenue in that quarter would have
disproportionately greater adverse effect on our operating results. In addition,
sales in Europe have historically declined during the summer months. If our
European sales increase as a percentage of net revenue, this seasonal effect
will have a more significant impact on our financial results.
We employed 316 people at December 31, 1998, compared to 185 at January 1,
1997. This increase in headcount resulted primarily from an increase in sales
and marketing personnel associated with our efforts to market and sell our
Dragon NaturallySpeaking family of products. We expect to continue to increase
expenses associated with our sales and marketing infrastructure in anticipation
of continued sales growth. Additionally, we expect to increase our headcount in
research and development to support new product development efforts. Given the
expected increase in headcount, we anticipate that we will need to either expand
our existing offices or relocate to a larger facility within the next 12 to 18
months. We believe that this expansion or relocation will result in an increase
in total facilities costs.
Our ability to grow will depend, in part, on our success in adding sales,
marketing and research and development personnel during 1999 and in future
periods. In addition, our future success will depend in part on our ability to
attract, retain and motivate highly qualified technical and management
personnel, for whom competition is intense. We expect that future expansion will
continue to challenge our ability to hire, train, motivate, and manage our
employees, and to attract and retain qualified senior managers and technical
staff, such as programmers and software engineers. Dragon's business, financial
condition and operating results could be materially and adversely affected if:.
- our revenue does not increase relative to our operating expenses;
- our management systems do not expand to meet increasing demands;
- we fail to attract, assimilate and retain qualified personnel; or
- our management otherwise fails to manage Dragon's expansion effectively.
15
<PAGE> 18
RESULTS OF OPERATIONS
The following table sets forth selected consolidated financial information
included in our consolidated statements of operations expressed as a percentage
of net revenue for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Net revenue:
Software licenses......................................... 67.4% 72.7% 92.0%
Development contracts..................................... 32.6 27.3 8.0
----- ----- -----
Total net revenue................................. 100.0 100.0 100.0
----- ----- -----
Cost of revenue:
Cost of software licenses................................. 20.3 20.1 26.0
Cost of development contracts............................. 21.0 18.6 4.6
----- ----- -----
Total cost of revenue............................. 41.3 38.7 30.6
----- ----- -----
Gross profit...................................... 58.7 61.3 69.4
----- ----- -----
Operating expenses:
Research and development.................................. 46.9 35.7 19.7
Selling and marketing..................................... 31.7 34.9 33.2
General and administrative................................ 11.4 9.3 6.1
----- ----- -----
Total operating expenses.......................... 90.0 79.9 59.0
----- ----- -----
Operating income (loss)..................................... (31.3) (18.6) 10.4
Interest income........................................... 3.1 1.9 0.9
----- ----- -----
Income (loss) before income taxes................. (28.2) (16.7) 11.3
Provision for (benefit from) income taxes................... (3.3) (8.2) 3.4
----- ----- -----
Income (loss) from continuing operations.......... (24.9) (8.5) 7.9
----- ----- -----
Gain (loss) on discontinued operations:
Loss from operations.............................. (10.0) (11.3) (3.0)
Gain on sale, net of taxes........................ -- -- 9.5
----- ----- -----
Gain (loss) on discontinued operations....... (10.0) (11.3) 6.5
----- ----- -----
Net income (loss)......................................... (34.9%) (19.8%) 14.4%
===== ===== =====
</TABLE>
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NET REVENUE
Net revenue increased 166.2% to $71.4 million in 1998, from $26.8 million
in 1997 and increased by $9.8 million or 57.4% in 1997 from $17.0 million in
1996. The increase in net revenue in 1997 and 1998 was primarily attributable to
sales of our Dragon NaturallySpeaking continuous speech product family, which
was introduced in mid-1997 and began to generate significant revenue in the
third quarter of 1997.
Software Licenses. Of the revenue increase, software license revenue
increased by $46.2 million or 236.6% to $65.7 million from $19.5 million in 1997
and increased by $8.0 million or 69.9% from $11.5 million in 1996. Since our
1997 introduction of Dragon NaturallySpeaking, we have continued to increase our
product offerings, including products for multiple languages and telephony
applications, and developed several new versions of our core dictation product
designed to meet the needs of consumers, mobile users and medical, legal and
other professional and corporate users. Sales from software licenses accounted
for 92.0% of net revenue in 1998 compared to approximately 72.7% in 1997 and
67.4% in 1996.
During 1998 and the latter part of 1997, we significantly expanded our
sales channels, both inside and outside North America, to respond to the market
demand for our software products. While we believe that our
16
<PAGE> 19
revenue will continue to grow as we introduce new products with enhanced
capabilities and expand our penetration in the retail markets both domestically
and abroad, we expect to face significant product and price competition in the
future which could adversely impact revenue growth and profit margins.
Development Contracts. Development contract revenue decreased 21.6% to
$5.7 million in 1998 from $7.3 million in 1997 and increased by $1.8 million or
31.6% from $5.6 million in 1996. Development contract revenue decreased as a
percentage of total revenue primarily because of the significant increase in
total revenue. The decrease from 1997 to 1998 in absolute dollars was primarily
the result of the completion of certain government projects. The increase from
1996 to 1997 was primarily attributable to increased funding for existing
projects.
COSTS OF REVENUE
Software Licenses. Software license costs increased $13.2 million or
244.6% from $5.4 million in 1997 and increased $1.9 million or 55.7% from $3.5
million in 1996. As a percentage of software license revenue these costs were
28.3% in 1998, 27.7% in 1997, and 30.2% in 1996. The absolute dollar increase
from 1997 to 1998 was primarily the result of increased sales volume associated
with the first full year of sales of the Dragon NaturallySpeaking product family
partially offset by decreasing per unit costs. In addition, we increased our
investment in technical support by $1.6 million or 161.2% to $2.6 million due to
increased unit sales resulting in increased demand for technical support. The
increase in shipping and receiving costs of approximately $928,000 was primarily
due to increased freight expense incurred as a result of entering into contracts
with two major national distributors and, to a lesser extent, increasing
personnel to handle the increased volume. The increase as a percentage of
revenue from 1997 to 1998 was primarily due to product mix changes and the
introduction of new product offerings, including lower price point products and
our new mobile product, which bundles Dragon NaturallySpeaking software with a
handheld recorder. The absolute dollar increase from 1996 to 1997 was primarily
due to increased materials costs associated with higher product sales resulting
from the introduction of the Dragon NaturallySpeaking product family.
Development Contracts Development contract costs decreased by $1.7 million
or 34.4% to $3.3 million in 1998 from $5.0 million in 1997 and increased by $1.4
million or 39.4% from $3.6 million in 1996. As a percentage of development
contract revenue, these costs were 57.1% in 1998, 68.3% in 1997, and 64.4% in
1996. The decrease in 1998 was primarily due to a decline in government
contracts. The increase from 1996 to 1997 was principally due to increased labor
expense associated with two large United States government projects.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of personnel costs, as well as travel, and facilities and
equipment-related expenses associated with our research and development efforts.
Research and development expenses increased by $4.5 million or 46.8% from $9.6
million in 1997 to $14.1 million in 1998 and increased by $1.6 million or 20.0%
from $8.0 million in 1996. The absolute dollar increases in each year were
principally attributable to costs associated with increased headcount, primarily
product development personnel, associated with the commercialization and
expansion of our Dragon NaturallySpeaking product family. We had 177 employees
engaged in research and development activities on December 31, 1998 compared to
135 on December 31, 1997 and 125 on December 31, 1996. Our internally-funded
research and development was 19.7% of net revenue in 1998 compared to 35.7% in
1997 and 46.9% in 1996.
In addition to internally-funded research and development, we incur
research and development expenses relating to government and customer-funded
projects. These expenses are included in the cost of development contracts.
Research and development costs, including government and customer-funded
expenses, totaled $17.3 million in 1998, $14.6 million in 1997 and $11.6 million
in 1996.
We believe that continued investment in research and development is
critical to attaining our strategic objectives, and as a result expect research
and development costs to increase in absolute dollars in future periods.
17
<PAGE> 20
Selling and Marketing. Selling and marketing expenses consist primarily of
advertising and promotional expenses, compensation and related costs for sales
and marketing personnel and tradeshow and travel expenses. Selling and marketing
expenses increased to $23.7 million or 153.5% in 1998 from $9.4 million in 1997
and increased by $3.9 million or 73.1% from $5.4 million in 1996. The absolute
dollar increases were primarily due to the costs associated with increased
retail advertising and promotions in connection with the release of our Dragon
NaturallySpeaking product family, increased sales personnel and increased sales
commissions associated with increased sales.
General and Administrative. General and administrative expenses consist
primarily of salaries and other related costs for administrative employees,
professional fees, and other general corporate expenses. General and
administrative expenses increased 76.2% to $4.4 million in 1998 from $2.5
million in 1997 and increased 28.1% from $1.9 million in 1996. The increase from
1997 to 1998 was principally the result of increases in senior executive staff
as well as accounting and finance personnel needed to support our business
expansion. The absolute dollar increase from 1996 to 1997 was primarily related
to expenses associated with additional finance and administrative staff and
infrastructure necessary to support increased sales.
Interest, Net. Net interest income increased to $629,000 in 1998 from
$511,000 in 1997 and decreased from $520,000 in 1996. The absolute dollar
increase in 1998 was primarily due to higher return rates on average cash and
investment balances.
Provision for (Benefit from) Income Taxes. Our provision for income taxes
of $2.4 million resulted in an effective tax rate for 1998 of 29.6%. During 1997
and 1996, we utilized our net operating losses and recognized an income tax
benefit of $2.2 million in 1997 and $564,000 in 1996.
Discontinued Operations. We incurred an operating loss from discontinued
operations of $2.1 million in 1998, $3.0 million in 1997 and $1.7 million in
1996. On September 2, 1998, Dragon sold its interest in Articulate. See Note 3
of Notes to Consolidated Financial Statements.
18
<PAGE> 21
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial
information both in absolute dollars and as a percentage of net revenue for the
each of our last eight quarters. This information is derived from Dragon's
unaudited consolidated financial statements and has been prepared on the same
basis as Dragon's annual consolidated financial statements which appear
elsewhere in this prospectus. In the opinion of Dragon's management, this
information reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of such information. These
unaudited quarterly results should be read in conjunction with Dragon's
consolidated financial statements and related notes appearing elsewhere in this
prospectus. The results for any quarter are not necessarily indicative of future
quarterly results of operations, and Dragon believes that period-to-period
comparisons should not be relied upon as an indication of future performance.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- -------- --------- -------- --------- -------- --------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Net revenue:
Software licenses.................... $ 3,309 $ 3,187 $ 3,726 $ 9,284 $12,262 $13,754 $18,750 $20,899
Development contracts................ 1,920 1,607 1,679 2,109 1,350 1,503 1,957 922
------- ------- ------- ------- ------- ------- ------- -------
Total net revenue.................. 5,229 4,794 5,405 11,393 13,612 15,257 20,707 21,821
------- ------- ------- ------- ------- ------- ------- -------
Cost of revenue:
Cost of software licenses............ 854 1,134 818 2,588 3,216 3,330 5,616 6,424
Cost of development contracts........ 1,171 1,087 1,402 1,333 801 827 967 680
------- ------- ------- ------- ------- ------- ------- -------
Total cost of revenue.............. 2,025 2,221 2,220 3,921 4,017 4,157 6,583 7,104
------- ------- ------- ------- ------- ------- ------- -------
Gross profit....................... 3,204 2,573 3,185 7,472 9,595 11,100 14,124 14,717
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development............. 2,127 2,469 2,500 2,481 3,247 3,475 3,885 3,449
Selling and marketing................ 1,546 1,860 2,328 3,616 3,853 4,953 7,219 7,673
General and administrative........... 558 549 662 716 941 924 1,042 1,471
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses........... 4,231 4,878 5,490 6,813 8,041 9,352 12,146 12,593
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss)............... (1,027) (2,305) (2,305) 659 1,554 1,748 1,978 2,124
Interest income...................... 104 100 165 142 156 149 147 177
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income
taxes............................ (923) (2,205) (2,140) 801 1,710 1,897 2,125 2,301
Provision for (benefit from) income
taxes................................ (453) (1,081) (1,049) 393 507 562 630 688
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing
operations......................... (470) (1,124) (1,091) 408 1,203 1,335 1,495 1,613
------- ------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued
operations:
Loss from operations................. (599) (907) (800) (713) (851) (675) (616) --
Gain on sale, net of taxes of
$1,420............................. -- -- -- -- -- -- 6,782 --
------- ------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued
operations....................... (599) (907) (800) (713) (851) (675) 6,166 --
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss).................. $(1,069) $(2,031) $(1,891) $ (305) $ 352 $ 660 $ 7,661 $ 1,613
======= ======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF NET REVENUE:
Net revenue:
Software licenses.................... 63.3% 66.5% 68.9% 81.5% 90.1% 90.1% 90.5% 95.8%
Development contracts................ 36.7 33.5 31.1 18.5 9.9 9.9 9.5 4.2
------- ------- ------- ------- ------- ------- ------- -------
Total net revenue.................. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of software licenses............ 16.3 23.7 15.1 22.7 23.6 21.8 27.1 29.4
Cost of development contracts........ 22.4 22.7 25.9 11.7 5.9 5.4 4.7 3.1
------- ------- ------- ------- ------- ------- ------- -------
Total cost of revenue.............. 38.7 46.4 41.0 34.4 29.5 27.2 31.8 32.5
------- ------- ------- ------- ------- ------- ------- -------
Gross profit....................... 61.3 53.6 59.0 65.6 70.5 72.8 68.2 67.5
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development............. 40.7 51.5 46.3 21.8 23.9 22.8 18.8 15.8
Selling and marketing................ 29.6 38.8 43.1 31.7 28.3 32.5 34.9 35.2
General and administrative........... 10.7 11.5 12.2 6.3 6.9 6.1 5.0 6.7
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses........... 81.0 101.8 101.6 59.8 59.1 61.4 58.7 57.7
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss)............... (19.7) (48.2) (42.6) 5.8 11.4 11.4 9.5 9.8
Interest income...................... 2.0 2.1 3.1 1.2 1.1 1.0 0.7 0.8
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income
taxes............................ (17.7) (46.1) (39.5) 7.0 12.5 12.4 10.2 10.6
Provision for (benefit from) income
taxes................................ (8.7) (22.5) (19.4) 3.4 3.7 3.7 3.0 3.2
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing
operations......................... (9.0) (23.6) (20.1) 3.6 8.8 8.7 7.2 7.4
------- ------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued
operations:
Loss from operations................. (11.5) (18.9) (14.8) (6.3) (6.3) (4.4) (3.0) --
Gain on sale, net of taxes........... -- -- -- -- -- -- 32.8 --
------- ------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued
operations....................... (11.5) (18.9) (14.8) (6.3) (6.3) (4.4) 29.8 --
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss).................. (20.5)% (42.5)% (34.9)% (2.7)% 2.5% 4.3% 37.0% 7.4%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
19
<PAGE> 22
In the last eight quarters, expenses and operating income as a percentage
of net revenue have varied primarily due to increased revenue from our Dragon
NaturallySpeaking family of products. During the quarter ended September 30,
1998, and the quarter ended December 31, 1998, selling and marketing expense
increased in absolute dollars, as we spent $2.1 million in the third quarter and
$1.4 million in the fourth quarter to advertise with an Internet content
provider. In addition, cost of software licenses increased as a percentage of
net revenue during these quarters primarily as a result of the introduction and
increased sales of Dragon Point & Speak, a lower-priced, mass market consumer
product, and the introduction of our mobile product, which contains a
significant hardware component.
Our quarterly operating results have fluctuated in the past, and will
likely continue to fluctuate in the future, as a result of a number of factors,
many of which are outside our control. These factors include:
- the demand for our software products and services;
- the level of product and price competition that we encounter, including
the frequency of changes in pricing policies;
- the timing of new product introductions and product enhancements by us or
our competitors;
- market acceptance of new products;
- our ability to retain and hire research and development and sales
personnel;
- the mix of products and services we sell;
- seasonality of purchasers;
- expansion of our international operations;
- budgeting cycles of our customers;
- missed deliveries by sole source supplier; and
- distribution backlog to our retail and channel customers.
Our software products are typically shipped when orders are received and
consequently, backlog at the beginning of any quarter has in the past
represented only a small portion of that quarter's expected revenue. Since our
operating expenses are based on anticipated revenue levels, and because a high
percentage of our expenses are relatively fixed in the near term, any shortfall
from anticipated revenue could result in significant variations in operating
results from quarter to quarter.
Based on these factors, we believe that future revenue, expenses and
results of operations could vary significantly from quarter-to-quarter. As a
result, quarter-to-quarter comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance. Due to all of the foregoing factors, it is possible that in some
future quarter our operating results will be below the expectations of public
market analysts and investors. In such event, the market price of our common
stock could be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
From inception until 1994, we funded our operating activities primarily
through cash provided from operations. We received $14.5 million in July 1994
and $12.0 million in September 1997 of net cash from the sale of common and
convertible preferred stock to Seagate.
Our cash and cash equivalent balances were $4.9 million at December 31,
1998 and 1997. Working capital increased to approximately $23.2 million at
December 31, 1998 compared to $13.5 million at December 31, 1997. This increase
in working capital was due primarily to an increase in accounts receivable and
inventory, partially offset by increases in accounts payable and accrued
expenses. While our management believes that the risks associated with
collection of accounts receivable have been adequately addressed in our reserves
and credit and collection policies, there can be no assurance that our reserves
will be adequate.
Cash used in operating activities was approximately $6.0 million during
1998, $6.5 million during 1997 and $1.6 million during 1996. The cash used in
1998 and 1997 was primarily attributable to an increase in our sales and
operational requirements. These increases resulted in cash being used for
accounts receivable, inventory and prepayments, netted against the increase in
accounts payable and accrued expenses.
20
<PAGE> 23
The net cash provided by investing activities during 1998 was primarily a
result of the cash received from the sale of our investments, including our
equity interest in Articulate. Net cash used in investing activities was $5.1
million during 1997 and $2.5 million during 1996. Net cash used in investing
activities in 1997 and 1996 was primarily related to purchases of property and
equipment needed to support our expansion and, to a lesser degree, short-term
investment activity.
Net cash provided by financing activities was $74,000 for 1998, $12.9
million for 1997 and $24,000 in 1996. Net cash provided by financing activities
in 1998 and 1996 was related to the exercise of stock options and in 1997 was
primarily related to the sale of common and convertible preferred stock to
Seagate.
We have no debt. In December 1998, we entered into an agreement with a bank
providing for a domestic credit facility of up to $6.0 million. This credit
facility can be used for revolving loans and letters of credit. The actual
amounts available under this credit facility will be determined using an
accounts receivable based borrowing formula. This credit facility is secured by
the domestic inventory and accounts receivable and bears interest at the bank's
prime rate of interest. There was no outstanding balance on the credit facility
at December 31, 1998.
We expect that our requirements for facilities, equipment and other capital
expenditures will grow as demand for our products increases. We plan to hire
additional researchers and development engineers in the future to accelerate our
new product offerings. We also plan to hire additional sales and marketing
personnel to support anticipated sales growth. As a result of this planned
growth, we anticipate incurring additional capital and other expenditures during
future periods.
We believe that the net proceeds from this offering, together with our
current cash balances and income from operations, will be sufficient to fund our
working capital and capital expenditures for at least the next 12 months. To the
extent that we are unable to fund our operations from cash flows, we may need to
obtain financing from external sources in the form of additional equity,
indebtedness, or both. There can be no assurance that additional financing will
be available at all, or that, if available, such financing will be obtainable on
terms favorable to us.
To date, inflation has not had a significant impact on our financial
results.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the year code field. These
systems and software products will need to accept four digit entries to
distinguish 21st century from 20th century dates. As a result, computer systems
and/or software used by many companies and governmental agencies may need to be
upgraded to comply with Year 2000 requirements or risk system failure or
miscalculations causing disruptions to normal business activities.
State of Readiness. We have completed our assessment of our products and
information technology systems. We believe that our software products are Year
2000 compliant. We have completed our initial survey of the information
technology systems of our principal vendors, suppliers and customers as well as
our own non-information technology systems (such as microcontrollers embedded in
machinery and equipment). Based on representations of our principal vendors,
suppliers and customers, we believe that the information technology systems of
such third parties, as they relate to us, do not pose significant operational
issues. Our assessment is on-going and will continue with all principal vendors,
suppliers and customers. In addition, we do not believe our embedded systems
pose Year 2000 concerns because we believe we have identified all of our
software and hardware that require Year 2000 updates or modifications. We plan
to have completed all updates and modifications by the end of the third calendar
quarter of 1999. We have no proprietary systems.
Costs. To date, we have not spent material sums in connection with our
Year 2000 risk assessment and remediation activities. Our costs associated with
replacing or modifying our information systems to address Year 2000 concerns
have not been material. We believe that an additional $100,000 will be required
to complete the replacement or modification of our information systems. We have
funded these activities principally through income from operations.
21
<PAGE> 24
Risks. We believe that the principal Year 2000 risks we face relate to
potential disruptions in materials or component supply and in order processing
and fulfillment by third parties in the event that the information systems of
third parties are materially and adversely affected by Year 2000 related
software failures.
Contingency Plan. To date, we have not formulated contingency plans
relating to third-party Year 2000 disruptions because we believe the probability
of such disruptions to be relatively remote. As discussed above, we are engaged
in ongoing assessment and remediation activities and the responses received from
third-party vendors and suppliers will be taken into account in determining the
nature and extent of any contingency plans.
RECENT ACCOUNTING PRONOUNCEMENTS
In March, 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". SOP 98-1 is effective for the
year ended December 31, 1999 and provides guidance for the accounting treatment
of costs of computer software developed or obtained for internal use. We do not
expect adoption of this statement to have a material impact on our consolidated
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". The statement is effective for the year ending December
31, 2000 and 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.
We do not expect adoption of this statement to have a material impact on our
consolidated financial position or results of operations.
In December 1998, the AICPA issued 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" as defined in SOP 98-9 for recognition of revenue under
certain multiple-element arrangements. We do not expect the adoption of SOP 98-9
to have a material impact on our consolidated financial position or results of
operations.
22
<PAGE> 25
BUSINESS
Dragon 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. Our products and
technologies enable electronic devices to understand speech, the most natural
and effective means of communication. As a result, users of our products can
interact with electronic devices faster and more intuitively than with other
input methods, such as the keyboard or computer mouse, thereby increasing
productivity. We market a variety of speech products worldwide, including our
Dragon NaturallySpeaking family of continuous dictation products. Dragon
NaturallySpeaking products are currently available in six languages:
American-English, British-English, French, German, Italian and Spanish, with
Japanese and Mandarin versions scheduled for release in 1999. In addition, third
parties have used our speech technology to develop small vocabulary products in
other languages, including Hebrew and Swedish. Since 1997, we and our Dragon
NaturallySpeaking products have received over 70 industry awards and citations
including:
- BYTE, Best of COMDEX: Best of Show (Spring 1997)
- PC/Computing, 1997 MVP Winner: Input Device (January 1998)
- Innovation 98 Info PC, iT/COMDEX France: Best Development Tool (February
1998)
- BYTE Espana, 1997 Award of Excellence, Spain (February 1998)
- PC Professionell, Innovation of the Year 1997-1998: Software Category,
Germany (CeBIT April 1998)
- PC World, World Class Award: Best Voice Recognition Software (June 1998)
- PC World, World Class Award: Most Promising Software Newcomer (June 1998)
- Retail Vision: Six awards including Best Vendor and Best Retail Strategy
(August 1998)
- PC Magazine, Editor's Choice: Best Speech Dictation Product (October
1998)
- SMAU, 31st Premio SMAU Industrial Design Award: Business Software
Category, Italy (October 1998)
- PC World, Best New Handheld Device (November 1998)
- PC Magazine Australia, Editor's Choice, Australia (December 1998)
Since our founding in 1982, we have developed and commercialized successive
versions of high-quality speech products and technologies and have been the
first to market a number of innovative products. We were the first to introduce
products incorporating built-in PC speech recognition (1984), large vocabulary,
general purpose, discrete dictation (1990), and software-only dictation for use
with most Windows applications (1993). In June 1997, we achieved an important
milestone by introducing Dragon NaturallySpeaking 1.0, the world's first large
vocabulary, general purpose, continuous speech dictation product. From our
inception, we have funded our research and development and other activities
primarily through funds generated from operations. In addition, our financial
resources have been supplemented by Seagate Technology, which made significant
equity investments in Dragon in 1994 and 1997.
We are applying our technologies beyond PC-based products to multiple
products such as hand-held and mobile devices and developing advanced
applications for emerging speech markets such as consumer electronics and
telephony. We are also collaborating with major corporations and federal
agencies to voice-enable existing hardware and software platforms. For example,
we led the development of a speech recognition system for a global package
company that increases worker productivity by allowing package handlers to enter
data using speech instead of the keyboard.
Our end-users include individuals and companies which use Dragon speech
products and technologies for a wide range of applications, including general
purpose dictation, legal and medical dictation, inventory management and
in-bound customer telephone interactions. These end-users include Bank of
America, Boeing, the Los Angeles Police Department, Peugeot and Wells Fargo. We
sell our products worldwide predominantly through major distributors to retail
channel accounts and VARs, and directly to OEMs and ISVs.
23
<PAGE> 26
INDUSTRY OVERVIEW
Although speech is the most natural and effective means of human
communication, historically it has not been used as a primary means of
interaction between people and machines. Basic speech recognition technology has
existed for a number of years and effectively addressed certain specialized
applications, such as limited data entry and retrieval. However, its widespread
use has been constrained by technical limitations and inadequate PC processing
power. For example, until recently, speech recognition products had limited
vocabularies and required users to speak discretely, pausing after each word,
rather than naturally and continuously. These technical constraints limited the
widespread use of speech technology. As a result, the development of speech
technology capable of recognizing natural and continuous speech and suitable for
widespread commercial application has been an attractive but, until recently,
elusive goal.
In June 1997, Dragon became the first company to develop, produce and
market large vocabulary, general purpose, continuous speech recognition
technology for commercial applications. The introduction of this technology
represented the culmination of a series of technological breakthroughs by Dragon
over the past two decades. We believe that the advent of continuous speech
recognition technology and the increased availability of powerful, low-cost
microprocessors and memory are creating a wide range of commercial applications
for speech-based products. As hardware devices shrink and become more portable,
sacrificing keyboard space, we believe that speech will become the preferred and
most efficient method for operating electronic devices.
Currently available speech recognition products allow PC users to use
speech in addition to the keyboard to significantly increase the speed with
which they can generate, edit and format text in popular word processing,
contact management and e-mail programs. Until the introduction of Dragon
NaturallySpeaking, commercially available speech technology required users to
speak discretely, and was unable to recognize natural and continuous speech. As
a result, early speech recognition products did not provide the accuracy, speed,
ease-of-use and functionality required for widespread market acceptance.
According to a Voice Information Associates report, the market for continuous
speech dictation products alone is expected to reach $3.0 billion by the year
2001 as manufacturers incorporate such speech technology into PCs and other
electronic devices.
The increasing use and growing complexity of computers and sophisticated
electronic devices, along with the broad deployment of software applications,
has created a need for a faster, easier to use and more intuitive method of
interacting with machines. This need is driving the development of an increasing
number of applications for speech recognition technology, ranging from consumer
electronics to enterprise-wide applications, that will enable individuals to
interact with machines more productively. For instance, as speech recognition
technology has become more prevalent, speech-enabled applications and systems
have been deployed to enhance productivity in a variety of commercial
environments beyond PC-based dictation applications, including package handling,
order taking and call center management.
In addition, we believe there is increasing demand for a broad range of
speech-enabled products that will not be dependent on end-user PC platforms.
Although the personal computer will remain an important speech technology
platform, we believe that speech recognition technology will lead to the
development of a broad market of mobile, networked and consumer "information
appliances," including hand-held computers and wireless communication devices
that will transmit information quickly and effectively in response to speech.
Some of these appliances will provide telephone and Internet access as well. We
expect strong growth in the demand for a range of platforms from hand-held
personal organizers and wireless communicators to multi-user, server-based
systems with vertical and enterprise-wide applications. We also expect strong
growth in the demand for embedded systems such as automobile command/control and
navigation devices and server-based platforms which will support customized
transcription and audio indexing devices. However, to exploit successfully the
opportunity that these platforms represent for the speech industry, speech
recognition products and technologies operating on these platforms must continue
to offer high levels of accuracy, speed and ease-of-use.
24
<PAGE> 27
THE DRAGON SOLUTION
We believe that our award-winning products and technologies offer the
following benefits which will promote the adoption of speech as a standard user
interface between people and machines and expand the market for speech
technology and products:
Increased Productivity. Our products significantly increase productivity
by allowing users to generate, edit and format documents, e-mail messages and
other text faster and with greater accuracy than existing data entry methods,
such as typing. Several published product comparisons have identified the Dragon
NaturallySpeaking product family as an industry leader in speech recognition
accuracy and have awarded these products their highest ratings on a
words-per-minute basis. In addition, our mobile products enable users to record
text, documents and e-mail messages while away from the workplace for later
processing and transcription by the users' PCs. We expect to continue to
introduce new speech products and technologies which will enhance productivity
including: (1) an enterprise-wide speech application integrated with word
processing and time and contact management software, and (2) audio file search
products, which will permit rapid search and retrieval of spoken words contained
in audio and multimedia recordings.
Ease-of-Use. Our products are designed to enable people to interact
intuitively and easily with a variety of PCs, server platforms, telephones and
other electronic devices. Included in our patent portfolio are patents covering
usability features which are incorporated into the design of each of our
products and applications. For example, our natural language commands and text
editing features permit the correction of entire phrases, as well as individual
words, by issuing a single intuitive verbal command instead of carrying out a
series of manual steps using a keyboard or computer mouse. We believe that as
consumers become more aware of the benefits of speech technology and its
ease-of-use attributes, demand for speech-enabled products and applications will
continue to grow substantially.
Product Design that Facilitates Product Family Expansion. Our speech
recognition architecture is designed to permit rapid product family expansion to
additional targeted markets after a product is initially released. For example,
soon after introducing Dragon NaturallySpeaking for general dictation use, we
modified the product by integrating specialized vocabularies and language models
to create both Dragon NaturallySpeaking Legal Suite and Medical Suite. In
addition, our core speech recognition technology is not dependent on any
specific language. This feature has enabled us to release British-English,
French, German, Italian and Spanish language versions of our products shortly
after the commercial release of the American-English version.
Superior Technological Capabilities. Our products offer users leading-edge
speech technology. We employ a highly qualified staff of scientific and
technical personnel in our research and development organization. More than 89
of our employees hold either doctorates or masters degrees and the majority of
our personnel have significant technical expertise in speech technologies. In
addition, our co-founder, Dr. Janet Baker, has more than 25 years of experience
in the field of speech technology and is recognized as a pioneer in the
industry. We believe we have assembled a team of professionals with superior
technical knowledge in a number of computer and linguistic fields which will
enable us to maintain our position as an innovative industry leader.
Product and Application Versatility. Our speech technology can be easily
adapted to operate on multiple operating systems and hardware platforms. In an
effort to increase the commercial appeal of our products, we seek to make our
products compatible with widely-used software products from Corel Corporation,
Microsoft, Symantec Corporation and other leading software developers. Our
products currently operate on Windows 3.1, Windows 95, Windows 98, Windows NT,
UNIX and other operating systems, and on hardware platforms including PCs and
workstations for certain custom applications.
Sophisticated Application Development Tools. In an effort to increase
product license revenue and to establish our speech technology as the industry
standard, we market a suite of sophisticated software development tools
(NaturallySpeaking Developer Tools Suite). These tools allow software developers
to easily integrate advanced speech recognition and output capabilities into
their software applications and to create a wide variety of continuous
dictation, data entry, and command and control applications. In addition, we
25
<PAGE> 28
market our Dragon PhoneQuery SDK which enables developers to create
caller-friendly, interactive telephony systems that allow callers to access
information using natural and continuous speech without wading through more
complex discrete speech and push-button menus.
STRATEGY
Our objective is to enhance our position as a leading worldwide developer
and provider of advanced speech products and technologies. The key elements of
our strategy are:
Extend Technological Leadership. We believe that our core speech
recognition technology is the world's most accurate and highest performing and
positions us as a world leader in speech technology for current and emerging
applications. We plan to continue to develop and enhance our speech recognition
and related technologies, including our comprehensive, high-quality acoustic and
language data to extend our technological leadership. We also intend to continue
to build on our patent portfolio to protect our future innovations in speech and
related technologies. In addition, we intend to continue to attract superior
technical personnel and may seek to acquire complementary technologies and
businesses. We believe that this strategy is essential to the development and
delivery of leading-edge speech recognition and related technologies for
emerging applications.
Identify and Develop Emerging Markets for Speech Technology. We
continually analyze emerging market opportunities for speech technology. We
focus our product development efforts on products and applications that, among
other things,
- address a large or rapidly growing market,
- represent a technically viable extension of our technology,
- can be marketed cost-effectively through our current and future
distribution channels, and
- operate within the computational and memory capabilities of commonly used
electronic devices.
We have identified, and are in the process of applying our core speech
recognition technology to, a number of existing and emerging applications in the
following areas:
- consumer electronics (mobile computing and dictation products);
- embedded systems, including automotive products;
- industrial machinery products;
- large scale business enterprises (server-based speech products);
- telephony applications;
- broadcast media (transcription and audio indexing products); and
- vertical market applications (enhanced dictation products for targeted
markets).
Maintain Reputation for Being First to Market With Quality Speech
Products. We believe that we have earned a reputation for consistently being
first to develop and market innovative, high-quality speech products. By being
first to market with high-quality products, we increase our brand-name
recognition, reinforce our market leadership position and capture additional
market share. In addition, we believe that our market position facilitates the
formation of cooperative product development relationships with other technology
leaders and co-marketing agreements with well-known software and consumer
product companies. These relationships enable us to share technical and industry
knowledge and to co-develop, and generate demand for, a variety of
speech-enabled applications.
Increase Market Penetration Through Multiple Distribution Channels. A key
component of our strategy is to expand market penetration of our speech
technology by increasing our multi-channel sales effort. To achieve this
objective, we plan to expand our direct sales operations, leverage our position
of market leadership to add additional distributors and VARs, and increase our
use of e-commerce. We will supplement these
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efforts with targeted marketing campaigns, preferred training programs and
in-store product demonstrations. To increase demand for our technology, we also
will continue to provide software development tools to OEMs, VARs and ISVs to
encourage them to speech-enable their products. We also expect to enter into
additional joint marketing relationships and product bundling arrangements with
leading ISVs and OEMs which offer complementary products or services. We believe
that a multi-channel sales effort will broaden customer awareness of our
products and will allow us to effectively target a wide variety of industries
that would benefit from our solutions.
Expand Global Presence through Product Introductions and Increased
Worldwide Marketing. We intend to capitalize on our products' adaptability and
language independence to introduce product family extensions for international
markets. In addition, through increased worldwide marketing and sales programs,
coupled with increased use by international consumers of PCs with sufficient
computational and memory capabilities, we believe that global acceptance of our
products will increase significantly. The Company currently has subsidiaries in
the United Kingdom and Germany and a sales office in France. Dragon
NaturallySpeaking products are currently available in six languages:
American-English, British-English, French, German, Italian and Spanish, with
Japanese and Mandarin language versions scheduled for release in 1999.
Expand Strategic Alliances. We believe that we can rapidly expand and
penetrate markets by collaborating with industry-leading hardware and software
companies. By integrating our technology with leading products manufactured or
developed in cooperation with third parties, we can provide solutions offering
enhanced capabilities that are targeted to customers in existing and new
markets. We have such relationships with Corel, Genie Telecommunication, Inc.,
GoldMine Software Corporation, Intel Corporation, Seagate Technology, Sony
Corporation and others. Products and technologies arising from these
relationships are typically made available by one or both parties through
multiple distribution channels.
TECHNOLOGY
Since our founding, we have been recognized as a pioneer and leader in
speech recognition technology. Our core speech recognition technology uses
complex models that represent crucial underlying patterns found in speech and
language. We believe that Dr. James Baker, co-founder of Dragon, in 1971 became
one of the first to use Hidden Markov models, now the speech industry standard,
as the basis for his research in the field of speech recognition. This technique
and other sophisticated methods, when combined with our extensive collection of
high-quality acoustic and language data, form the basis for the development of
our proprietary high-performance speech recognition technology. In addition to
our proprietary technology, we license third-party technology such as
text-to-speech capabilities in developing our products.
Dragon's speech recognition technology uses three kinds of information: a
lexicon (the set of words to be recognized together with their pronunciations),
a language model (which specifies the relative likelihood of a sequence of
words), and an acoustic model (which specifies the acoustic correlates of a
given pronunciation). Dragon has derived its lexicon and language and acoustic
models from its extensive internal data resources which include: hundreds of
hours of recordings of the speech of many different speakers in a variety of
languages, hundreds of millions of words of computer readable text in those
languages, and lengthy human-edited lists of words and their pronunciations.
Furthermore, we designed our software and algorithms to be task and language
independent, permitting easy development of products in new languages or for new
applications.
Automatic speech recognition algorithms must evaluate a large number of
hypotheses in order to determine the most plausible transcription of a given
utterance. This evaluation is a computationally intensive task. For this reason,
we have directed most of our research and engineering efforts specifically
towards issues of computational efficiency and recognition accuracy.
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<PAGE> 30
The following chart depicts our core speech recognition technologies and
illustrates their operation:
[CHART]
[Pick Up EDGAR information from PCN 950]
Our core speech recognition technology enables our products to recognize
naturally spoken continuous speech, as opposed to isolated words or discrete
speech. Our technology is capable of high-quality speaker independent
recognition. However, it is capable of achieving even higher performance through
the use of speaker dependent recognition, whereby the technology automatically
customizes its language and acoustic models and lexicon to a particular speaker
using sample speech or text that the speaker provides. Using our speaker
adaptation techniques, it is possible for the recognition performance to
continually improve with usage.
We are also using our core speech recognition technology to develop future
applications beyond the PC. These include applications which will permit users
to operate speech-based products outdoors or in commercial environments
presenting significant technological challenges such as poor signal quality,
high background noise and reduced signal bandwidth. In addition, we are adapting
our core technology to create speech-enabled mobile dictation devices,
speech-enabled telephony solutions and audio indexing products. We are
continuing to develop software that is capable of recognizing informal or
spontaneous speech transmitted over diverse signal channels, such as radio or
television broadcasts (where there may be background music or noise) or the
telephone, including wireless transmissions (where there is reduced audio signal
bandwidth). For some applications, such as our new audio indexing products, the
resulting text can be very useful even if not perfectly transcribed because it
allows accurate and rapid location of specified words and topics in audio
recordings.
PRODUCTS
We have marketed various generations of speech products since 1983. We
currently offer products that address demand in six principal markets: consumer,
professional/corporate, mobile, telephony, OEM and developer tools. The
following table lists certain information relating to our principal current
products:
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- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRODUCT KEY FEATURES FIRST RELEASE DATE LANGUAGES AVAILABLE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CONSUMER PRODUCTS
Dragon Point & Continuous speech recognition; May 1998 - American-English
Speak dictate text into most Windows - British-English
applications; vocabulary - French
building to easily add - German
thousands of new words, names - Italian
and specialized terms - Spanish
Dragon All Dragon Point & Speak November 1997 - American-English
NaturallySpeaking features, plus dictate, - British-English
Standard NaturallySpeaking edit and - French
format words and phrases by - German
voice, Standard using - Italian
Select-and-Say technology, - Spanish
BestMatch tech-
nology, Natural Language
Commands
Dragon All Dragon NaturallySpeaking November 1997 - American-English
NaturallySpeaking Standard features, plus Dragon - British-English
Preferred NaturallyMobile software to - French
transcribe dictation from a - German
specialized recorder including - Italian
additional mobile software; - Spanish
dictation playback;
text-to-speech
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Standard features in a package
for Teens specifically designed for
teenage voices and
vocabularies. Includes an
updated user interface
DragonDictate Discrete speech recognition; March 1990 - American-English
hands-free PC & mouse - British-English
operation; voice macros; - French
specialty vocabularies - German
available for legal, medical, - Italian
journalism, technology and - Spanish
business professionals - Swedish
- ---------------------------------------------------------------------------------------------------------
PROFESSIONAL/
CORPORATE PRODUCTS
Dragon All Dragon NaturallySpeaking October 1997 - American-English
NaturallySpeaking Preferred features, plus macro - British-English
Professional language capability for - French
sophisticated speech commands; - German
targeted for serious business - Italian
users - Spanish
Dragon All Dragon NaturallySpeaking May 1998 - American-English
NaturallySpeaking Professional features, plus - German
Legal Suite extensive legal vocabulary;
targeted for attorneys and
other legal professionals
Dragon All Dragon NaturallySpeaking May 1998 - American-English
NaturallySpeaking Professional features, plus
Medical Suite extensive medical vocabulary;
targeted for doctors and other
medical professionals
- ---------------------------------------------------------------------------------------------------------
MOBILE PRODUCTS
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Preferred features, packaged - British-English
Mobile with specialized mobile
software and hand-held digital
recorder; targeted for serious
business users
- ---------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 32
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRODUCT KEY FEATURES FIRST RELEASE DATE LANGUAGES AVAILABLE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Legal Suite features, packaged - British-English
Mobile Legal Suite with specialized mobile
software and a customized
recorder; targeted for
attorneys and other legal
professionals
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Medical Suite features, - British-English
Mobile Medical Suite packaged with specialized
mobile software plus a
customized recorder; targeted
for doctors and other medical
professionals
- ---------------------------------------------------------------------------------------------------------
TELEPHONY PRODUCT
Dragon All Dragon NaturallySpeaking March 1998 - American-English
NaturallySpeaking Professional features, plus a
Call Center switch box designed to allow
the speaker to talk over the
telephone or into the dictation
system
- ---------------------------------------------------------------------------------------------------------
OEM PRODUCTS
Dragon Full dictation, edit and format June 1997 - American-English
NaturallySpeaking words and phrases by voice in a - British-English
Personal single application - French
- German
- Italian
- Spanish
Dragon Dragon NaturallySpeaking June 1998 - American-English
NaturallySpeaking Personal designed for use with - British-English
WordPerfect Edition Corel WordPerfect 8; vocabulary - French
building to easily add - German
thousands of new words, names - Italian
and specialized terms - Spanish
- ---------------------------------------------------------------------------------------------------------
DEVELOPER TOOLS
Dragon All Dragon NaturallySpeaking August 1998 - American-English
NaturallySpeaking Professional features, plus
Developer Tools Suite software tools that allow for
the integration of speech into
custom applications
Dragon VoiceTool Software tools that allow for April 1995 - American-English
Dragon X-Tools the integration of speech - British-English
DragonSpeech Tools commands and discrete dictation - French
into custom applications - German
- Italian
- Spanish
Dragon Phone Query SDK Speech recognition for building February 1998 - American-English
interactive voice response
systems over the telephone;
natural voice response; speaker
independence, multi-port
telephony server support
- ---------------------------------------------------------------------------------------------------------
</TABLE>
In addition, we plan to introduce the following products during the second
quarter of 1999:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRODUCT KEY FEATURES LANGUAGES AVAILABLE
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Dragon Permits network-based administration of Dragon - American-English
NaturallySpeaking NaturallySpeaking application software user files - British-English
Network Edition and data for enterprise-wide application
Dragon Permits speech-based use of Symantec's ACT! and - American-English
NaturallyOrganized other personal information management programs
- ------------------------------------------------------------------------------------------------------
</TABLE>
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AWARDS AND CITATIONS
Set forth below is a partial list of selected major industry awards and
citations of recognition that we and our Dragon NaturallySpeaking products have
received during the last three years:
1999
PC World, Best Buy (January 1999)
PC World New Zealand, Readers' Choice
Business Software: Speech
Recognition Category, New Zealand (December 1998/January 1999)
Home Office Computing, Best Buy:
Professional Voice Dictation Category
(February 1999)
PC Guide, 1998 Product of the Year: Business Software Category, Switzerland
(February 1999)
TechnoLawyer, "@" Award for Favorite
Voice Recognition Software (January 1999)
Wired, Best -- First Class (January 1999)
PC World New Zealand, Readers' Choice --
Most Promising Newcomer: Software
Category, New Zealand
(December 1998/January 1999)
Mobile Insights, 1999 Mobility Award --
Software: Applications Category
(February 1999)
1998
Fortune, Annual Product Review/Technology Buyer's Guide-Product to Watch:
Software/ Cool Stuff Category (Winter 1998)
BusinessWeek, The Best New Products: Software to Watch in 1998 (January 1998)
PC/Computing, Usability Hall of Fame (January 1998)
PC/Computing, 1997 MVP Winner: Usability Achievement of the Year (January 1998)
PC/Computing, 1997 MVP Winner: Input Device (January 1998)
Time, The Best Cybertech of 1997
(January 1998)
BYTE Espana, 1997 Award of Excellence, Spain (February 1998)
Innovation 98 Info PC iT/COMDEX France: Best Development Tool (February 1998)
CTI, 1997 Product of the Year: Speech Recognition Category (February 1998)
CallCenter Magazine, Best of CT EXPO 98 (March 1998)
PC Professionell, Innovation of the Year 1997-1998: Software Category, Germany
(April 1998)
Telebusiness, 1998 Awards for Excellence: Winner of The Philip Shipman Award for
Innovative Technology, United Kingdom (June 1998)
PC World, World Class Award: Most
Promising Software Newcomer (June 1998)
PC World, World Class Award: Best Voice Recognition Software (June 1998)
PC/Computing, Time Capsule -- The 12 Best PC Products on the Planet: Input
Device Category (August 1998)
Retail Vision: Six awards including Best Vendor and Best Retail Strategy (August
1998)
PC Magazine, Editors' Choice (October 1998)
SMAU, Winner 31st Premio SMAU
Industrial Design Award: Business Software Category, Italy (October 1998)
PC World, Best New Handheld Device (November 1998)
WIN, Top Product, Germany (November 1998)
Home Office Computing, The HOC 100 Gold Award Winner-Software: Business
Productivity Category (December 1998)
Newsweek, The Top 50 CD-ROMs of 1998 (Winter 1998)
Personal Computer World, Editors' Choice, United Kingdom (October 1998)
PC Magazine Australia, Editor's Choice, Australia (December 1998)
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<PAGE> 34
1997
BYTE, Best of COMDEX Spring '97: Best of Show (August 1997)
PC IT 97, Best Pro Award: Best Personal
Computing Product, Australia
(September 1997)
PC Magazine, Technical Excellence Award: Software Category (December 1997)
Popular Science Magazine, The Best of What's New: 1997 Grand Winner for
Computers & Software (December 1997)
PC Magazine Middle & Near East, 1997 Award of Excellence: Most Innovative
Software Product of the Year, United Arab Emirates (October 1997)
PC Week, Best of COMDEX Fall 1997: Best Utility Software (November 1997)
BYTE, 1997 Editors' Choice Award: Award of Excellence (December 1997)
END-USERS
Our end-users range from individuals using the products for a wide range of
personal and professional purposes to companies and government agencies using
our products and technologies for a particular function or department. Some of
the companies and government agencies that use our products or technology for
significant applications include:
<TABLE>
<CAPTION>
CORPORATE/INDUSTRIAL GOVERNMENT HEALTH CARE/PHARMACEUTICAL
<S> <C> <C>
Abbott Laboratories Federal Government of Georgetown University
Allianz AG Holding Australia Parliamentary School of Medicine
Boeing Reporting Service, Hansard Kaiser Permanente
Canadian Pacific Railway French Ministry of Michigan Rehabilitation
Deere & Company Education Services
Peugeot Los Angeles Police Princess Alexandra
Seiko Epson Corporation Department Hospital
Teradyne Shaw Air Force Base, S.C. V.A. Medical Centers,
Wal-Mart The United States Navy over 10 locations in
Victoria Board of 7 states
Workman's
Compensation
</TABLE>
<TABLE>
<CAPTION>
LEGAL BANKING/FINANCIAL SERVICES
<S> <C> <C>
Hourigans Kluger & Bank of America
Quinn, P.C. Citibank Privatkunden AG
Kilpatrick Stockton LLP Deutsche Bank
Long, Weinberg, Ansley Seafirst Bank
and Wheeler, LLP Wells Fargo, Ltd.
</TABLE>
The following case studies describe the manner in which certain of our
end-users employ our products and technologies:
- A global package delivery company uses our voice recognition technology
for timely and accurate package sorting. The voice-driven system allows
that company's package handlers to sort packages by speaking city, state
and zip code data instead of using the keyboard.
- A cancer specialist uses Dragon NaturallySpeaking together with a
hand-held digital recorder to dictate patient visit notes, grant
proposals, textbook chapters and medical journal manuscripts. After
dictating into the recorder, he connects the recorder to his computer
which transcribes his dictation. This process reduces the time required
for transcription, improves first-draft accuracy and reduces the cost of
transcription services. As a result of this physician's experience, the
cancer center at which he practices plans to deploy Dragon
NaturallySpeaking to additional doctors on staff.
- An attorney in New York City uses Dragon NaturallySpeaking to document
client conversations and to generate legal documents and correspondence
associated with his law practice. He has advised us that he has
significantly reduced, and in some cases eliminated, transcription costs
and document review cycles. In addition, Dragon NaturallySpeaking allows
him to create many of his own documents
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<PAGE> 35
quickly and accurately, thereby freeing his assistant to work on other
projects and administrative duties.
- Police officers at a division of a large urban police department
typically spent as much as 60% of their time preparing reports and other
paperwork. Using Dragon NaturallySpeaking speech recognition software,
officers now dictate their reports into their computers and their words
are immediately transcribed into typed police reports, freeing up time
for patrols and other police duties. According to this police department,
some officers using everyday speech, achieve dictation rates up to 100
words per minute with an accuracy rating of 99%.
- A franchiser of an internationally known Italian designer, manufacturer
and distributor of knitwear uses our dictation products to manage stock
and control inventory in approximately one-third the time required by the
manual methods. Productivity is further enhanced because of our
software's short training time and multi-user support.
- To automate receipt of inventory and shipment of production, an Italian
newspaper distributor adopted a robotic system, consisting of two mobile
industrial robots enabled with our discrete speech recognition technology
which communicates with the newspaper's servers. One robot accompanies
warehouse workers and responds to their dictated commands with very high
accuracy. The second robot provides billing or materials information to
clerical personnel, and can answer inquiries such as, "Tell me the
price," or "Tell me the stock quantity."
- We and a federal government agency have developed a portable translation
device called the Multilingual Interview System. This system allows
English-speaking users to conduct basic interviews and give instructions
to targeted non-English-speakers. It uses over 7,000 common phrases and
combines voice recognition and digital voice recording of translations
with a wearable computer. This system has been deployed in Bosnia to aid
U.S. forces in performing a number of important tasks requiring
communication with locals, including medical care, landmine management,
force protection and refugee resettlement.
SALES, MARKETING AND DISTRIBUTION
Our marketing organization uses a variety of marketing programs to promote
our advanced products and technologies and to increase demand worldwide. We have
teams of dedicated sales professionals assigned to each of our channel markets.
Our marketing efforts support our direct sales and indirect distribution
channels through participation in trade shows, targeted advertising, channel
sales programs, public relations campaigns, retail promotions, product bundles,
customer surveys and profiles and product promotion through our website.
We market and sell our products worldwide indirectly through distributors,
retailers, catalogs, e-commerce, VARs and ISVs and directly through our website
and telesales organization. Over 50 major retail channel accounts worldwide sell
our products. In addition, we license our technology to OEMs. Our OEM agreements
generally license the OEMs to incorporate our speech recognition and related
technologies into their products and applications in exchange for royalty
payments to us. As of January 29, 1999, our indirect distribution channel was
composed of approximately 35 distributors, 729 VARs, and 19 ISVs and OEM
licensees. In the fourth quarter of 1998, we started using volume license
agreements to sell and market our Dragon NaturallySpeaking family of continuous
dictation products.
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<PAGE> 36
The following table lists our principal North American and international
distributors, retail channel accounts, VARs and ISVs/OEMs:
NORTH AMERICA
<TABLE>
<CAPTION>
DISTRIBUTORS RETAIL CHANNELS VARS ISVS/OEMS
<S> <C> <C> <C>
GT Interactive America Online Compaq Services Compaq
Software Best Buy Division of Compaq Corel
Ingram Micro CompUSA Computer Corporation MetroBook Computer
Merisel Americas Fry's Electronics Government Technology Micron Technology
Tech Data OfficeMax Services Syracuse Language Systems
Staples Pomeroy Computer Resources
Softmart
Software House
International
Software Spectrum
</TABLE>
INTERNATIONAL
<TABLE>
<CAPTION>
DISTRIBUTORS RETAIL CHANNELS VARS ISVS/OEMS
<S> <C> <C> <C>
CHS Electronics CDC Point Mysoft G DATA Software
Holding Dixon's Store Group Talk Write Limited Hexaglot Holding
HCL Infosystems Groupe FNAC Voelter EDV-Beratung Jurasoft Microcomputer
Ingram Micro Harvey Norman Voice Perfect Systems
Innelec Multimedia Media Market
Marketing Results
Northamber Group
Tech Data
Tech Pacific
</TABLE>
Our two largest distributors are Ingram Micro and Tech Data. Ingram Micro
accounted for approximately 5% of our net revenue for 1997 and 22% of our net
revenue for 1998. Tech Data accounted for approximately 9% of our net revenue
for 1997 and 40% of our net revenue for 1998. Our agreements with our
distributors typically are not exclusive, have no stated minimum purchase
obligations and may be terminated by either party without cause. We believe that
in the event of termination of our relationship with one or more of our
distributors, we could enter into replacement agreements with new distributors.
However, failure to replace these distributors with distributors of equal
marketing capabilities and reputation could have a material adverse effect on
our business, results of operations and financial condition.
We intend to penetrate the international retail market indirectly through
distributors, increase our VAR business targeted at corporate accounts and
expand our OEM business. We have sales professionals at each of our European
subsidiaries in Germany, France and England. Sales outside North America
accounted for approximately 15% of our net revenue in 1997 and approximately 12%
in 1998.
PRODUCTION AND FULFILLMENT
Production of our products involves the purchase of microphones and digital
recorders, duplication of CD-ROMs (outsourced) and assembly of product
components, user manuals and product books. We seek to minimize production costs
by outsourcing production requirements, improving process efficiencies and
realizing economies of scale. We subject all of the components of our products
purchased from outside vendors to high certification standards designed to
ensure product compatibility.
We outsource the production, packaging, and order fulfillment of our
products, both domestically and internationally, to third parties when it is
cost effective to do so. To the extent possible, we limit our internal
production activities to such tasks as quality inspection and testing. We
currently have production
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<PAGE> 37
arrangements with ZBR Publications Inc., Omnet Technology Corp., The Media Farm,
Inc. and Modus Media International N.V. and order fulfillment agreements with
CompUSA Direct and Modus Media. We believe that our existing production capacity
is sufficient to accommodate potential increases in sales volume for the
foreseeable future.
RESEARCH AND DEVELOPMENT
Our success will depend on our ability to develop and introduce on a timely
basis new products and enhancements to our existing products. We have invested,
and intend to continue to invest, significant resources in product and
technology development. We focus and modify our extensive product development
efforts based on customers' needs and changes in the marketplace. Our research
and development organizations are principally responsible for enhancing our core
speech recognition engine, as well as the acoustic and language models and
noise-handling algorithms. We currently focus our development efforts on
commercializing our research innovations into new products and product
enhancements that are more accurate and easier to use, as well as the
development of additional speech-related applications.
Our strategic long-term research has been greatly aided by a succession of
competitively-awarded federal government contracts involving several federal
agencies. As a result of this government-subsidized research, we have been able
to further develop our leading technology in technically challenging areas,
including high noise, limited channel communication, automatic information
retrieval and automatic speaker, language and topic identification. We deliver
specialized systems to various federal government agencies and regularly
participate in government-sponsored performance evaluations. However, we retain
commercial rights to our government-sponsored research. In addition to
government-funded research and development, we conduct speech research and
development and custom engineering for a number of major industrial customers in
such areas as industrial automation, automotive engineering and
telecommunications. We have successfully commercialized various elements of
speech technology developed in collaboration with the federal government and
third parties.
As of December 31, 1998, we employed 177 individuals in our research and
development organizations, 77 of whom hold doctorates or masters degrees in a
number of diverse fields, including mathematics, physics, electrical
engineering, and linguistics. We believe that this team and its expertise in
speech technology provide us with a significant competitive advantage. Our
ability to attract and retain highly qualified employees will be a major
determinant of our success in maintaining our technological leadership.
Company-funded research and development expenses were approximately $8.0
million in 1996, $9.6 million in 1997 and $14.1 million in 1998.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
We outsource our technical support and customer service operations and
provide in-house backup capabilities. In this way, we manage service call
volumes cost-effectively and minimizes fixed costs and overhead, while
maintaining a high level of customer service.
Our in-house technical support organization responds to support questions
arising from our website, writes and posts technical tips, publishes answers to
frequently asked questions and provides other pertinent technical information.
This organization also supplies patches and free updates that users or VARs may
need. In addition, this department provides backup support to our outsourced
support providers in North America and Europe, including handling time-sensitive
support problems and providing training for new products. This organization also
provides support directly to the our VARs and key corporate customers.
Our present support policy provides all registered users with 90 days of
free telephone support via a standard toll-free number (30 days for Dragon Point
& Speak). Electronic support is provided free to registered users for a period
ending six months after we discontinue a product.
Our customer service department handles non-technical incoming calls from
both our registered users and potential customers interested in learning more
about our products. This group provides information consumers may need in
deciding whether to purchase Dragon products. Customers may purchase or return
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<PAGE> 38
Dragon products or product upgrades through the customer service department
either via telephone or our website.
COMPETITION
The market for speech recognition products is relatively new, intensely
competitive and subject to rapid technological change. To compete effectively we
must, among other things,
- establish favorable brand name recognition for our products,
- develop new products that consumers want to buy,
- introduce new versions of and enhancements to our existing products,
- develop new applications for speech technology,
- price our products at appropriate and competitive levels,
- provide strong marketing support to promote our products,
- gain and maintain access to retail outlets with sufficient shelf space,
and
- establish relationships with prominent distributors, VARs, and OEMs.
In the PC applications market, we compete with companies that are larger
and have greater financial resources, including our primary competitors, IBM,
Lernout and Philips. Microsoft is also a significant potential competitor in
this market. As we expand into the telephony market, we will also face
competition from other large and well-capitalized companies such as AT&T, GTE
Internetworking, Lucent Technologies, Nuance Communications, Philips,
SpeechWorks International, and Voice Control Systems. If we cannot compete
successfully with these companies, we could lose our share of the market for
PC-based speech applications or may have to increase our expenses or reduce the
price of our products. In addition, we may be unable to penetrate new markets.
Any of these developments could have a material adverse effect on our future
growth or financial condition.
Microsoft Windows is the leading desktop operating system for the PC.
Microsoft defines the various software developer standards that permit
interoperability within the Windows operating system including SAPI, its speech
application interface. Our success depends, in part, on the ability of our
products to run effectively on Windows. Recently, Microsoft publicly stated its
intention to bundle SAPI and its own competitive speech recognition technology,
known as "Whisper," into future releases of Windows. In addition, in September
1998, Microsoft made SAPI 4.0, which contains Whisper, widely available to the
Microsoft Developer Network free of charge. Microsoft also has taken steps to
make the new release of SAPI more restrictive to competitors' speech recognition
technologies. This could make it more difficult for us to market innovative
products. For example, SAPI requires the use of a computer mouse to correct
errors. This feature renders useless our voice-based error correction
capabilities. As a result, if Microsoft bundles Whisper with Windows, is
successful in influencing independent software developers to use Whisper when
speech-enabling their software applications, or continues to make SAPI more
restrictive with respect to non-Microsoft speech recognition technology, we will
sell fewer products and our future financial results will be materially and
adversely affected. Similarly, if other developers of operating systems offer
speech recognition technology embedded in their operating systems, or make their
systems incompatible with our technologies, our business could suffer
significantly.
In addition to being a potential competitor, Microsoft is a significant
stockholder of Lernout, one of our primary competitors, and has a representative
on Lernout's Board of Directors. Although we cannot definitively assess the
degree of current or future cooperation between Microsoft and Lernout, we
believe that a successful coordination of their activities would have an adverse
effect on our future financial results.
We believe that our products compete favorably on the basis of performance,
quality and ease-of-use. However, many of our current and potential competitors
have significantly greater financial, technical, marketing, public relations and
distribution resources than we have. Increased competition from these companies
or new competitors, including the introduction of new or enhanced versions of
competitive products or changes in competitors' pricing policies, could
materially adversely affect the Company's business, results of operations and
financial condition.
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INTELLECTUAL PROPERTY
As of January 29, 1999, we owned 14 United States patents and had 29 United
States patent applications pending, most of which cover various aspects of our
speech recognition technology. In addition, we hold 20 registered trademarks in
the United States and abroad, including the Dragon logo. As of January 29, 1999,
we and our UK subsidiary also owned one UK patent and one European patent
granted by the European Patent Office and had 11 patent applications pending at
the European Patent Office, as well as a patent application pending in each of
France, Canada and the UK.
In September 1993, Dragon and Kurzweil Applied Intelligence settled pending
litigation by entering into two settlement and cross-license agreements.
Pursuant to one of these agreements, each party granted the other an
irrevocable, worldwide, non-exclusive, non-transferable 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.
We rely primarily on a combination of patent, copyright and trademark laws
to establish and protect our proprietary rights. We also rely on trade secret
laws, confidentiality procedures and licensing arrangements to establish and
protect our technology rights. In addition, we seek to protect our proprietary
rights through the use of confidentiality agreements with employees,
consultants, advisors and others. There can be no assurance that these
agreements will provide adequate protection for our proprietary rights in the
event of any unauthorized use or disclosure, that our employees, consultants,
advisors or others will maintain the confidentiality of such proprietary
information, or that such proprietary information will not otherwise become
known, or be independently developed, by competitors.
Despite our efforts to protect our intellectual property, unauthorized
third parties may attempt to copy aspects of our products, to violate our
patents or to obtain and use our proprietary information. A substantial portion
of our sales are derived from the licensing of Dragon products under "shrink
wrap" license agreements that are not signed by licensees and therefore may be
unenforceable under the laws of certain jurisdictions. In addition, the laws of
some foreign countries do not protect our intellectual property to the same
extent as do the laws of the United States. In addition, we do not generally
incorporate copy-protection mechanisms in our software because we do not believe
they are practical or cost-effective. Current United States laws that prohibit
software copying give us only limited practical protection from software
"pirates," and the laws or law enforcement practices of many other countries
provide almost no protection for our intellectual property. Policing
unauthorized use of our products is difficult, expensive and time-consuming and
we expect that software piracy will be a persistent problem for our desktop
software products. The loss of any material trademark, trade name, trade secret
or copyright could have a material adverse effect on our business, results of
operations and financial condition.
We do not believe that our products infringe the rights of third parties.
However, there can be no assurance that third parties will not assert
infringement claims against us in the future or that any such assertion will not
result in costly litigation or require us to obtain a license to third party
intellectual property. In addition, there can be no assurance that such licenses
will be available on reasonable terms or at all, which could have a material
adverse effect on our business, results of operations and financial condition.
Our business also includes funded research and development for certain
commercial customers and governmental agencies pursuant to which we typically
retain copyrights and other intellectual property rights associated with the
software developed. Although our contracts with those customers provide that we
retain the rights to intellectual property employed or developed by us, there
can be no assurance that customers will not assert rights in, or seek to limit
our use of, such intellectual property.
EMPLOYEES
As of December 31, 1998, we employed 316 people including 177 employees in
research and development and 88 employees in sales and marketing. None of our
employees is represented by a labor union, and we have never experienced a work
stoppage. We consider our relations with our employees to be good.
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<PAGE> 40
Our future performance depends largely upon our continuing ability to
attract and retain highly qualified scientific, technical, sales and managerial
personnel. Competition for such personnel is intense, particularly in the fields
of software engineering and research.
We believe that our dynamic, entrepreneurial and creative culture is
particularly attractive to technologists seeking new, non-traditional work
environments. We strive to maintain our competitive and creative leadership by
employing professionals with a variety of academic backgrounds including
mathematics, engineering, linguistics, physics and other disciplines.
FACILITIES
We lease approximately 81,000 square feet of office and distribution
facilities in Newton, Massachusetts under two leases that expire on November 30,
2001. We have the right to purchase our Newton, Massachusetts location under
certain circumstances. The aggregate rental expense under these leases was
approximately $1,095,000 during 1998. We also lease office space for our
employees in California, England, France and Germany. The aggregate rental
expense for such office space was approximately $41,000 during 1998. We believe
that additional space may be required as our business expands and will be
available as required on acceptable terms.
LEGAL PROCEEDINGS
In February 1996, Articulate sued Apple Computer, Inc. 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 Dragon, 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
Dragon and one of its customers, MetroBook Computer Corporation, in Virginia
alleging that the Company's Dragon NaturallySpeaking product infringed three
Apple patents.
Articulate's initial suit in Massachusetts is still pending. In Apple's
California suit, the court has granted summary judgment motions in favor of
Articulate and Dragon 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 Dragon 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. We
believe that our Dragon PowerSecretary and Dragon NaturallySpeaking products do
not infringe any of Apple's patents, but there can be no assurance that we will
prevail in these matters. Our patent counsel, Fish & Richardson P.C., based on
information known to it as of the date of this prospectus, has advised us that
we have substantial defenses in each case, but the outcome cannot be predicted.
On February 12, 1999, AllVoice Computing Plc of Devon, England filed a
lawsuit against us in the U.S. District Court for the District of Massachusetts,
which alleges infringement by Dragon of AllVoice's U.S. Patent No. 5,799,273 and
violation of Chapter 93A of the Massachusetts General Laws (that state's unfair
trade practices statute). AllVoice is seeking injunctive relief and unspecified
damages, including treble damages.
On January 26, 1999, Voice Recognition Systems, Inc. of Annapolis, Maryland
filed a lawsuit against Dragon in the Circuit Court for Anne Arundel County,
Maryland, which alleges breach of contract, misappropriation of trade secret,
conversion, unjust enrichment and fraud. The plaintiff is seeking injunctive
relief and damages.
Because these two lawsuits have only recently been commenced, we are unable
to give any assurance that we will prevail. However, based on our preliminary
review of the plaintiffs' allegations, we believe that we have meritorious
defenses in each case and that these lawsuits will not have a material adverse
effect on our financial condition or operations, although an unfavorable outcome
could adversely affect our operating results for the quarter in which the
unfavorable outcome would occur.
We are not a party to any other material legal proceedings.
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<PAGE> 41
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of Dragon, and their ages and
positions as of March 1, 1999 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Janet M. Baker....................... 51 Chairman of the Board of Directors and Chief Executive
Officer
John D. Shagoury..................... 40 President and Director
Diane M. Hudson...................... 45 Chief Financial Officer, Vice President, Finance,
Treasurer and Assistant Secretary
Kim B. Edwards(1)(2)................. 51 Director
Stephen J. Luczo(1)(2)............... 41 Director
Robert Roth.......................... 48 Principal Research Scientist and Director
Paul G. Bamberg...................... 56 Vice President
Laurence S. Gillick.................. 48 Vice President, Research
Roger Matus.......................... 44 Vice President, Marketing, North America
Jeanne F. McCann..................... 47 Vice President, Development
Tamah Solomon Rosker................. 35 Vice President, Human Resources and Secretary
Steven Semenzato..................... 36 Vice President, Channel Sales, North America
Andreas E. Widmer-Schultz............ 32 Director, International Sales and Marketing
</TABLE>
- ------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Janet M. Baker co-founded Dragon and has served as Chairman of the Board
and Chief Executive Officer since December 1998. Dr. Baker served as President
and Secretary from June 1982 until December 1998 and has served as a director
since June 1982. Prior to co-founding Dragon, Dr. Baker was a research staff
member at IBM, where she was a contributor to the Continuous Speech Research
Project, from June 1974 to January 1979, and was also Vice President of Research
at the Verbex Division of Exxon Enterprises, where she worked from January 1979
to May 1982. Dr. Baker received her B.S. and B.A. degrees from Tufts University
and her Ph.D. in Computer Science from Carnegie Mellon University.
John D. Shagoury joined Dragon in June 1998 as Chief Operating Officer, and
was promoted to President and elected Director in December 1998. Mr. Shagoury
has over 17 years of management experience in the PC software industry. From
January 1993 to June 1998 Mr. Shagoury held various senior executive positions,
most recently as President, North America, at Corporate Software & Technology,
Inc. Prior to that he held various management positions including Vice President
of Sales and Marketing for ON Technology and Director of Sales Support and
Distribution Channels at Lotus Development Corp. Mr. Shagoury received his B.S.
in Marketing and M.B.A. from Babson College.
Diane M. Hudson joined Dragon in April 1995 as Vice President, Finance, was
elected Treasurer in September 1995 and became Chief Financial Officer in April
1998 and Assistant Secretary in August 1998. From December 1988 to April 1995,
Ms. Hudson was Controller and Director of Financial Planning at MicroTouch
Systems, Inc., a leading manufacturer and distributor of touch screen systems.
Ms. Hudson received her A.S. in accounting from Becker Junior College, studied
business administration at Northeastern University, and received her M.B.A. from
Simmons Graduate School of Management.
Kim B. Edwards was elected as a Director of Dragon in December 1998. From
January 1994 to March 1998, Mr. Edwards served as President and Chief Executive
Officer of Iomega Corporation. From
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<PAGE> 42
March 1993 to December 1993, he was President and Chief Executive Officer of
Gates Energy Products, Inc., a manufacturer of rechargeable batteries and the
successor of General Electric Battery Division. From January 1987 until March
1993, Mr. Edwards served in various other executive positions for Gates Energy
Products, Inc. Prior to that, Mr. Edwards was employed for 18 years at General
Electric Company in various sales and marketing positions. He earned his B.S. in
Mechanical Engineering from Lafayette College.
Stephen J. Luczo has served as a Director since July 1994. Since October
1993, Mr. Luczo has held various executive positions with Seagate, where he
currently serves as President and Chief Executive Officer and as a member of the
Board of Directors. Prior to joining Seagate, Mr. Luczo was Senior Managing
Director of the Global Technology Group of Bear, Stearns & Co., an investment
banking firm, from February 1992 to October 1993. Mr. Luczo received his A.B.
from Stanford University and his M.B.A. from the Stanford University Graduate
School of Business.
Robert Roth has been employed as a Principal Research Scientist at Dragon,
and has served as a Director since June 1982. He received his S.B. from the
Massachusetts Institute of Technology, and his M.S. and Ph.D. from the
University of California, Berkeley.
Paul G. Bamberg joined Dragon in June 1982 as a Principal Research
Scientist and has served as Vice President since January 1994. He served as a
Director from January 1994 until December 1998. From 1967 to June 1995, Dr.
Bamberg was a faculty member of Harvard University in the physics department and
division of continuing education. He received his A.B. from Harvard College and
his D.Phil. from Oxford University, where he studied as a Rhodes Scholar.
Laurence S. Gillick joined Dragon in January 1985 as a researcher and has
served as Vice President, Research, since October 1996. Dr. Gillick taught on
the mathematics faculty of Northeastern University from 1979 and then was
Visiting Assistant Professor of Applied Mathematics at the Massachusetts
Institute of Technology from September 1981 to May 1983. Dr. Gillick received
his B.A. from Swarthmore College, his M.A. in Chemistry from Columbia
University, and his Ph.D. in Mathematics from the Massachusetts Institute of
Technology.
Roger Matus joined Dragon as Director of Marketing in May 1995 and was
promoted to Vice President, Marketing, North America, in July 1997. From January
1994 to April 1995 he was Director of Product Marketing at ATI Technologies,
Inc., a producer of personal computer boards, components, and multimedia
software. From February 1982 to December 1993 he held various positions,
including Director of Marketing, Personal Computer Business Unit at Digital
Equipment Corporation. Mr. Matus received his B.A. from Syracuse University,
M.B.A. from the University of Chicago, and his M.Sc. in Engineering from Boston
University.
Jeanne F. McCann joined Dragon in July 1998 as Vice President, Development.
From March 1997 to July 1998 she was Vice President, Development at Eastman
Software, Inc. and held various positions, including Vice President, Development
at Wang Laboratories, Inc. from February 1979 to March 1997. Ms. McCann received
her B.A. from Simmons College and her M.B.A. from Babson College.
Tamah Solomon Rosker joined Dragon in October 1994 as Director, Human
Resources and was promoted to Vice President, Human Resources in October 1998.
From June 1994 to September 1994 she was Manager, Human Resources at PerSeptive
Biosystems, Inc. and was Director, Human Resources at Kendall Square Research
from February 1992 to June 1994. She received her B.S. from Tufts University and
her J.D. from Boston College Law School.
Steven Semenzato joined Dragon as Director, North American Sales, in
February 1996 and was promoted to Vice President, Channel Sales, North America
in October 1998. From September 1992 to February 1996, Mr. Semenzato held
various positions, including North American Desktop Channel Sales Manager, from
April 1995 to February 1996, at Avid Technology, Inc. Mr. Semenzato received an
engineering degree from Staffordshire University in England.
Andreas E. Widmer-Schultz joined Dragon as Director, International Sales
and Marketing in August 1996. From July 1990 to August 1996, Mr. Widmer-Schultz
held several positions at FTP Software
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<PAGE> 43
Worldwide, Inc., including vice president in the sales and marketing area. Mr.
Widmer-Schultz received his B.S. in International Business from Merrimack
College, studied finance and accounting at the Benedict School in Lucerne,
Switzerland, and received his B.S. in Sales Management from Kaufmaennische
Schule Luzern in Lucerne, Switzerland.
See "Certain Transactions" and "Principal Stockholders" for certain
information concerning the Company's directors and executive officers.
ELECTION OF DIRECTORS
Following this offering, the Board of Directors will be divided into three
classes, each of whose members will serve for a staggered three-year term. Mr.
Luczo and Dr. Roth will serve in the class whose term expires in 2000; Messrs.
Edwards and Shagoury will serve in the class whose term expires in 2001; and Dr.
Janet Baker will serve in the class whose term expires in 2002. Upon the
expiration of the term of a class of directors, directors in such class will be
elected for three-year terms at the annual meeting of stockholders in the year
in which such term expires.
COMPENSATION OF DIRECTORS
We reimburse non-employee directors for reasonable out-of-pocket expenses
incurred in attending meetings of the Board of Directors. We may, in our
discretion, grant stock options and other equity awards to our non-employee
directors from time to time pursuant to our 1999 Stock Incentive Plan. We have
not yet determined the amount and timing of such grants or awards.
BOARD COMMITTEES
The Board of Directors has established a Compensation Committee and an
Audit Committee. The Compensation Committee, which consists of Messrs. Edwards
and Luczo, reviews executive salaries, administers our bonus, incentive
compensation and stock option plans, and approves the salaries and other
benefits of our executive officers. In addition, the Compensation Committee
consults with our management regarding our pension and other benefit plans and
compensation policies and practices.
The Audit Committee, which consists of Messrs. Edwards and Luczo, reviews
the professional services provided by our independent accountants, the
independence of such accountants from our management, our annual financial
statements and our system of internal accounting controls. The Audit Committee
also reviews such other matters with respect to our accounting, auditing and
financial reporting practices and procedures as it may find appropriate or may
be brought to its attention.
TECHNICAL ADVISORY BOARD
We plan to establish a Technical Advisory Board whose membership is
expected to include experts in basic fields of science and technology which are
relevant to our future products, such as linguistics, statistics, acoustics,
phonetics and mathematics. Dr. James K. Baker, a co-founder of Dragon, has
agreed to serve as Chairman of the Technical Advisory Board without
compensation. The other members of the Board are expected to be appointed during
the first half of 1999. It is expected that the Technical Advisory Board will
meet with our key research and development personnel at least quarterly and will
provide advice regarding future trends in technology and basic sciences.
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<PAGE> 44
EXECUTIVE COMPENSATION
The table below sets forth, for the year ended December 31, 1998, the cash
compensation earned and shares underlying options granted to (1) our former
Chief Executive Officer, (2) our current Chief Executive Officer and (3) each of
the four other most highly compensated other executive officers who received
annual compensation in excess of $100,000 collectively referred to below as the
Named Executive Officers. In accordance with the rules of the Securities and
Exchange Commission the compensation set forth in the table below does not
include medical, group life or other benefits which are available to all of our
salaried employees, and perquisites and other benefits, securities or property
which do not exceed the lesser of $50,000 or 10% of the person's salary and
bonus shown in the table. In the table below, columns required by the
regulations of the Securities and Exchange Commission have been omitted where no
information was required to be disclosed under those columns.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
------------------- SHARES ALL OTHER
NAME AND SALARY BONUS UNDERLYING COMPENSATION
PRINCIPAL POSITION ($) ($) OPTIONS(#) ($)
- ------------------------------------------------- -------- ------- ------------ ------------
<S> <C> <C> <C> <C>
James K. Baker(1)................................ $199,710 $ 8,108 70,000 $ 7,751(3)
Janet M. Baker(1)................................ 224,450 161,233 110,000 7,751(3)
Chairman of the Board of Directors and Chief
Executive Officer
John D. Shagoury(1).............................. 125,638 44,231 561,000 750(4)
President
Steven Semenzato................................. 220,367(2) 10,000 67,500 2,769(5)
Vice President, Channel Sales, North America
Laurence S. Gillick.............................. 124,566(3) 36,310 47,500 6,960(6)
Vice President, Research
Paul G. Bamberg.................................. 142,311 14,082 -- 7,807(7)
Vice President
</TABLE>
- ------------
(1) Dr. James K. Baker served as our Chief Executive Officer and Chairman of
the Board of Directors during the fiscal year ended December 31, 1997 and
resigned from such capacities effective December 1, 1998. Dr. Janet M.
Baker became our Chairman of the Board and Chief Executive Officer on
December 1, 1998 and John D. Shagoury became our President on December 1,
1998. Mr. Shagoury began his employment with us on June 15, 1998 as Chief
Operating Officer.
(2) Consists of $84,195 base salary and $136,172 sales commission.
(3) Composed of $7,751 of 401(k) matching payments.
(4) Composed of $750 of disability insurance premiums.
(5) Composed of $2,769 of 401(k) matching payments.
(6) Composed of $6,310 of 401(k) matching payments and $650 of disability
insurance premiums.
(7) Composed of $7,082 of 401(k) matching payments and $725 of disability
insurance premiums.
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<PAGE> 45
STOCK OPTIONS
The table below contains information concerning the grant of options to
purchase shares of our common stock to each of the Named Executive Officers
during the fiscal year ended December 31, 1998. The percentage of total options
granted to employees set forth below is based on an aggregate of 775,000 shares
subject to options granted to our employees in 1998. All options were granted at
or above fair market value as determined by the Board of Directors on the date
of grant.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------
PERCENT OF
NUMBER OF TOTAL POTENTIAL REALIZABLE
SECURITIES OPTIONS VALUE AT ASSUMED
UNDERLYING GRANTED TO ANNUAL RATES OF STOCK
OPTIONS EMPLOYEES IN EXERCISE OF APPRECIATION FOR OPTION TERM
GRANTED FISCAL BASE PRICE EXPIRATION ----------------------------
NAME (#) YEAR ($/SH) DATE 5%($) 10%($)
- ---- ---------- ------------ ----------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
James K. Baker............... -- -- -- -- -- --
Janet M. Baker............... -- -- -- -- -- --
John D. Shagoury............. 561,000 72.39% $16.00 6/30/08 $5,644,958 $14,305,432
Steven Semenzato............. -- -- -- -- -- --
Laurence S. Gillick.......... -- -- -- -- -- --
Paul G. Bamberg.............. -- -- -- -- -- --
</TABLE>
- ------------
(1) Amounts reported in the columns represent amounts that may be realized upon
exercise of options immediately prior to the expiration of their term
assuming the specified compounded rates of appreciation (5% and 10%) of our
common stock over the term of the options. The potential realizable values
set forth above do not take into account applicable tax and expense payments
that may be associated with such option exercises. Actual realizable value,
if any, will be dependent on the future price of the common stock on the
actual date of exercise, which may be earlier than the stated expiration
date. The 5% and 10% assumed annualized rates of stock price appreciation
over the exercise period of the options used in the table above are mandated
by the rules of the Securities and Exchange Commission and do not represent
our estimate or projection of the future price of our common stock on any
date. There is no representation either express or implied that the stock
price appreciation rates for our common stock assumed for purposes of this
table will actually be achieved.
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<PAGE> 46
FISCAL YEAR-END OPTION VALUES
The table below sets forth information for each of the Named Executive
Officers with respect to the value of options outstanding as of December 31,
1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUE
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED OPTIONS AT FISCAL YEAR-END IN-THE-MONEY OPTIONS AT
ON VALUE (#) FISCAL YEAR-END($)
EXERCISE REALIZED --------------------------- ---------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------- ---------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
James K. Baker............... -- -- 70,000 -- $938,550 $ --
Janet M. Baker............... -- -- 73,750 36,250 999,338 474,313
John D. Shagoury............. -- -- -- 561,000 -- --
Steven Semenzato............. -- -- 32,500 35,000 439,275 468,825
Laurence S. Gillick.......... 171,240 $1,207,242 26,625 26,875 271,858 338,913
Paul G. Bamberg.............. -- -- -- -- -- --
</TABLE>
There was no public trading market for our common stock as of December 31,
1998. Accordingly, as permitted by the rules of the Securities and Exchange
Commission, the value of unexercised in-the-money options at fiscal year-end has
been calculated on the basis of the fair market value of our common stock as of
December 31, 1998, of $15 per share, as determined by the Board of Directors,
less the aggregate exercise price.
EMPLOYMENT AGREEMENTS
We entered into a letter agreement with John D. Shagoury dated May 14, 1998
that sets forth the terms of Mr. Shagoury's employment with us. Under the
agreement, Mr. Shagoury's annual base salary through July 1, 1999 is fixed at
$250,000, provided, however that this amount may be increased in accordance with
normal business practice. Under the agreement, Mr. Shagoury earned a bonus of
$37,500 during 1998 and is eligible for a performance bonus of up to $150,000
for calendar 1999 and thereafter, if certain performance criteria are met. In
addition, we granted Mr. Shagoury stock options to purchase an aggregate of
561,000 shares of common stock, of which 330,000 shares are subject to incentive
stock options and 231,000 shares are subject to non-statutory options. The
exercise price of these options is $16.00 per share. The incentive stock options
will vest in four equal, annual installments. The non-statutory stock options
are exercisable at the end of seven years from the date of the agreement,
provided that, if certain performance-based criteria are met, a percentage of
such options will vest prior to the end of the seven-year vesting period. These
criteria include certain specified revenue, after-tax profit, and market
capitalization targets. Also, Mr. Shagoury is entitled to severance pay if we
terminate his employment without cause on or before December 31, 2000, as
follows: $250,000 if such termination occurs before December 31, 1999 and
one-half of his base salary as of the date of termination if such termination
occurs on or after January 1, 2000 and prior to December 31, 2000. The severance
payments are subject to Mr. Shagoury's full compliance with his non-disclosure
and non-competition agreements with us.
BENEFIT PLANS
1994 Stock Option Plan. In July 1994, our Board of Directors approved the
1994 Stock Option Plan, which provides for the grant of incentive stock options
and non-qualified stock options. An aggregate of 4,033,545 shares of common
stock (less the number of shares issuable under options granted pursuant to the
Dragon Systems UK Company Share Option Plan) are authorized to be issued
pursuant to the 1994 Stock Option Plan. As of January 29, 1999, an aggregate
number of 3,152,282 shares of common stock at a weighted
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<PAGE> 47
average exercise price of $5.21 per share were outstanding under the 1994 Stock
Option Plan. No additional option grants will be made under the 1994 Stock
Option Plan.
1999 Stock Incentive Plan. In December 1998, our Board of Directors
approved the 1999 Stock Incentive Plan. The Incentive Plan provides for the
grant of restricted stock and other stock-based awards and stock options
(collectively referred to as, "awards") for an aggregate of 3,000,000 shares of
common stock. The grant of incentive stock options under the Incentive Plan is
intended to qualify under Section 422 of the Internal Revenue Code of 1986, as
amended. During December 1998, our Board of Directors authorized the future
grant of options to acquire an aggregate of 387,440 shares of our common stock
at an exercise price of $ per share.
Our officers, employees, directors, consultants and advisors are eligible
to receive awards under the Incentive Plan; however, incentive stock options may
only be granted to employees. The maximum number of shares with respect to which
awards may be granted to any participant under the Incentive Plan may not exceed
300,000 shares in any calendar year.
Options may be granted at an exercise price which may be less than, equal
to or greater than the fair market value of the common stock on the date of
grant. Under present law, incentive stock options and options intended to
qualify as performance-based compensation under Section 162(m) of the Internal
Revenue Code may not be granted at an exercise price less than the fair market
value of the common stock on the date of grant (or less than 110% of the fair
market value in the case of incentive stock options granted to optionees holding
more than 10% of the voting power of Dragon). The Incentive Plan permits the
Board of Directors to determine the manner of payment of the exercise price of
options, including through payment by cash, check or in connection with a
"cashless exercise" through a broker, by surrender to us of shares of common
stock, by delivery to us of a promissory note, or by an combination of the
permitted forms of payment.
The Incentive Plan is administered by the Compensation Committee of the
Board of Directors. The Compensation Committee has the authority to adopt, amend
and repeal the administrative rules, guidelines and practices relating to the
Incentive Plan and to interpret its provisions. Pursuant to the terms of the
Incentive Plan, the Board of Directors may delegate authority under the
Incentive Plan to one or more committees of the Board of Directors and, subject
to certain limitations, to one or more of our executive officers. Subject to any
applicable limitations contained in the Incentive Plan, the Board of Directors,
the Compensation Committee or any other committee or executive officer to whom
the Board of Directors delegates authority, as the case may be, selects the
recipients of awards and determines:
- the number of shares of common stock covered by options and the dates
upon which such options become exercisable,
- the exercise price of options,
- the duration of options,
- the number of shares of common stock subject to any restricted stock or
other stock-based awards and the terms and conditions of such awards,
including the conditions for repurchase, issue price and repurchase
price.
In the event of a merger, liquidation or other "acquisition event" (as
defined in the Incentive Plan), the Board of Directors is authorized to provide
for outstanding options or other stock-based awards to be assumed or substituted
for by the acquiror. If the acquisition event also constitutes a "change in
control" (as defined in the Incentive Plan), (1) each outstanding option shall
become exercisable for one-half of the shares subject to each such option with
the remaining half vesting in accordance with the original vesting schedule, and
(2) restrictions on one-half of each other outstanding stock-based award shall
lapse. In addition, following an acquisition event, an assumed or substituted
award will accelerate if the employment of its holder with the acquiror is
terminated prior to the first anniversary of the acquisition event other than
"for cause" or if the holder terminates his or her employment for "good reason,"
each as defined in the Incentive Plan.
No award may be granted under the Incentive Plan after December 2008, but
the vesting and effectiveness of awards previously granted may extend beyond
that date. The Board of Directors may at any
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<PAGE> 48
time amend, suspend or terminate the Incentive Plan, except that no award
granted after an amendment of the Incentive Plan and designated as subject to
Section 162(m) of the Internal Revenue Code by the Board of Directors shall
become exercisable, realizable or vested (to the extent such amendment was
required to grant such award) unless and until such amendment is approved by our
stockholders.
Dragon Systems UK Company Share Option Plan. In 1997, our Board of
Directors approved the Dragon Systems UK Company Share Option Plan. This plan
provides for the grant of stock options in compliance with the laws of England
and Wales. The maximum number of shares of common stock issuable upon the
exercise of options granted under this plan is limited to 200,000 shares.
1999 Employee Stock Purchase Plan. Our 1999 Employee Stock Purchase Plan
was adopted by the Board of Directors in December 1998. This plan authorizes the
issuance of up to a total of 500,000 shares of common stock to participating
employees. We intend to make the Employee Stock Purchase Plan effective at or
about the time of this offering.
All of our employees, including directors who are employees, who have been
employed for more than six months are eligible to participate in the Employee
Stock Purchase Plan. Employees who would immediately after the grant own 5% or
more of the total combined voting power or value of the stock of Dragon or any
subsidiary are not eligible to participate.
The Employee Stock Purchase Plan permits eligible employees to purchase
common stock through payroll deductions, which may not exceed 10% of an
employee's compensation, subject to certain limitations. On the first day of a
designated payroll deduction period, we will grant to each eligible employee who
has elected to participate in this plan the right to purchase shares of our
common stock. On the last day of an offering period, the employee is deemed to
have exercised the option, at the purchase price, to the extent of accumulated
payroll deductions. Under the terms of this plan, the purchase price is an
amount equal to 85% of the fair market value per share of our common stock on
either the first day or the last day of an offering period, whichever is lower.
The Compensation Committee may, in its discretion, choose an offering period of
12 months or less for each of the offerings and choose a different offering
period for each offering.
An employee who is not a participant on the last day of an offering period
is not entitled to exercise his purchase right, and the amount of such
employee's accumulated payroll deductions will be refunded. An employee's rights
under the Employee Stock Purchase Plan terminate upon voluntary withdrawal from
the plan at any time, or when such employee ceases employment for any reason,
except that upon termination of employment because of death, the employee's
beneficiary has certain rights to elect to exercise the option to purchase the
shares which the accumulated payroll deductions in the participant's account
would purchase at the date of death.
401(k) Plan. Our 401(k) Profit Sharing Plan is a tax-qualified plan
covering all of our full-time U.S. employees who have met the minimum age and
service requirements. Under the 401(k) Plan, participants may elect to defer a
portion of their eligible compensation, subject to certain limitations. In
addition, at the discretion of the Board of Directors, we may make matching
contributions to the 401(k) Plan for all eligible employees. We currently match
100% of each employee's pre-tax contribution to the plan, with such matching
subject to a limit of 5% of such employee's eligible compensation. Our 401(k)
Plan provides that, at the discretion of the Board of Directors, we may make
profit sharing contributions for all of our eligible employees. Profit sharing
contributions and matching contributions currently vest in increments over a
two-year period, beginning on an employee's date of employment. We contributed
approximately $398,000 during 1996, $419,000 during 1997 and $472,000 during
1998 to our 401(k) Plan.
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<PAGE> 49
CERTAIN TRANSACTIONS
We are a party to a development and marketing agreement dated as of October
25, 1996 with Articulate and Medifax, Inc. This agreement was superseded by a
technology license agreement, dated July 7, 1998, between us and Articulate
pursuant to which we have granted Articulate a limited exclusive license to
certain of our speech technology in one field of use (radiology, emergency
medicine and cardiology) and a limited non-exclusive license in another (the
remainder of the healthcare market). At the time we entered into the technology
license agreement, we owned 49.7% of the outstanding voting securities of
Articulate. We sold our minority interest in Articulate to fonix corporation on
September 2, 1998.
We received approximately $655,000 in 1997 and $345,000 in 1996 under a
commercial development contract with Seagate Technology, which owned
approximately 38% of our outstanding capital stock prior to this offering. We
believe that this agreement was entered into on an arm's-length basis on terms
that were no less favorable to us than could have been obtained from an
unaffiliated third party. Mr. Luczo, Seagate's President and Chief Executive
Officer, has been a member of our Board of Directors since July 1994.
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<PAGE> 50
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of our common stock as of January 29, 1999 and as adjusted to reflect
the sale of the shares in this offering by (1) each person who owns beneficially
more than 5% of the outstanding shares of our common stock, (2) each of our
directors and the Named Executive Officers, and (3) all of our directors and
executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING(1) AFTER THE OFFERING(1)(2)
------------------------- -------------------------
NAME NUMBER PERCENT NUMBER PERCENT
- ---- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
James K. Baker(3)............................... 15,592,060 52.0%
Janet M. Baker(4)............................... 15,592,060 52.0
Seagate Technology, Inc.(5)..................... 11,466,130 38.3
Paul G. Bamberg................................. 1,761,340 5.9
John D. Shagoury................................ -- *
Robert Roth(6).................................. 849,650 2.8
Kim B. Edwards.................................. -- *
Stephen J. Luczo(7)............................. 11,466,130 38.3
Steven Semenzato(8)............................. 45,000 *
Laurence S. Gillick(9).......................... 196,560 *
All executive officers and directors as a group
(13 persons)(10).............................. 30,113,240 99.5
</TABLE>
- ------------
* Less than 1% of the outstanding common stock.
(1) The number of shares of common stock deemed outstanding prior to this
offering includes: 13,718,545 shares of common stock outstanding as of
January 29, 1999 and shares issuable pursuant to options held by each
person included in this table which may be exercised within 60 days after
January 29, 1999, as set forth below. The number of shares of common stock
deemed outstanding after this offering includes the shares that are
being offered for sale by us in this offering. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission, and includes voting and investment power with respect to
shares. Unless otherwise indicated below, to our knowledge, all persons
named in the table have sole voting and investment power with respect to
their shares of common stock, except to the extent authority is shared by
spouses under applicable law. Unless otherwise indicated, the address of
each person owning more than 5% of the outstanding shares of common stock
is c/o Dragon Systems, Inc., 320 Nevada Street, Newton, MA 02460.
(2) The above table assumes no exercise of the over-allotment option to
purchase up to an aggregate of shares of common stock. If the
underwriters exercise their over-allotment option in full, the following
stockholders (the "Selling Stockholders") will sell such number of
additional shares of common stock pursuant to such option and, after such
sale, will beneficially own such number of shares of common stock, that is
set forth below opposite their respective names:
<TABLE>
<CAPTION>
SHARES TO BE BENEFICIALLY
SHARES OWNED AFTER OFFERING
BEING --------------------------
NAME OFFERED NUMBER PERCENTAGE
---- ----------- ----------- -----------
<S> <C> <C> <C>
James K. Baker...............................
Janet M. Baker...............................
Paul G. Bamberg..............................
Laurence S. Gillick..........................
Robert Roth..................................
Dean Sturtevant..............................
</TABLE>
(3) Includes an aggregate of 7,797,905 shares held by Dr. Janet Baker.
(4) Includes 73,750 shares issuable pursuant to options held by Dr. Janet Baker
that may be exercised within 60 days after January 29, 1999. Also includes
an aggregate of 7,794,155 shares held by Dr. James Baker.
(5) The address of Seagate Technology, Inc. is 920 Disk Drive, Scotts Valley,
CA 95066.
48
<PAGE> 51
(6) Includes 11,875 shares issuable pursuant to options held by Dr. Roth that
may be exercised within 60 days after January 29, 1999.
(7) Includes 11,466,130 shares held by Seagate as to which Mr. Luczo disclaims
beneficial ownership.
(8) Includes 45,000 shares issuable pursuant to options held by Mr. Semenzato
that may be exercised within 60 days after January 29, 1999.
(9) Includes 20,625 shares issuable pursuant to options held by Mr. Gillick
that may be exercised within 60 days after January 29, 1999.
(10) Includes 343,150 shares of common stock issuable upon the exercise of stock
options that vest within 60 days after January 29, 1999. See notes (3)
through (9).
49
<PAGE> 52
DESCRIPTION OF CAPITAL STOCK
On the closing of this offering, our authorized capital stock will consist
of 100,000,000 shares of common stock, $.04 par value per share, and 5,000,000
shares of preferred stock, $.04 par value per share. The following is a summary
of the material features of our capital stock. For more detail, please see our
restated certificate of incorporation and restated by-laws, filed as exhibits to
the Registration Statement of which this prospectus is a part.
COMMON STOCK
As of January 29, 1999, there were 13,718,545 shares of common stock
outstanding held by 21 stockholders of record. Based upon the number of shares
outstanding as of that date, and giving effect to the issuance of the
shares of common stock offered by the Company in this offering, there will be
shares of common stock outstanding upon the closing of this offering. In
addition, as of January 29, 1999, there were outstanding stock options for the
purchase of a total of 3,152,282 shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares present
in person or by proxy at the meeting and entitled to vote in such election.
Subject to preferences that may be applicable to any outstanding preferred
stock, holders of common stock are entitled to receive ratably such dividends,
if any, as may be declared by the Board of Directors out of funds legally
available to pay dividends. Upon the liquidation, dissolution or winding up of
Dragon, the holders of common stock are entitled to receive ratably all assets
after the payment of liabilities of Dragon, subject to the prior rights of any
outstanding preferred stock. Holders of the common stock have no preemptive,
subscription, redemption or conversion rights. They are not entitled to the
benefit of any sinking fund. The outstanding shares of common stock are, and the
shares offered by us in this offering will be, when issued and paid for, validly
issued, fully paid and nonassessable. The rights, powers, preferences and
privileges of holders of common stock are subject to the rights of the holders
of shares of any series of preferred stock which we may designate and issue in
the future.
PREFERRED STOCK
On the closing of this offering, the Board of Directors will be authorized,
subject to any limitations prescribed by law, without further stockholder
approval, to issue up to an aggregate of 5,000,000 shares of preferred stock.
The preferred stock may be issued in one or more series and on one or more
occasions. Each series of preferred stock shall have such number of shares,
designations, preferences, voting powers, qualifications and special or relative
rights or privileges as the Board of Directors may determine. These rights and
privileges may include, among others, dividend rights, voting rights, redemption
provisions, liquidation preferences, conversion rights and preemptive rights.
Our stockholders have granted the Board of Directors authority to issue the
preferred stock in order to eliminate delays associated with a stockholder vote
on specific issuances. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could adversely affect the voting power or other rights of
the holders of common stock. In addition, the issuance of preferred stock could
make it more difficult for a third party to acquire us, or discourage a third
party from attempting to acquire us.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS; ANTI-TAKEOVER EFFECTS
We are subject to the provisions of Section 203 of the General Corporation
Law of Delaware. Section 203 prohibits a publicly-held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. A "business combination" includes mergers, consolidations,
asset sales and other transactions involving Dragon and an interested
stockholder. In general, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within three years did own, 15% or more
of the corporation's voting stock.
50
<PAGE> 53
Our restated certificate of incorporation and restated by-laws to be
effective on the closing of this offering provide:
- that the Board of Directors be divided into three classes, as nearly
equal in size as possible, with staggered three-year terms;
- that directors may be removed only for cause by the affirmative vote of
the holders of at least 75% of the shares of our capital stock entitled
to vote;
- that any vacancy on the Board of Directors, however occurring, including
a vacancy resulting from an enlargement of the Board, may only be filled
by vote of a majority of the directors then in office.
The classification of the Board of Directors and the limitations on the
removal of directors and filling of vacancies could have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from acquiring, us.
Our restated certificate of incorporation and restated by-laws also provide
that, after the closing of this offering:
- any action required or permitted to be taken by the stockholders at an
annual meeting or special meeting of stockholders may only be taken if it
is properly brought before such meeting and may not be taken by written
action in lieu of a meeting
- special meetings of the stockholders may only be called by the Chairman
of the Board of Directors, the President, or by the Board of Directors.
Our restated by-laws provide that, in order for any matter to be
considered "properly brought" before a meeting, a stockholder must comply
with requirements regarding advance notice to us. These provisions could
delay until the next stockholders' meeting stockholder actions which are
favored by the holders of a majority of our outstanding voting
securities. These provisions may also discourage another person or entity
from making a tender offer for our common stock, because such person or
entity, even if it acquired a majority of our outstanding voting
securities, would be able to take action as a stockholder (such as
electing new directors or approving a merger) only at a duly called
stockholders meeting, and not by written consent.
Delaware's corporation law provides generally that the affirmative vote of
a majority of the shares entitled to vote on any matter is required to amend a
corporation's certificate of incorporation or by-laws, unless a corporation's
certificate of incorporation or by-laws, as the case may be, requires a greater
percentage. Our restated certificate of incorporation requires the affirmative
vote of the holders of at least 75% of the shares of our capital stock entitled
to vote to amend or repeal any of the foregoing provisions of our restated
certificate of incorporation. Generally our restated by-laws may be amended or
repealed by a majority vote of the Board of Directors or the holders of a
majority of the shares of our capital stock issued and outstanding and entitled
to vote. To amend our restated by-laws regarding special meetings of
stockholders, written actions of stockholders in lieu of a meeting, and the
election, removal and classification of members of the Board of Directors
requires the affirmative vote of the holders of at least 75% of the shares of
our capital stock entitled to vote. The stockholder vote would be in addition to
any separate class vote that might in the future be required pursuant to the
terms of any series preferred stock that might be outstanding at the time any
such amendments are submitted to stockholders.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our restated certificate of incorporation provides that our directors and
officers shall be indemnified by us to the fullest extent authorized by Delaware
law. This indemnification would cover all expenses and liabilities reasonably
incurred in connection with their services for or on behalf of us. In addition,
our restated certificate of incorporation provides that our directors will not
be personally liable for monetary damages to us for breaches of their fiduciary
duty as directors, unless they violated their duty of loyalty to us or our
stockholders, acted in bad faith, knowingly or intentionally violated the law,
authorized illegal dividends or redemptions or derived an improper personal
benefit from their action as directors.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is BankBoston, N.A.
51
<PAGE> 54
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have shares of common
stock outstanding (assuming no exercise of outstanding options). Of these
shares, the shares ( shares if the over-allotment option is
exercised in full) to be sold in this offering will be freely tradable without
restriction or further registration under the Securities Act of 1933, as
amended, except that any shares purchased by our affiliates, as that term is
defined in Rule 144 under the Securities Act, may generally only be sold in
compliance with the limitations of Rule 144 described below.
SALES OF RESTRICTED SHARES
<TABLE>
<CAPTION>
APPROXIMATE SHARES
DAYS AFTER DATE OF ELIGIBLE FOR
THIS PROSPECTUS FUTURE SALE COMMENT
------------------ ------------------ -------
<S> <C> <C>
On effectiveness............... Freely tradeable shares sold in
offering
90 days........................ Shares saleable under Rule 144
180 days....................... Lock-up released; Shares saleable
under Rule 144 or Rule 701
Thereafter..................... Restricted securities held for one
year or less
</TABLE>
In general, under Rule 144, a person (or persons whose shares are
aggregated), including an affiliate, who has beneficially owned shares for at
least one year is entitled to sell, within any three-month period, a number of
such shares that does not exceed the greater of (1) one percent of the then
outstanding shares of common stock (approximately shares immediately
after this offering) or (2) the average weekly trading volume in the common
stock in the over-the-counter market during the four calendar weeks preceding
the date on which notice of such sale is filed, provided certain requirements
concerning availability of public information, manner of sale and notice of sale
are satisfied. In addition, our affiliates must comply with the restrictions and
requirements of Rule 144, other than the one-year holding period requirement, in
order to sell shares of common stock which are not restricted securities.
Under Rule 144(k), a person who is not an affiliate and has not been an
affiliate for at least three months prior to the sale and who has beneficially
owned shares for at least two years may resell such shares without compliance
with the foregoing requirements. In meeting the one- and two-year holding
periods described above, a holder of shares can include the holding periods of a
prior owner who was not an affiliate. The one-and two-year holding periods
described above do not begin to run until the full purchase price or other
consideration is paid by the person acquiring the shares from the issuer or an
affiliate. Rule 701 provides that currently outstanding shares of common stock
acquired under our employee compensation plans may be resold beginning 90 days
after the date of this prospectus (1) by persons, other than affiliates, subject
only to the manner of sale provisions of Rule 144, and (2) by affiliates under
Rule 144, and by affiliates under Rule 144 without compliance with its one-year
minimum holding period, subject to certain limitations.
STOCK OPTIONS
At January 29, 1999, approximately 1,212,541 shares of common stock were
issuable pursuant to vested options or pursuant to other rights granted under
our 1994 Stock Option Plan of which approximately 308,835 shares are not subject
to Lock-up Agreements with the Underwriters.
We intend to file one or more registration statements on Form S-8 under the
Securities Act following the date of this prospectus, to register up to
3,943,380 shares of common stock subject to outstanding stock options or other
rights granted pursuant to our 1994 Stock Option Plan and our UK Company Share
Option Plan as of January 29, 1999, including the 1,212,603 shares of common
stock subject to options vested as of January 29, 1999, and 2,730,777 shares of
common stock issuable pursuant to our 1994 Stock Option Plan and our UK Company
Share Option Plan. These registration statements are expected to become
effective upon filing.
52
<PAGE> 55
LOCK-UP AGREEMENTS
Subject to certain exceptions, we and our executive officers, directors,
the selling stockholders in this offering and other Dragon securityholders have
agreed that, without the prior written consent of Morgan Stanley & Co.
Incorporated, none of us will, during the period ending 180 days after the date
of this prospectus, (1) offer, pledge, sell, contract to sell, sell any option
or contract to purchase, purchase any option or contract to sell, grant any
option, right or warrant to purchase, lend, or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities convertible
into or exercisable or exchangeable for common stock (regardless of whether such
shares or any such securities are then owned by such person or are thereafter
acquired), or (2) enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership of
the common stock, regardless of whether any such transactions described in
clauses (1) or (2) of this paragraph are to be settled by delivery of such
common stock or such other securities, in cash or otherwise. In addition, for a
period of 180 days from the date of this prospectus, except as required by law,
we have agreed that our Board of Directors will not consent to any offer for
sale, sale or other disposition, or any transaction which is designed or could
be expected, to result in, the disposition by any person, directly or
indirectly, of any shares of common stock without the prior written consent of
Morgan Stanley & Co. Incorporated. See "Underwriters."
REGISTRATION RIGHTS
We and Seagate Technology are parties to an amended and restated
registration rights agreement dated September 4, 1997. Under the terms of this
agreement, Seagate is entitled to certain demand registration rights regarding
the registration of its shares under the Securities Act after the closing of
this offering, subject to certain limitations and restrictions. Under the terms
of the agreement, we are not required to effect any additional registrations
upon demand after we have effected two such registrations and such registrations
have been declared or ordered effective. In addition, we are not required to
effect a registration within six months after the closing of this offering. We
are also not required to effect more than one demand registration in any
six-month period. The agreement also grants Seagate piggyback registration
rights, subject to conditions, with respect to the registration of its shares
under the Securities Act. In the event that we propose to register any shares of
common stock under the Securities Act, either for ourself or other
securityholders, the agreement provides that Seagate is entitled to receive
notice of the registration, and has the right to include its shares in that
registration, subject to certain limitations. Under the terms of the agreement,
we are not required to effect more than one piggyback registration in any
six-month period. Further, the agreement provides that Seagate may require us to
file up to an aggregate of three registration statements under the Securities
Act on Form S-3 with respect to our shares, subject to certain limitations. We
are not required to effect such a registration on Form S-3 within one year of
the closing of this offering or for a period 60 days prior to or six months
following the effective date of other registration statements we may file.
Further we are not required to effect more than one such registration on Form
S-3 in any six month period. The various registration rights provided under the
agreement are subject to conditions and limitations, including the right of the
underwriters of an offering to limit the number of shares of common stock held
by securityholders with registration rights to be included in such registration.
Other than registrations on Form S-3 requested to be filed by Seagate, we are
generally required to bear all of the expenses of all registrations, except
underwriting discounts, commissions, and stock transfer taxes. Seagate shall
bear all of the expenses of any demand registration on Form S-3 requested to be
filed by Seagate. Registration of any of the shares of common stock held by
securityholders with registration rights would result in such shares becoming
freely tradable without restriction under the Securities Act upon effectiveness
of such registration.
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<PAGE> 56
UNDERWRITERS
Under the terms and subject to the conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Hambrecht & Quist LLC and SG Cowen
Securities Corporation are acting as representatives, have severally agreed to
purchase, and we have agreed to sell to them, severally, the respective number
of shares of common stock set forth opposite the names of such underwriters
below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- ---- ----------------
<S> <C>
Morgan Stanley & Co. Incorporated...........................
Hambrecht & Quist LLC.......................................
SG Cowen Securities Corporation.............................
--------
Total..................................................
========
</TABLE>
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from us and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of common stock offered in this offering are
subject to the approval of certain legal matters by their counsel and to certain
other conditions. The underwriters are obligated to take and pay for all the
shares of common stock offered in this offering (other than those covered by the
over-allotment option described below) if any such shares are taken.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the cover
page of this prospectus and part to certain dealers at a price that represents a
concession not in excess of $ a share under the public offering price. Any
underwriter may allow, and such dealers may reallow, a concession not in excess
of $ a share to other underwriters or to certain dealers. After the initial
offering of the shares of common stock, the offering price and other selling
terms may from time to time be varied by the representatives.
The selling stockholders have granted the underwriters an option,
exercisable for 30 days from the date of this prospectus, to purchase up to an
aggregate of additional shares of common stock at the public offering
price set forth on the cover page of this prospectus, less underwriting
discounts and commissions. The underwriters may exercise this option solely for
the purpose of covering over-allotments, if any, made in connection with this
offering. To the extent such option is exercised, each underwriter will become
obligated, subject to certain conditions, to purchase approximately the same
percentage of such additional shares of common stock as the number set forth
next to such underwriter's name in the preceding table bears to the total number
of shares of common stock set forth next to the names of all underwriters in the
preceding table. If the underwriters' option is exercised in full, the total
price to the public would be $ , the total underwriters' discounts and
commissions would be $ , and total proceeds to us would be $ .
At our request, the underwriters have reserved up to shares of
the common stock offered in this offering for sale at the initial public
offering price to our employees, consultants, business associates and related
persons. The number of shares of common stock available for sale to the general
public will be reduced to the extent such persons purchase such reserved shares.
Any reserved shares not so purchased will be offered by the underwriters to the
general public on the same basis as the other shares offered in this prospectus.
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<PAGE> 57
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares of
common stock offered by them.
Our common stock has been approved for quotation, subject to official
notice of issuance, on the Nasdaq National Market under the symbol "DRGN."
We and our executive officers, directors, selling stockholders and certain
other of our securityholders have each agreed that none of us will, during the
period ending 180 days after the date of this prospectus:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend, or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock
(regardless of whether such shares or any such securities are then owned
by such person or are thereafter acquired), or
- enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the
common stock,
regardless of whether any such transactions described above are to be settled by
delivery of such common stock or such other securities, in cash or otherwise.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering, if the syndicate repurchases previously
distributed common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the common stock above independent market
levels. The underwriters are not required to engage in these activities, and may
end any of these activities at any time.
From time to time, certain of the underwriters have provided, and may
continue to provide, investment banking services to us.
We, the selling stockholders and the underwriters have agreed to indemnify
each other against certain liabilities, including liabilities under the
Securities Act.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock. The initial public offering price will be determined by negotiations
among us and the representatives of the underwriters. Among the factors to be
considered in determining the initial public offering price will be our future
prospects and those of our industry in general; our net sales, earnings and
certain other financial and operating information in recent periods; and the
price-earnings ratios, certain other ratios, and market prices of securities and
certain financial and operating information of companies engaged in activities
similar to ours. The estimated initial public offering price range set forth on
the cover page of this preliminary prospectus is subject to change as a result
of market conditions and other factors.
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<PAGE> 58
LEGAL MATTERS
The validity of the shares of common stock we are offering will be passed
upon for us by Hale and Dorr LLP, Boston, Massachusetts. Certain legal matters
in connection with this offering will be passed upon for the underwriters by
Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts.
EXPERTS
Our Consolidated Financial Statements and Financial Statement Schedule as
of December 31, 1997 and December 31, 1998 and for the three years in the period
ended December 31, 1998 included in this prospectus and elsewhere included in
the Registration Statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
The statements in the prospectus in the first two paragraphs under the
caption "Business -- Intellectual Property" and the first two paragraphs under
the caption "Business -- Legal Proceedings" have been reviewed and approved by
Fish & Richardson P.C., our patent counsel, as experts on patent matters, and
are included herein in reliance upon that review and approval and the authority
of such counsel as experts in patent law.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, a registration
statement on Form S-1 under the Securities Act with respect to the common stock
we propose to sell in this offering. This prospectus, which constitutes part of
the registration statement, does not contain all of the information set forth in
the registration statement. For further information about us and the common
stock we propose to sell in this offering, we refer you to the registration
statement and the exhibits and schedules filed as a part of the registration
statement. Statements contained in this prospectus as to the contents of any
contract or other document filed as an exhibit to the registration statement are
not necessarily complete. If a contract or document has been filed as an exhibit
to the registration statement, we refer you to the copy of the contract or
document that has been filed. The registration statement may be inspected
without charge at the principal office of the Securities and Exchange Commission
in Washington, D.C. and copies of all or any part of which may be inspected and
copied at the public reference facilities maintained by the Securities and
Exchange Commission at 450 Fifth Street, N.W., Judiciary Plaza, Room 1024,
Washington, D.C. 20549, and at the Commission's regional offices located at
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511 and 7 World Trade Center, Suite 1300, New York, New York 10048.
Copies of such material can also be obtained at prescribed rates by mail from
the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. In addition, the Securities and Exchange Commission
maintains a website (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Securities and Exchange Commission.
56
<PAGE> 59
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Stockholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 60
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Dragon Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Dragon
Systems, Inc. and subsidiaries as of December 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company'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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our 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, 1997 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
January 29, 1999
(except for the matter
discussed in Note 9(b),
as to which the date is
February 12, 1999)
F-2
<PAGE> 61
DRAGON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PROFORMA
(NOTE 2C)
1997 1998 1998
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 4,894 $ 4,911 $ 4,911
Investments, available-for-sale........................... 7,427 3,932 3,932
Accounts receivable, net of allowance for bad debt of $813
and $925................................................ 2,501 12,592 12,592
Unbilled revenues......................................... 968 352 352
Inventories............................................... 2,162 7,827 7,827
Refundable income taxes................................... 570 545 545
Prepaid expenses and other current assets................. 482 1,583 1,583
Deferred tax assets....................................... 2,809 4,482 4,482
------- ------- -------
Total current assets.................................... 21,813 36,224 36,224
------- ------- -------
Property and equipment, net................................. 1,373 1,994 1,994
Other assets................................................ -- 207 207
------- ------- -------
Total assets............................................ $23,186 $38,425 $38,425
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,615 $ 7,979 $ 7,979
Accrued expenses.......................................... 2,745 5,029 5,029
Income taxes payable...................................... 453 10 10
Deferred revenue.......................................... 24 40 40
Net liabilities of a discontinued operation............... 2,495 -- --
------- ------- -------
Total current liabilities............................... 8,332 13,058 13,058
------- ------- -------
Commitments and contingencies (Note 8)
Stockholders' equity:
Convertible preferred stock, $.04 par value; 5,000,000
shares authorized; 3,207,598 and 3,238,951 shares issued
and outstanding; none issued and outstanding proforma
(preference in liquidation: $64,779).................... 128 130 --
Common stock, $.04 par value; 45,000,000 shares
authorized; 13,483,120 and 13,635,805 shares issued and
outstanding; 100,000,000 shares authorized and
29,830,560 shares issued and outstanding proforma
(preference in liquidation: $18,545).................... 539 545 1,193
Additional paid-in capital................................ 30,975 31,041 30,523
Retained deficit.......................................... (16,718) (6,432) (6,432)
Accumulated other comprehensive income.................... (70) 83 83
------- ------- -------
Total stockholders' equity.............................. 14,854 25,367 25,367
------- ------- -------
Total liabilities and stockholders' equity.............. $23,186 $38,425 $38,425
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 62
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Net revenue:
Software licenses......................................... $11,479 $19,506 $65,665
Development contracts..................................... 5,559 7,315 5,732
------- ------- -------
Total net revenue...................................... 17,038 26,821 71,397
------- ------- -------
Cost of revenue:
Cost of software licenses................................. 3,465 5,394 18,586
Cost of development contracts............................. 3,582 4,993 3,275
------- ------- -------
Total cost of revenue.................................. 7,047 10,387 21,861
------- ------- -------
Gross profit........................................... 9,991 16,434 49,536
------- ------- -------
Operating expenses:
Research and development.................................. 7,983 9,577 14,056
Selling and marketing..................................... 5,403 9,350 23,698
General and administrative................................ 1,940 2,485 4,378
------- ------- -------
Total operating expenses............................... 15,326 21,412 42,132
------- ------- -------
Operating income (loss)..................................... (5,335) (4,978) 7,404
Interest, net............................................. 520 511 629
------- ------- -------
Income (loss) from continuing operations before income
taxes................................................. (4,815) (4,467) 8,033
Provision for (benefit from) income taxes................... (564) (2,190) 2,387
------- ------- -------
Income (loss) from continuing operations............... (4,251) (2,277) 5,646
------- ------- -------
Gain (loss) on discontinued operations:
Loss from operations................................... (1,706) (3,019) (2,142)
Gain on sale, net of taxes of $1,420................... -- -- 6,782
------- ------- -------
Gain (loss) on discontinued operations................. (1,706) (3,019) 4,640
------- ------- -------
Net income (loss)...................................... $(5,957) $(5,296) $10,286
======= ======= =======
Earnings per share:
Income (loss) from continuing operations:
Basic.................................................. $ (.36) $ (.18) $ .42
Diluted................................................ $ (.36) $ (.18) $ .18
Gain (loss) from discontinued operations:
Basic.................................................. $ (.14) $ (.24) $ .34
Diluted................................................ $ (.14) $ (.24) $ .14
Net income (loss):
Basic.................................................. $ (.50) $ (.43) $ .76
Diluted................................................ $ (.50) $ (.43) $ .32
Weighted average shares outstanding:
Basic.................................................. 11,922 12,460 13,624
Diluted................................................ 11,922 12,460 31,964
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 63
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ACCUMULATED
----------------- ------------------ ADDITIONAL OTHER TOTAL
NUMBER OF PAR NUMBER OF PAR PAID-IN RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES VALUE SHARES VALUE CAPITAL DEFICIT INCOME EQUITY
--------- ----- ---------- ----- ---------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1995...................... 2,830,962 $113 11,897,225 $476 $18,115 $(5,465) $ (9) $13,230
Exercise of stock options
and units............... 16,387 1 68,895 3 20 24
Net loss.................. (5,957) (5,957)
Foreign currency
translation
adjustment.............. (5) (5)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income......
Balance, December 31,
1996...................... 2,847,349 114 11,966,120 479 18,135 (11,422) (14) 7,292
Exercise of stock options
and units............... 510 -- 5,010 -- 4 4
Issuance of convertible
preferred stock and
common stock............ 359,739 14 1,511,990 60 11,926 12,000
Issuance of subsidiary
stock................... 910 910
Net loss.................. (5,296) (5,296)
Foreign currency
translation
adjustment.............. (56) (56)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income......
Balance, December 31,
1997...................... 3,207,598 128 13,483,120 539 30,975 (16,718) (70) 14,854
Exercise of stock options
and units............... 31,353 2 152,685 6 66 74
Net income................ 10,286 10,286
Unrealized gain on
investments,
available-for-sale...... 179 179
Foreign currency
translation
adjustment.............. (26) (26)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income......
Balance, December 31,
1998...................... 3,238,951 $130 13,635,805 $545 $31,041 $(6,432) $ 83 $25,367
========= ==== ========== ==== ======= ======== ==== =======
<CAPTION>
COMPREHENSIVE
INCOME
-------------
<S> <C>
Balance, December 31,
1995......................
Exercise of stock options
and units...............
Net loss.................. $(5,957)
Foreign currency
translation
adjustment.............. (5)
-------
Comprehensive income...... (5,962)
Balance, December 31,
1996......................
Exercise of stock options
and units...............
Issuance of convertible
preferred stock and
common stock............
Issuance of subsidiary
stock...................
Net loss.................. (5,296)
Foreign currency
translation
adjustment.............. (56)
-------
Comprehensive income...... (5,352)
Balance, December 31,
1997......................
Exercise of stock options
and units...............
Net income................ 10,286
Unrealized gain on
investments,
available-for-sale...... 179
Foreign currency
translation
adjustment.............. (26)
-------
Comprehensive income...... $10,439
Balance, December 31,
1998......................
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 64
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $(5,957) $ (5,296) $ 10,286
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Depreciation and amortization............................. 1,919 970 890
Gain on sale of discontinued operations................... -- -- (6,782)
Deferred income taxes..................................... -- (2,594) (1,673)
Changes in operating assets and liabilities:
Accounts receivable..................................... 1,119 (1,503) (10,091)
Unbilled receivables.................................... (563) 333 616
Inventories............................................. (58) (1,681) (5,665)
Refundable income taxes................................. (697) 836 25
Prepaid expenses and other current assets............... (143) (38) (1,101)
Accounts payable........................................ 285 1,902 5,364
Accrued expenses........................................ 742 307 2,284
Deferred revenues....................................... (52) 24 16
Income taxes payable.................................... 347 418 (1,864)
Discontinued operations................................. 1,506 (140) 1,719
------- -------- --------
Net cash used in operating activities................... (1,552) (6,462) (5,976)
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets................................... (660) (1,003) (1,515)
Purchases of investments, available-for-sale................ (3,296) (8,418) (2,383)
Maturities and sales of investments, available-for-sale..... 1,963 4,287 7,623
Cash from sale of discontinued operations................... -- -- 2,230
Additions to capitalized software costs..................... (538) -- --
Other assets................................................ 60 17 (14)
------- -------- --------
Net cash provided by (used in) investing activities..... (2,471) (5,117) 5,941
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible preferred stock and
common stock.............................................. 24 12,004 74
Proceeds from issuance of subsidiary preferred stock........ -- 910 --
------- -------- --------
Total cash provided by financing activities............. 24 12,914 74
------- -------- --------
Foreign exchange impact on cash and cash equivalents........ (4) (57) (22)
------- -------- --------
Net increase (decrease) in cash and cash equivalents........ (4,003) 1,278 17
Cash and cash equivalents, beginning of period.............. 7,619 3,616 4,894
------- -------- --------
Cash and cash equivalents, end of period.................... $ 3,616 $ 4,894 $ 4,911
======= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for (refunds received from) income taxes........ $ (68) $ (872) $ 5,909
======= ======== ========
Cash paid for interest.................................... $ -- $ -- $ 12
======= ======== ========
SUPPLEMENTAL DISCLOSURE OF NON CASH 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.
F-6
<PAGE> 65
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. THE COMPANY
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.
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) Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of income and expenses during the reporting
periods. Operating results in the future could vary from the amounts derived
from management's estimates and assumptions.
(c) Proforma Presentation
The Company's Convertible Preferred Stock is convertible into a total of
16,194,755 shares of common stock upon the Company's initial public offering
currently in process. The proforma unaudited balance sheet as of December 31,
1998 reflects the conversion of the Convertible Preferred Stock. In addition,
upon the closing of the Company's initial public offering, the Company will have
100,000,000 shares of common stock authorized for issuance.
(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 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) Revenue Recognition
The Company sells its products predominantly through major distributors to
retail channel accounts and VARs and directly to 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 product sold directly to end users at the time of
shipment. Purchases of the Company's products are evidenced by 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. Revenue from royalty fees
is recognized upon the shipment of units by the OEM.
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
F-7
<PAGE> 66
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
completion of the related work and attainment of milestones are recorded as
deferred revenue. Unbilled revenue represents revenue recognized in excess of
amounts billed.
The Company has historically provided customers with free technical support
services for a ninety-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 financial statements.
(f) 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.
For the years ended December 31, 1997 and 1998, no software development
costs were capitalized, as the amounts expended subsequent to reaching
technological feasibility were immaterial. In 1996, approximately $538 of
software development costs were capitalized. Amortization expense for the years
ended 1996, 1997 and 1998 were $1,007, $174 and $0, respectively. Net
capitalized software costs are included in other assets in the accompanying
balance sheet.
(g) 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 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.
(h) Net Income (Loss) per Share
All earnings per share information presented has been calculated in
accordance with SFAS No. 128, "Earnings Per Share." Under SFAS 128, basic net
income (loss) per common share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted income (loss) per common share is computed
using the weighted average number of common shares and common stock equivalent
shares outstanding during the periods in accordance with the treasury stock
method.
F-8
<PAGE> 67
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
\A reconciliation between basic and diluted earnings per share is as follows for
the three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Net income (loss)....................................... $ (5,957) $ (5,296) $ 10,286
Basic EPS:
Basic common shares................................... 11,922,261 12,460,192 13,624,191
Basic EPS............................................. $ (.50) $ (.43) $ .76
Diluted EPS:
Basic common shares................................... 11,922,261 12,460,192 13,624,191
Plus: convertible preferred stock..................... -- -- 16,189,172
Plus: impact of stock options......................... -- -- 2,150,801
----------- ----------- -----------
Diluted common shares................................. 11,922,261 12,460,192 31,964,164
----------- ----------- -----------
Diluted EPS........................................... $ (.50) $ (.43) $ .32
----------- ----------- -----------
</TABLE>
For the years ended 1996 and 1997, convertible preferred stock which is
convertible into 14,184,585 and 14,823,265 weighted average shares of common
stock, respectively, was outstanding but not included in the calculation of
dilutive net income (loss) per share because their effect would be antidilutive.
In addition, options to purchase 2,125,875; 2,883,385 and 698,500 shares of
common stock were outstanding in the years ended 1996, 1997 and 1998,
respectively, but were not included in the calculation of dilutive net income
(loss) per share because their effect would be antidilutive.
(i) 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 balance sheets. The investments available-for-sale are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1997 1998
--------------- ---------------
COST MARKET COST MARKET
------ ------ ------ ------
<S> <C> <C> <C> <C>
U.S. government and government agency securities... $6,891 $6,891 $1,990 $1,990
Corporate securities............................... 536 536 198 198
fonix Class A common stock......................... -- -- 1,565 1,744
------ ------ ------ ------
Total investments.................................. $7,427 $7,427 $3,753 $3,932
====== ====== ====== ======
</TABLE>
Investments in U.S. government and government agency and corporate
securities mature within one year.
(j) 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 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,
F-9
<PAGE> 68
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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.
(k) Major Customers
The Company's sales to the United States government under contracts were
approximately 25%, 27% and 6% of net revenue for the years ended December 31,
1996, 1997 and 1998, respectively. At December 31, 1997 and 1998, total amounts
due from the United States government were approximately $943 and $653,
respectively (including unbilled amounts of approximately $916 and $352,
respectively).
The Company's sales to its two largest distributors were approximately 40%
and 22%, respectively, of net revenue for 1998. At December 31, 1998, total
amounts included in accounts receivable from the two distributors were
approximately $5,565 and $2,034, net of allowances. For the years ended December
31, 1996 and 1997, no customer accounted for 10% or more of net revenues.
(l) 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.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1998
------ ------
<S> <C> <C>
Component parts............................................. $ 756 $3,173
Finished goods.............................................. 1,406 4,654
------ ------
$2,162 $7,827
====== ======
</TABLE>
(m) 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:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- DEPRECIABLE
1997 1998 LIFE IN YEARS
------ ------ ---------------------
<S> <C> <C> <C>
Furniture and fixtures............................. $ 580 $ 623 3-5
Office and computer equipment...................... 4,262 5,803 3-5
Leasehold improvements and other................... 613 697 3-10 or term of lease
------ ------
5,455 7,123
Less: accumulated depreciation and amortization.... 4,082 5,129
------ ------
$1,373 $1,994
====== ======
</TABLE>
F-10
<PAGE> 69
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(n) Accrued Expenses
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1998
------ ------
<S> <C> <C>
Compensation................................................ $ 840 $3,027
Marketing costs............................................. 356 457
Other....................................................... 1,549 1,545
------ ------
$2,745 $5,029
====== ======
</TABLE>
(o) Recent Accounting Pronouncements
In March, 1998 the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective
for the year ended December 31, 1999. SOP 98-1 provides guidance for the costs
of computer software developed or obtained for internal use. The Company does
not expect adoption of SOP 98-1 to have a material impact on its consolidated
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities." The statement is
effective for the year ended December 31, 2000. SFAS 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 AICPA issued 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.
(p) Stock-Based Compensation
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company has elected to continue to account for stock options at intrinsic
value under Accounting Principles Board Opinion (APB) No. 25 with disclosure of
the effects of fair value accounting on the net income and earnings per share on
a pro forma basis (see Note 7).
(q) Advertising Expenses
Advertising expenses are charged to operations as incurred. Total
advertising expenses included in the accompanying statements of operations were
$436, $1,486 and $9,180 in 1996, 1997 and 1998, respectively.
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
F-11
<PAGE> 70
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
then represented 38% of Articulate's outstanding voting securities, to fonix
corporation. 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 has fully reserved the value of the notes as part of
the gain on sale from the Articulate stock. To the extent that the notes are
collected in the future, the Company would recognize a gain. See also Note 8 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 three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Net sales................................................... $ 1,829 $ 770 $ 329
Loss before income taxes.................................... (1,706) (3,019) (2,142)
Loss from discontinued operations........................... (1,706) (3,019) (2,142)
</TABLE>
4. CREDIT FACILITY
In December 1998, the Company entered into an agreement with a bank
providing for a domestic credit facility of up to $6 million. This credit
facility can be used for revolving loans and letters of credit. The actual
amounts available under this credit facility will be determined using an
accounts receivable based borrowing formula. This credit facility is secured by
domestic inventory and accounts receivable and bears interest at the bank's
prime rate of interest. There was no outstanding balance on the credit facility
at December 31, 1998.
5. INCOME TAXES
The provision for income taxes consists of the following for the three
years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
----- ------- -------
<S> <C> <C> <C>
Current provision:
Federal................................................... $(599) $ 341 $ 3,438
State..................................................... -- 35 585
Foreign................................................... 35 28 37
----- ------- -------
Total current............................................. $(564) $ 404 $ 4,060
----- ------- -------
Deferred provision:
Federal................................................... $ -- $(2,205) $(1,420)
State..................................................... -- (389) (253)
Foreign................................................... -- -- --
----- ------- -------
Total deferred............................................ $ -- $(2,594) $(1,673)
----- ------- -------
Total tax provision......................................... $(564) $(2,190) $ 2,387
===== ======= =======
</TABLE>
F-12
<PAGE> 71
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Reconciliations of the U.S. federal statutory rate to the Company's
effective tax rate are as follows for the three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- ----
<S> <C> <C> <C>
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............................... (27.8) -- (7.0)
Tax credits generated....................................... -- 7.6 (4.6)
Other, net.................................................. (.5) 1.4 1.2
----- ----- ----
Effective tax rate.......................................... 11.7% 49.0% 29.6%
===== ===== ====
</TABLE>
The temporary differences and carryforwards that created the deferred tax
assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1998
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss and credit carryforward................ $ 755 $ --
Deferred revenues......................................... 2,813 3,849
Non deductible reserves and accruals...................... 1,186 1,825
Other..................................................... 39 208
------- -------
Total deferred tax assets......................... 4,793 5,882
Valuation allowance....................................... (1,984) (1,400)
------- -------
Net deferred taxes.......................................... $ 2,809 $ 4,482
------- -------
</TABLE>
The net tax benefits have been reduced by a valuation allowance as they do
not satisfy the recognition criteria set forth in SFAS 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, 1998, the Company had no net operating loss
carryforwards or credit carryforwards available for federal or state income
taxes.
6. STOCKHOLDERS' EQUITY
Convertible Preferred Stock
At December 31, 1998, the Company had 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 initial public
offering 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 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 votes equal to the
number of shares of common stock into which the shares of Convertible Preferred
Stock could 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.
F-13
<PAGE> 72
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
During 1997, the Company recorded $910 of additional paid in capital
resulting from Articulate's issuance of preferred stock.
Common Stock
At December 31, 1998, the Company had 20,220,875 shares of its common stock
reserved for issuance upon conversion of Convertible Preferred Stock 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.
7. EMPLOYEE BENEFIT PLANS
Stock Option Plans
In June 1984, the Company adopted the 1984 Stock Option Plan (the "1984
Plan") and upon its expiration 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. At December 31, 1998, the total number of
shares available under all of the Company's stock option plans is 4,026,120.
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 granted cannot exceed
ten years. No options have been granted under the 1984 Plan since its expiration
in 1994.
F-14
<PAGE> 73
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The activity under the Company's stock option plans is as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
---------------------------
WEIGHTED
RESERVED AVERAGE
SHARES NUMBER EXERCISE PRICE
--------- --------- --------------
<S> <C> <C> <C>
Outstanding, December 31, 1995.......................... 3,299,910 1,229,250 $1.36
Granted............................................... -- 832,500 1.40
Exercised............................................. -- --
Terminated............................................ -- (229,000) 1.36
--------- --------- -----
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............................................. (29,925) (20,925) 2.78
Terminated............................................ -- (107,941) 2.45
--------- --------- -----
Outstanding, December 31, 1998.......................... 4,026,120 3,241,084 $5.12
========= ========= =====
</TABLE>
The above table reflects options for common stock. In addition, at December
31, 1995 the Company had 6,625 options which 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 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, 1998,
all options to acquire units had been exercised.
As of December 31, 1998, the status of the Company's outstanding and
exercisable options was as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- -------------- ----------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 1.36 - $ 1.55 1,717,586 7.19 $ 1.38 1,103,357 $ 1.38
$ 2.30 - $ 2.55 25,000 8.27 $ 2.35 6,250 $ 2.35
$ 3.18 - $ 3.50 723,498 8.75 $ 3.18 185,736 $ 3.19
$ 7.20 - $ 7.20 41,500 9.17 $ 7.20 -- $ --
$10.00 - $10.00 35,000 9.33 $10.00 -- $ --
$16.00 - $17.00 698,500 9.66 $16.03 -- $ --
- --------------- --------- ---- ------ --------- ------
$ 1.36 - $17.00 3,241,084 8.29 $ 5.12 1,295,343 $ 1.65
</TABLE>
F-15
<PAGE> 74
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
As reported........................................... $(5,957) $(5,296) $10,286
Pro forma............................................. (6,081) (5,524) 9,539
</TABLE>
Consistent with SFAS 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 $.45, $.90, and
$4.21 for options granted during 1996, 1997 and 1998, 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:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Risk free interest rate................................. 6.58% 6.09% 5.51%
Expected life........................................... 6 years 6 years 6 years
Volatility factor....................................... 0% 0% 0%
Expected dividend yield................................. 0% 0% 0%
</TABLE>
1999 Plans
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 participating
employees.
All employees of the Company, including the Company's employee-directors,
who have been employed for more than six months are eligible to participate in
the Purchase Plan. Employees who would immediately after the grant own 5% or
more of the total combined voting power or value of the stock of the Company or
any subsidiary are not eligible to participate.
The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions, which may not exceed 10% of an employee's
compensation, subject to certain limitations. On the first day of a designated
payroll deduction period (the "Offering Period"), the Company will grant to each
eligible employee who has elected to participate in the Purchase Plan an option
to purchase shares of common stock. On the last day of the Offering Period, the
employee is deemed to have exercised the option, at the option exercise price,
to the extent of accumulated payroll deductions. Under the terms of the Purchase
Plan, the option price is an amount equal to 85% of the fair market value per
share of the common stock on either the first day or the last day of the
Offering Period, whichever is lower. The Compensation Committee may, in its
discretion, choose an Offering Period of 12 months or less for each of the
Offerings and choose a different Offering Period for each Offering.
1999 Stock Incentive Plan
In December 1998, the Company approved the 1999 Stock Incentive Plan
(Incentive Plan). The plan provides for the granting of an aggregate of
3,000,000 shares issuable pursuant to incentive stock options, non qualified
stock options, restricted stock awards and other stock based awards. As of
December 31, 1998, no awards were granted under the Incentive Plan.
F-16
<PAGE> 75
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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 $789,
$762 and $2,615 in fiscal 1996, 1997 and 1998, respectively.
8. 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 entities.
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.
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.
Financial Information
The following table reflects certain financial information relating to each
reportable segment for the three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
SEGMENT DATA: ------- ------- -------
<S> <C> <C> <C>
Net revenue from external customers:
Software licensing........................................ $11,479 $19,506 $65,665
Development contracts..................................... 5,559 7,315 5,732
------- ------- -------
Total net revenue......................................... $17,038 $26,821 $71,397
======= ======= =======
</TABLE>
Contribution towards selling, marketing, general and administrative for the
three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Software licensing........................................ $ 31 $ 4,535 $33,023
Development contracts..................................... 1,977 2,322 2,457
------- ------- -------
Total contribution........................................ $ 2,008 $ 6,857 $35,480
======= ======= =======
</TABLE>
F-17
<PAGE> 76
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Depreciation and amortization expense included in the determination of
contribution for the three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Software licensing........................................ $ 1,355 $ 422 $ 253
Development contracts..................................... 145 110 56
------- ------- -------
Total depreciation and amortization....................... $ 1,500 $ 532 $ 309
======= ======= =======
</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>
DECEMBER 31,
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Software licensing........................................ $ 1,536 $ 4,368 $20,281
Development contracts..................................... 1,244 1,538 857
Unallocated assets........................................ 10,333 17,280 17,287
------- ------- -------
Total assets.............................................. $13,113 $23,186 $38,425
======= ======= =======
</TABLE>
GEOGRAPHIC DATA:
Net revenue from external customers for the three years ended December 31:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
United States............................................. $12,148 $22,750 $62,324
Rest of world............................................. 4,890 4,071 9,073
------- ------- -------
Total net revenue......................................... $17,038 $26,821 $71,397
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Total assets:
United States............................................. $12,752 $22,816 $38,038
Rest of world............................................. 361 370 387
------- ------- -------
Total assets.............................................. $13,113 $23,186 $38,425
======= ======= =======
</TABLE>
Net reveune from external customers has been attributed to a geographical
area based on the location of the customer.
9. 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, 1998 are as
follows:
<TABLE>
<S> <C>
1999........................................................ $1,195
2000........................................................ 1,167
2001........................................................ 1,054
2002........................................................ 13
2003 and thereafter......................................... 9
------
Total minimum lease payments................................ $3,438
======
</TABLE>
Total rental expense for years ended 1996, 1997 and 1998 was $731, $1,053,
and $1,166, respectively.
F-18
<PAGE> 77
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(b) Contingencies
In February 1996, Articulate 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 Dragon, 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
Dragon and one of its customers, MetroBook, in Virginia, alleging that the
Company's Dragon NaturallySpeaking product infringed three Apple patents.
Articulate's initial suit in Massachusetts is still pending. 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 $200,000 in 1996, $1,749,000 in 1997
and $774,000 in 1998.
In connection with the Articulate sale to fonix, the Company has agreed to
jointly defend the pending lawsuit in Massachusetts 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 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.
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.
Because these two lawsuits have only recently been 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.
10. PATENT SETTLEMENT
In September 1993, the Company and Kurzweil Applied Intelligence
("Kurzweil") settled pending litigation by entering into two settlement and
cross-license 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.
F-19
<PAGE> 78
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In consideration for the license, the Company recorded software license
revenue in the amounts of $902, $1,019 and $1,151 during the years ended
December 31, 1996, 1997 and 1998, respectively. In addition, Kurzweil is
required to pay $1,301 and $1,470 during the years ended December 31, 1999 and
2000, 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
$13,539 from 1999 through 2006.
11. RELATED PARTY
Approximately $345 and $655 of net revenue for the years ended 1996 and
1997, respectively, represent amounts earned under a commercial development
contract with the holder of 38% of the Company's outstanding common stock on an
as converted basis as of December 31, 1998. Management believes that the
contract represents fair value to the Company and was negotiated on an
arm's-length basis.
F-20
<PAGE> 79
[Description for Inside Back Cover]
Text: Dragon Systems
The National Speech Company [TM]
Graphic: Picture of a sample of awards won
by Dragon Systems products.
Text: Internationally recognized as a leader
in speech technology.
<PAGE> 80
DRAGON SYSTEMS LOGO
<PAGE> 81
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than the
underwriting discount, payable by the Registrant in connection with the sale of
common stock being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fees and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $27,800.00
NASD filing fee............................................. 10,500.00
Nasdaq National Market listing fee..........................
Printing and engraving expenses.............................
Legal fees and expenses.....................................
Accounting fees and expenses................................
Blue Sky fees and expenses (including legal fees)...........
Transfer agent and registrar fees and expenses..............
Miscellaneous...............................................
Total..................................................
</TABLE>
The Company will bear all expenses shown above.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Registrant's Amended and Restated Certificate of Incorporation (the
"Restated Certificate") provides that, except to the extent prohibited by the
Delaware General Corporation Law (the "DGCL"), the Registrant's directors shall
not be personally liable to the Registrant or its stockholders for monetary
damages for any breach of fiduciary duty as directors of the Registrant. Under
the DGCL, the directors have a fiduciary duty to the Registrant which is not
eliminated by this provision of the Restated Certificate and, in appropriate
circumstances, equitable remedies such as injunctive or other forms of
nonmonetary relief will remain available. In addition, each director will
continue to be subject to liability under the DGCL for breach of the director's
duty of loyalty to the Registrant, for acts or omissions which are found by a
court of competent jurisdiction to be not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are prohibited by the DGCL. This provision
also does not affect the directors' responsibilities under any other laws, such
as the federal securities laws or state or federal environmental laws. The
Registrant has obtained liability insurance for its officers and directors.
Section 145 of the DGCL empowers a corporation to indemnify its directors
and officers and to purchase insurance with respect to liability arising out of
their capacity or status as directors and officers, provided that this provision
shall not eliminate or limit the liability of a director: (i) for any breach of
the director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) arising under Section 174 of the DGCL including
for an unlawful payment of dividend or unlawful stock purchase or redemption, or
(iv) for any transaction from which the director derived an improper personal
benefit. The DGCL provides further that the indemnification permitted thereunder
shall not be deemed exclusive of any other rights to which the directors and
officers may be entitled under the corporation's by-laws, any agreement, a vote
of stockholders or otherwise. The Restated Certificate eliminates the personal
liability of directors to the fullest extent permitted by the DGCL and, together
with the Registrant's Amended and Restated By-Laws (the "Restated By-Laws"),
provides that the Registrant shall fully indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding (whether civil, criminal, administrative or
investigative) by reason of the fact that such person is or was a director or
officer of the
II-1
<PAGE> 82
Registrant, or is or was serving at the request of the Registrant as a director
or officer of another corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise, against expenses (including attorney's fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by such person in connection with such action, suit or proceeding. Reference is
made to the Registrant's Form of Amended and Restated Certificate of
Incorporation and Form of Amended and Restated By-Laws filed as Exhibits 3.2 and
3.4 hereto, respectively.
The Underwriting Agreement provides that the Underwriters are obligated,
under certain circumstances, to indemnify directors, officers and controlling
persons of the Company against certain liabilities, including liabilities under
the Securities Act of 1933, as amended (the "Act"). Reference is made to the
form of Underwriting Agreement to be filed as Exhibit 1.1 hereto.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent as to which indemnification will be
required or permitted under the Restated Certificate. The Registrant is not
aware of any threatened litigation or proceeding that may result in a claim for
such indemnification.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In the three years preceding the filing of this registration statement, the
Company has issued the following securities that were not registered under the
Securities Act as summarized below. The share information provided below
reflects a 5-for-1 split of the common stock effected on December 1, 1998:
(a) Issuances of Capital Stock. On September 4, 1997 the Company sold to
Seagate Technology, Inc. (i) an aggregate of 1,511,990 shares of the Company's
common stock for $4,805,104 and (ii) an aggregate of 359,739 shares of the
Company's preferred stock for $7,194,780 (convertible into 1,798,695 shares of
common stock).
(b) Certain Grants and Exercises of Stock Options. The Company's 1994 Stock
Option Plan was adopted by the Board of Directors and approved by the
stockholders of the Company on July 6, 1994. The Company's 1999 Stock Incentive
Plan was approved by the Board of Directors in December 1999, subject to
stockholder approval. As of January 29, 1999, options to purchase 106,529 shares
of common stock had been exercised for a consideration of approximately $166,000
under the Company's 1994 Stock Option Plan and options to purchase 3,112,282
shares of common stock were outstanding under the Company's 1994 Stock Option
Plan. As of January 29, 1999, no options under the Company's UK Plan and options
to purchase 40,000 shares of common stock were outstanding under the UK Plan. No
options to purchase shares of common stock are outstanding under the 1999 Stock
Incentive Plan.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options to purchase common stock, Rule 701 of the
Securities Act. All of the foregoing securities are deemed restricted securities
for the purposes of the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S> <C>
1.1* -- Form of Underwriting Agreement
3.1 -- Restated Certificate of Incorporation of the Registrant, as
amended
3.2** -- Form of Amended and Restated Certificate of Incorporation of
the Registrant, to be filed prior to the closing of this
offering
3.3** -- Amended and Restated By-Laws of the Registrant
3.4** -- Form of Amended and Restated By-Laws of the Registrant, to
be effective upon the closing of this offering
</TABLE>
II-2
<PAGE> 83
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S> <C>
4.1 -- Specimen common stock certificate
4.2** -- See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the
Restated Certificate of Incorporation and Amended and
Restated By-Laws of the Registrant defining the rights of
holders of common stock of the Registrant
5.1* -- Opinion of Hale and Dorr LLP
10.1** -- 1994 Stock Option Plan
10.2** -- Dragon Systems UK Company Share Option Plan
10.3** -- 1999 Employee Stock Purchase Plan
10.4** -- 1999 Stock Incentive Plan
10.5** -- 401(k) Plan
10.6** -- Lease dated February 1, 1991 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.7** -- Lease dated September 15, 1994 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.8+** -- Corel Reciprocal License Agreement dated effective January
25, 1998 between and among Corel Corporation, Corel
Corporation Limited, and the Registrant
10.9+** -- Dragon Reciprocal License Agreement dated effective January
25, 1998 between and among the Registrant and Corel
Corporation and Corel Corporation Limited
10.10+** -- Technology License Agreement dated effective July 7, 1998
between Articulate Systems, Inc. and the Registrant
10.11+** -- Development and License Agreement dated effective June 28,
1996 between Seagate Technology, Inc. and the Registrant
10.12+** -- Distribution Agreement dated effective December 15, 1997
between Ingram Micro Inc. and the Registrant, as amended
10.13+** -- Distribution Agreement dated effective April 30, 1998
between Ingram European Coordination Center N.V./S.A. and
the Registrant
10.14+** -- Distributor Agreement executed January 7, 1998 between
Merisel Americas, Inc. and the Registrant
10.15+** -- Authorized Distributor Agreement dated March 18, 1998
between MultiMicro, Inc. and the Registrant
10.16+** -- Software Distribution Agreement dated June 16, 1997 between
Tech Data Product Management, Inc. and the Registrant, as
amended
10.17+** -- Outsourcing Agreement dated January 19, 1998 between Modus
Media International N.V. and the Registrant
10.18+** -- Reseller Agreement dated May 15, 1998 between Sony
Electronics Inc. and the Registrant
10.19** -- Employment Agreement with John D. Shagoury
10.20** -- Agreement dated as of December 24, 1998 between the
Registrant and Fleet Bank N.A.
21** -- Subsidiaries of the Registrant
23.1 -- Consent of Arthur Andersen LLP
23.2* -- Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.3 -- Consent of Fish & Richardson P.C.
24.1 -- Powers of Attorney (see page II-5)
27.1** -- Financial Data Schedule
</TABLE>
- -------------------------
* To be filed by amendment.
** Previously filed.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.
II-3
<PAGE> 84
(b) Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have been
omitted.
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the Underwriter
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriter to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the registrant pursuant to the Delaware General
Corporation Law, the Restated Certificate of the registrant, the Underwriting
Agreement, or otherwise, the registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act, and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered hereunder, the registrant
will, unless in the opinion of counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
The undersigned registrant hereby undertakes that:
(1) For purpose of determining any liability under the Act, the information
omitted from the form of prospectus filed as part of this Registration
Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4),
or 497(h) under the Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be
deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 85
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Newton, Massachusetts, on this 4th
day of March, 1999.
DRAGON SYSTEMS, INC.
By: /s/ JANET M. BAKER
---------------------------------------
Janet M. Baker
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers, directors and authorized representatives of
Dragon Systems, Inc. hereby severally constitute and appoint Dr. Janet M. Baker,
Mr. John D. Shagoury, and Ms. Diane M. Hudson, and each of them singly, our true
and lawful attorneys with full power to them, and each of them singly, with full
powers of substitution and resubstitution, to sign for us and in our names in
the capacities indicated below, the Registration Statement on Form S-1 filed
herewith and any and all pre-effective and post-effective amendments to said
Registration Statement, and any subsequent Registration Statement for the same
offering which may be filed under Rule 462(b), and generally to do all such
things in our names and on our behalf in our capacities as officers and
directors to enable Dragon Systems, Inc. to comply with the provisions of the
Securities Act of 1933, as amended, and all requirements of the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our said attorneys, or any of them, or their substitute or
substitutes, to said Registration Statement and any and all amendments thereto
or to any subsequent Registration Statement for the same offering which may be
filed under Rule 462(b).
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* Chairman of the Board of Directors and March 4, 1999
- ------------------------------------------ Chief Executive Officer (Principal
Janet M. Baker Executive Officer)
* President and Director March 4, 1999
- ------------------------------------------
John D. Shagoury
* Chief Financial Officer, Vice March 4, 1999
- ------------------------------------------ President, Finance, Treasurer, and
Diane M. Hudson Assistant Secretary (Principal
Financial Officer and Principal
Accounting Officer)
* Principal Research Scientist and March 4, 1999
- ------------------------------------------ Director
Robert Roth
* Director March 4, 1999
- ------------------------------------------
Kim B. Edwards
* Director March 4, 1999
- ------------------------------------------
Stephen J. Luczo
</TABLE>
*By: /s/ JANET M. BAKER
-------------------------
Janet M. Baker
Attorney-in-Fact
II-5
<PAGE> 86
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of Dragon Systems, Inc. and subsidiaries
included in this Registration Statement and have issued our report thereon dated
January 29, 1999 (except for the matter discussed in Note 9(b), as to which the
date is February 12, 1999). Our audits were made for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
schedule listed in the accompanying index is the responsibility of the company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic consolidated financial statements and, in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic consolidated financial statements taken
as a whole.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 29, 1999
S-1
<PAGE> 87
DRAGON SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS BALANCE AT
BEGINNING OF CHARGED TO END OF
PERIOD EXPENSE DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
For the years ended December 31,
1998..................................... $ 813 $ 745 $ (633) $ 925
1997..................................... 381 533 (101) 813
1996..................................... 410 60 (89) 381
Reserve for returns, allowances and other:
For the years ended December 31,
1998..................................... $5,500 $1,048 $(4,835) $1,713
1997..................................... 360 5,140 -- 5,500
1996..................................... 240 120 -- 360
</TABLE>
S-2
<PAGE> 88
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S> <C>
1.1* -- Form of Underwriting Agreement
3.1 -- Restated Certificate of Incorporation of the Registrant, as
amended
3.2** -- Form of Amended and Restated Certificate of Incorporation of
the Registrant, to be filed prior to the closing of this
offering
3.3** -- Amended and Restated By-Laws of the Registrant
3.4** -- Form of Amended and Restated By-Laws of the Registrant, to
be effective upon the closing of this offering
4.1 -- Specimen common stock certificate
4.2** -- See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the
Restated Certificate of Incorporation and Amended and
Restated By-Laws of the Registrant defining the rights of
holders of common stock of the Registrant
5.1* -- Opinion of Hale and Dorr LLP
10.1** -- 1994 Stock Option Plan
10.2** -- Dragon Systems UK Company Share Option Plan
10.3** -- 1999 Employee Stock Purchase Plan
10.4** -- 1999 Stock Incentive Plan
10.5** -- 401(k) Plan
10.6** -- Lease dated February 1, 1991 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.7** -- Lease dated September 15, 1994 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.8+** -- Corel Reciprocal License Agreement dated effective January
25, 1998 between and among Corel Corporation, Corel
Corporation Limited, and the Registrant
10.9+** -- Dragon Reciprocal License Agreement dated effective January
25, 1998 between and among the Registrant and Corel
Corporation and Corel Corporation Limited
10.10+** -- Technology License Agreement dated effective July 7, 1998
between Articulate Systems, Inc. and the Registrant
10.11+** -- Development and License Agreement dated effective June 28,
1996 between Seagate Technology, Inc. and the Registrant
10.12+** -- Distribution Agreement dated effective December 15, 1997
between Ingram Micro Inc. and the Registrant, as amended
10.13+** -- Distribution Agreement dated effective April 30, 1998
between Ingram European Coordination Center N.V./S.A. and
the Registrant
10.14+** -- Distributor Agreement executed January 7, 1998 between
Merisel Americas, Inc. and the Registrant
10.15+** -- Authorized Distributor Agreement dated March 18, 1998
between MultiMicro, Inc. and the Registrant
10.16+** -- Software Distribution Agreement dated June 16, 1997 between
Tech Data Product Management, Inc. and the Registrant, as
amended
10.17+** -- Outsourcing Agreement dated January 19, 1998 between Modus
Media International N.V. and the Registrant
10.18+** -- Reseller Agreement dated May 15, 1998 between Sony
Electronics Inc. and the Registrant
10.19** -- Employment Agreement with John D. Shagoury
10.20** -- Agreement dated as of December 24, 1998 between the
Registrant and Fleet Bank N.A.
21** -- Subsidiaries of the Registrant
23.1 -- Consent of Arthur Andersen LLP
23.2* -- Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.3 -- Consent of Fish & Richardson P.C.
</TABLE>
<PAGE> 89
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -------- -----------
<C> <S> <C>
24.1 -- Powers of Attorney (see page II-5)
27.1** -- Financial Data Schedule
</TABLE>
- -------------------------
* To be filed by amendment.
** Previously filed.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.
<PAGE> 1
Exhibit 3.1
RESTATED CERTIFICATE OF INCORPORATION
OF
DRAGON SYSTEMS, INC.
(PURSUANT TO SECTIONS 242 & 245)
Dragon Systems, Inc., a corporation (the "Corporation") organized and
existing under and by virtue of the General Corporation Law of the State of
Delaware (the "GCL"), hereby certifies as follows:
FIRST: The name of the corporation is dragon Systems, Inc.
SECOND: The date on which the initial Certificate of
Incorporation of the Corporation was filed with the secretary of State of the
State of Delaware is June 24, 1982, under the name Dragon Systems, Inc.
THIRD: The Board of Directors of the Corporation, pursuant to
the GCL, adopted resolutions amending, integrating and restating the Certificate
of Incorporation to read in full as set forth in the Restated Certificate of
Incorporation attached hereto as Exhibit A.
FOURTH: Pursuant to resolutions of the Board of Directors, the
Restated Certificate of Incorporation was thereafter submitted to the
stockholders of the Corporation for their approval, which approval was given by
written consent of the stockholders pursuant to Section 228 of the GCL.
IN WITNESS WHEREOF, the Corporation has caused this Certificate to be
signed and attested by its duly authorized officers, this 6th day of July, 1994.
DRAGON SYSTEMS, INC.
/s/ Janet M. Baker
----------------------------------------
Janet M. Baker,
President
ATTEST:
/s/ Robert Goldberg
- -----------------------------
By: Robert Goldberg
--------------------------
Title: Assistant Secretary
-----------------------
<PAGE> 2
RESTATED CERTIFICATE OF
INCORPORATION OF
DRAGON SYSTEMS, INC.
Article I
The name of the Corporation is Dragon Systems, Inc.
Article II
The address of the Corporation's registered office in the State of
Delaware is 1209 Orange Street, Corporation Trust Center, in the City of
Wilmington, County of New Castle. The name of its registered agent at such
address is The Corporation Trust Company.
Article III
The nature of the business or purposes to be conducted or promoted is
as follows:
To develop, manufacture, market, sell, lease and otherwise dispose of,
and trade or deal in and with, speech processing equipment, systems and services
of every type and description.
To conduct or engage in any lawful act or activity for which
corporations may be organized under the General Corporation Law of Delaware.
Article IV
The Corporation is authorized to issue two classes of stock, designated
"Common Stock" and "Preferred Stock." The total number of shares which the
Corporation is authorized to issue is 15,000,000. The number of shares of Common
Stock which the Corporation is authorized to issue is 10,000,000, par value $.04
per share. The number of shares of Preferred Stock which the Corporation is
authorized to issue is 4,000,000, par value $.04 per share.
The Corporation shall from time to time in accordance with the laws of
the State of Delaware increase the authorized amount of its Common Stock if at
any time the number of shares of Common Stock remaining unissued and available
for issuance shall not be sufficient to permit conversion of the Preferred
Stock.
-2-
<PAGE> 3
The relative rights, preferences, privileges and restrictions granted
to or imposed upon the Preferred Stock and the Common Stock or the holders
thereof are as follows:
Section 1. Dividends. The holders of the Preferred Stock shall be
entitled to receive, when and as declared by the Board of Directors, dividends
at the rate of $1.60 per share per annum, payable quarterly as the Board of
Directors may from time to time determine out of funds legally available
therefor. No dividends (other than those payable solely in the Common Stock of
the corporation) shall be paid on any Common Stock of the Corporation during any
fiscal year of the Corporation until dividends in the total amount of $1.60 per
share on the Preferred Stock shall have been paid or declared and set apart
during that fiscal year. The right to such dividend on shares of Preferred Stock
shall not be cumulative, and no right shall accrue to holders of Preferred Stock
by reason of the fact that dividends on said shares are not declared in any
prior year.
After payment of such dividends any additional dividends declared shall
be distributed among all the holders of Preferred Stock and all holders of
Common Stock in proportion to the number of shares of Common Stock which would
be held by each such holder if all shares of Preferred Stock were converted into
Common Stock at the then effective Conversion Price (as defined in Section 4
below).
Section 2. Liquidation Preference. In the event of any liquidation,
dissolution, or winding up of the Corporation, either voluntary or involuntary,
distributions to the shareholders of the Corporation shall be made in the
following manner:
(a) The holders of the Preferred Stock shall be entitled to
receive, prior and in preference to any distribution of any of the assets or
surplus funds of the Corporation to the holders of the Common Stock by reason of
their ownership of such stock, the amount equal to the sum of (i) $20.00 per
share for each share of Preferred Stock then held by them, and (ii) an amount
equal to all declared but unpaid dividends on the Preferred Stock. If the assets
and funds thus distributed among the holders of the Preferred Stock pursuant to
this Section 2(a) shall be insufficient to permit the payment to such holders of
the full aforesaid preferential amount, then the entire assets and funds of the
Corporation legally available for distribution shall be distributed ratably
among the holders of the Preferred Stock in proportion to the preferential
amount that each such holder is otherwise entitled to receive.
(b) After payment has been made to the holders of the
Preferred Stock of the full amounts to which they shall be entitled as set forth
in the first sentence of this Section 2(a), then the holders of the Common Stock
shall be entitled to receive the amount equal to the sum of (i) $6.78 per share
for each share of Common Stock held by them, and (ii) an amount equal to all
declared but unpaid
-3-
<PAGE> 4
dividends on the Common Stock. If the assets and funds thus distributed among
the holders of the Common Stock pursuant to this Section 2(b) shall be
insufficient to permit the payment to such holders of the full aforesaid
preferential amount, then the entire assets and funds of the Corporation legally
available for distribution pursuant to this Section 2(b) shall be distributed
ratably among the holders of the Common Stock in proportion to the preferential
amount that each such holder is otherwise entitled to receive.
(c) After payment has been made to the holders of the
Preferred Stock of the full amounts to which they shall be entitled as set forth
in Section 2(a) above and after payment has been made to the holders of the
Common Stock of the full amounts to which they shall be entitled as set forth in
Section 2(b) above, then the entire remaining assets and funds of the
Corporation legally available for distribution, if any, shall be distributed on
a pro rata basis on the outstanding Common Stock and Preferred Stock (with the
outstanding Preferred Stock sharing in such distribution on an as-converted into
Common Stock basis).
(d) For purposes of this Section 2, a merger or consolidation
of the Corporation with or into any other corporation or corporations, or the
merger of any other corporation or corporations into the Corporation (other than
any merger or consolidation in which shareholders of the Corporation immediately
prior to such merger or consolidation beneficially own a majority of the voting
shares of the surviving corporation immediately following such merger or
consolidation), or a sale of all o substantially all of the assets of the
Corporation, shall be treated as a liquidation, dissolution or winding up of the
Corporation.
(e) Any securities to be delivered to the holders of the
Preferred Stock and Common Stock upon merger, reorganization or sale of
substantially all of the assets of the Corporation shall be valued as follows:
(1) if traded on a securities exchange or on the
NASDAQ National Market System, the value shall be deemed to be the average of
the closing prices of the securities on such exchange over the ten business day
period ending three (3) business days prior to the closing;
(2) if actively traded over-the-counter, the value
shall be deemed to be the average of the closing bid prices over the ten
business day period ending three (3) business days prior to the closing; and
(3) if there is no active public market, the value
shall be the fair market value thereof as mutually determined by the Corporation
and the holders of not less than a majority of the outstanding shares of
Preferred Stock voting as a single class, provided that if the Corporation and
the holders of a majority of the outstanding shares of Preferred Stock are
unable to reach agreement, then by
-4-
<PAGE> 5
independent appraisal by an investment banker hired and paid by the Corporation,
but acceptable to the holders of a majority of the outstanding shares of
Preferred Stock voting as a single class.
Section 3. Consent for Certain Repurchases of Common Stock Deemed to be
Distributions. Each holder of an outstanding share of Preferred Stock shall be
deemed to have consented, for purposes of Section 228 of the Delaware General
Corporation Law, to distributions made by the Corporation in connection with the
repurchase of shares of Common Stock at cost issued to or held by officers,
directors, employees or consultants upon termination of their employment or
services pursuant to agreements approved by the Board of Directors of the
Corporation.
Section 4. Conversion. The holders of the Preferred Stock shall have
conversion rights as follows (the "Conversion Rights").
(a) Right to Convert. Each share of Preferred Stock shall be
convertible, at the option of the holder thereof, at any time after the date of
issuance of such share, at the office of the Corporation or any transfer agent,
into such number of fully paid and nonassessable shares of Common Stock, as is
determined by dividing $20.00 by the Conversion Price, determined as hereinafter
provided, in effect at the time of conversion. The price at which shares of
Common Stock for each share of Preferred Stock. Such initial Conversion Price
shall be subject to adjustment as hereinafter provided.
Upon conversion, all declared and unpaid dividends on the Preferred
Stock shall be paid either in cash or in shares of Common Stock of the
Corporation, at the election of the Company. For purposes of such payments,
shares of Common Stock shall be valued at the fair market value at the time of
such conversion, as determined by the Board of Directors of the Corporation.
(b) Automatic Conversion. Each share of Preferred Stock shall
automatically be converted into shares of Common Stock, at the then effective
Conversion Price upon the closing of a firm commitment underwritten public
offering pursuant to an effective registration statement on Form S-1 or any
successor form under the Securities Act of 1933, as amended, covering the offer
and sale of Common Stock for the account of the Corporation to the public at a
price which results in aggregate net cash proceeds to the Company in excess of
$10,000,000. In the event of the automatic conversion of the Preferred Stock
upon a public offering as set forth herein, the person(s) entitled to receive
the Common Stock issuable upon such conversion of Preferred Stock shall not be
deemed to have converted such Preferred Stock until immediately prior to the
closing of such sale of securities.
(c) Mechanics of Conversion. No fractional shares of Common
Stock shall be issued upon conversion of the Preferred Stock. In lieu of any
fractional share
-5-
<PAGE> 6
to which the holder would otherwise be entitled, the Conversion shall (after
aggregating all shares into which shares of Preferred Stock held by each holder
could be converted) pay cash equal to such fraction multiplied by the then
effective Conversion Price. Before any holder or Preferred Stock shall be
entitled to convert the same into full shares of Common Stock and to receive
certificates therefor, the holder shall surrender the certificate of
certificates therefor, duly endorsed, at the office of the Corporation or of any
transfer agent, and shall give written notice to the Corporation at such office
that the holder elects to convert the same; provided, however, that in the event
of an automatic conversion pursuant to Section 3(b), the outstanding shares of
Preferred Stock shall be converted automatically without any further action by
the holders of such shares and whether or not the certificates representing such
shares are surrendered to the Corporation or its transfer agent, and provided
further, that the Corporation shall not be obligated to issue certificates
evidencing the shares of Common Stock issuable upon such automatic conversion
unless the certificates evidencing such shares of Preferred Stock are either
delivered to the Corporation or its transfer agent as provided above, or the
holder notifies the Corporation or its transfer agent that such certificates
have been lost, stolen or destroyed and executes an agreement satisfactory to
the Corporation to indemnify the Corporation from any loss incurred by it in
connection with such certificates. The Corporation shall, as soon as practicable
after such delivery, or such agreement and indemnification in the case of a lost
certificate, issue and deliver at such office to such holder of Preferred stock,
a certificate or certificates for the number of shares of Common Stock to which
the holder shall be entitled as aforesaid and a check payable to the holder in
the amount of any cash amounts payable as the result of a conversion into a
fractional share of Common Stock. Such conversion shall be deemed to have been
made immediately prior to the close of business on the date of such surrender of
the shares of Preferred to be converted, or in the case of automatic conversion
on the date of closing of the offering or the effective date of such written
consent, and the person or persons entitled to receive the shares of Common
Stock issuable upon such conversion shall be treated for all purposes as the
record holder or holders of such shares of Common Stock on such date.
(d) Adjustment of Conversion Price of Preferred Stock. The
Conversion Price shall be subject to adjustment from time to time as follows:
(1) Adjustments for Subdivisions, Combinations or
Consolidation of Common Stock. Following the date this Restated Certificate of
Incorporation is filed with the Secretary of State of the State of Delaware, in
the event the outstanding shares of Common Stock shall be subdivided by stock
split, stock dividends or otherwise, into a greater number of shares of Common
Stock, the Conversion Price then in effect shall, concurrently with the
effectiveness of such subdivision, be proportionately decreased. In the event
the outstanding shares of Common stock shall be combined or consolidated, by
reclassification or otherwise, into a lesser number of shares of Common Stock,
the conversion Price then in effect
-6-
<PAGE> 7
shall, concurrently with the effectiveness of such combination of consolidation,
be proportionately increased.
(2) Adjustments for Stock Dividends and Other
Distributions. In the event the Corporation at any time or from time to time
makes, or fixes a record date for the determination of holders of Common stock
entitled to receive any distribution (excluding any repurchases of securities by
the Corporation not made on a pro rata basis from all holders of any class of
the Corporation's securities) payable in property or in securities of the
Corporation other than shares of Common Stock, and other than as otherwise
adjusted in this Section 4 or as provided in Section 1, then and in each such
event the holders of Preferred Stock shall receive at the time of such
distribution, the amount of property or the number of securities of the
Corporation that they would have received had their Preferred Stock been
converted into Common Stock on the date of such event.
(3) Adjustments for Reclassification, Exchange and
Substitution. Except as provided in Section 2 upon any liquidation, dissolution
or winding up of the Corporation, if the Common Stock issuable upon conversion
of the Preferred Stock shall be changed into the same or a different number of
shares of any other class or classes of stock, whether by capital
reorganization, reclassification or otherwise (other than a subdivision or
combination of shares provided for above), each share of property to which a
holder of the number of shares of Common Stock of the Corporation deliverable
upon conversion of such share of Preferred Stock shall have been entitled upon
such reorganization or reclassification.
(e) No Impairment. The Corporation will not, by amendment of
its Certificate of Incorporation or through any reorganization, transfer of
assets, consolidation, merger, dissolution, issue or sale of securities or any
other voluntary action, avoid or seek to avoid the observance or performance of
any of the terms to be observed or performed hereunder by the Corporation but
will at all times in good faith assist in the carrying out of all the provisions
of this Section 4 and in the taking of all such action as may be necessary or
appropriate in order to protect the Conversion Rights of the holders of the
Preferred Stock against impairment.
(f) Certificate as to Adjustments. Upon the occurrence of each
adjustment or readjustment of the Conversion Price pursuant to this Section 4,
the Corporation at its expense shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and furnish to each holder of
Preferred Stock a certificate setting forth such adjustment or readjustment and
showing in detail the facts upon which such adjustment or readjustment is based.
The Corporation shall, upon the written request at any time of any holder of
Preferred Stock, furnish or cause to be furnished to such holder a like
certificate setting forth (i) such adjustments and readjustments, (ii) the
Conversion Price at the time in effect, and
-7-
<PAGE> 8
(iii) the number of shares of Common Stock and the amount, if any, of other
property which at the time would be received upon the conversion of Preferred
Stock.
(g) Notices of Record Date. In the event that the Corporation
shall propose at any time:
(i) to declare any dividend or distribution upon its
Common Stock, whether in cash, property, stock or other securities, whether or
not a regular cash dividend and whether or not out of earnings or earned
surplus;
(ii) to offer for subscription pro rata to the holder
of any class or series of its stock any additional shares of stock of any class
or series or other rights;
(iii) to effect any reclassification or
recapitalization of its Common Stock outstanding involving a change in the
Common Stock; or
(iv) to merge or consolidate with or into any other
corporation, or sell, lease or convey all or substantially all its property or
business, or to liquidate, dissolve or wind up;
then, in connection with each such event,
the Corporation shall send to the holders of the Preferred Stock:
(1) at least 20 days' prior written notice
of the date on which a record shall be taken for such dividend, distribution or
subscription rights (and specifying the date on which the holders of Common
Stock shall be entitled thereto) or for determining rights to vote in respect of
the matters referred to in (iii) and (iv) above; and
(2) in the case of the matters referred to
in (iii) and (iv) above, at least 20 days' prior written notice of the date when
the same shall take place (and specifying the date on which the holders of
Common Stock shall be entitled to exchange their Common Stock for securities or
other property deliverable upon the occurrence of such event).
Each such written notice shall be delivered personally or given by
first class mail, postage prepaid, addressed to the holder of Preferred Stock at
the address for each such holder as shown on the books of the Corporation.
Section 5. Voting Rights. Except as otherwise required by law or by
Section 6 or by Article V hereof, the holder of each share of Common stock
issued and outstanding shall have one vote with respect to such share and the
holder of each share of Preferred Stock shall be entitled with respect to such
share to a number of
-8-
<PAGE> 9
votes equal to the number of shares of Common Stock into which such share of
Preferred Stock could be converted at the record date for determination of the
shareholders entitled to vote on such matters, or, if no such record date is
established, at the dates such vote is taken or any written consent of
shareholders is solicited, such votes to be counted together with all other
shares of stock of the Company having general voting power and not separately as
a class (except as required by Section 2 or Section 6 or by the General
Corporation Law of Delaware). Holders of Common Stock and Preferred Stock shall
be entitled to notice of any stockholders' meeting in accordance with the Bylaws
of the Corporation. Fractional votes by the holders of Preferred Stock shall
not, however, be permitted and any fractional voting rights shall (after
aggregating all shares into which shares of Preferred Stock held by each holder
could be converted) be rounded to the nearest whole number.
Section 6. Covenants. In addition to any other rights provided by law,
so long as any Preferred Stock shall be outstanding, the Corporation shall not,
without first obtaining the affirmative vote or written consent of the holders
of not less than seventy-five and one-tenth percent (75.1%) of the then
outstanding shares of the Preferred Stock create any new class of shares which
has rights, preferences or privileges superior to the Preferred Stock.
Section 7. Residual Rights. All rights accruing to the outstanding
shares of the Corporation not expressly provided for to the contrary herein
shall be vested in the Common Stock.
Article V
In furtherance and not in limitation of powers conferred by statute, it
is further provided:
(a) Election of directors need not be by written ballot.
(b) The Board of Directors is expressly authorized to adopt, amend or
repeal the By-Laws of the Corporation.
Article VI
Whenever a compromise or arrangement is proposed between the
Corporation and its creditors or any class of them and/or between the
Corporation and its stockholders or any class of them, any court of equitable
jurisdiction within the State of Delaware may, on the application in a summary
way of the Corporation or of any creditor or stockholder thereof, or on the
application of any receiver or receivers appointed for the Corporation under the
provisions of Section 291 o Title 8 of the Delaware Code or on the application
of trustees in dissolution or of any receiver or
-9-
<PAGE> 10
receivers appointed for the Corporation under the provisions of Section 279 of
Title 8 of the Delaware Code order a meeting of the creditors or class of
creditors, and/or of the stockholders or class of stockholders of the
Corporation, as the case may be, to be summoned in such manner as the said court
directs. If a majority in number representing stockholders of the Corporation,
as the case may be, agree to any compromise or arrangement and to any
reorganization of the Corporation as consequence of such compromise or
arrangement, the said compromise or arrangement and the said reorganization
shall, if sanctioned by the court to which the said application has been made,
be binding on all the creditors or class of creditors, and/or on all the
stockholders or class of stockholders, of the Corporation, as the case may be,
and also on the Corporation.
Article VII
To the fullest extent permitted by the Delaware General Corporation Law
as the same exists or as may hereafter be amended, a director of the corporation
shall not be personally liable to the Corporation or its stockholders for
monetary damages for breach fiduciary duty as a director.
The corporation may indemnify to the fullest extent permitted by law
any person (including the representative of such person's estate and such
person's successors and assigns) made or threatened to be made a party to an
action or proceeding, whether criminal, civil, administrative or investigative,
by reason of the fact that he is or was a director, office or employee of the
corporation or served at any other enterprise as a director, officer or employee
at the request of the corporation.
Neither any amendment not repeal of this Article VII nor the adoption
of any provision of this corporation's Certificate of Incorporation inconsistent
with this Article VII shall eliminate or reduce the effect of this Article VII
in respect of any matter occurring, or any action or proceeding accruing or
arising or that, but for this Article VII, would accrue or arise, prior to such
amendment, repeal or adoption of an inconsistent provision.
Article VIII
The Corporation reserves the right to amend, alter, change or repeal
any provision contained in this Certificate of Incorporation, in the manner now
or hereafter prescribed by statute, and all rights conferred upon stockholders
herein are granted subject to this reservation.
-10-
<PAGE> 11
CERTIFICATE OF AMENDMENT OF
RESTATED CERTIFICATE OF INCORPORATION OF
DRAGON SYSTEMS, INC.
Pursuant to Section 242 of the General Corporation Law of the State of Delaware
-------------------------------------------------------------------------------
DRAGON SYSTEMS, INC. (hereinafter called the "Corporation"), organized and
existing under and by virtue of the General Corporation Law of the State of
Delaware, does hereby certify as follows:
By written action of the Board of Directors of the corporation resolutions
were duly adopted, pursuant to Sections 141 and 242 of the General Corporation
Law of the State of Delaware, setting forth an amendment to the Certificate of
Incorporation of the Corporation and declaring said amendment to be advisable.
The stockholders of the Corporation duly approved said proposed amendment by
written consent in accordance with Sections 228 and 242 of the General
Corporation Law of the State of Delaware, and written notice of such consent has
been or will be given to all stockholders who have not consented in writing to
said amendment. The resolution setting forth the amendment is as follows:
RESOLVED: That Article FOURTH of the Restated Certificate of Incorporation
of the Corporation be and hereby is amended by deleting the first
paragraph of Article FOURTH and by inserting the following in
lieu thereof:
"The Corporation is authorized to issue two classes of stock,
designated "Common Stock" and "Preferred Stock." The total number
of shares which the Corporation is authorized to issue is
50,000,000. The number of shares of Common Stock which the
Corporation is authorized to issue is 45,000,000, par value $.04
per share. The number of shares of Preferred Stock which
<PAGE> 12
the Corporation is authorized to issue is 5,000,000, par value
$.04 per share."
IN WITNESS WHEREOF, the Corporation has caused its corporate seal to be
affixed hereto and this Certificate of Amendment to be signed by its President
as of the 16th day of November, 1998.
/s/ Janet M. Baker
-----------------------------------
Janet M. Baker, President
2
<PAGE> 1
EXHIBIT 4.1
[LOGO]
NUMBER SHARES
DRAGON SYSTEMS, INC.
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
THIS CERTIFICATE IS TRANSFERABLE IN BOSTON, MA OR NEW YORK, NY
SEE REVERSE FOR CERTAIN DEFINITIONS
COMMON STOCK CUSIP 26144 A 10 9
THIS CERTIFIES THAT
is the owner of
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK,
$.04 PAR VALUE OF
...........................................................DRAGON SYSTEMS, INC.
...............................................................................
transferable only on the books of Dragon Systems, Inc. (the "Corporation") by
the holder hereof in person or by duly authorized attorney upon surrender of
this Certificate properly endorsed or assigned.
This Certificate and the shares of Common Stock represented hereby are
received and held subject to the laws of the State of Delaware and to the
Amended and Restated Certificate of Incorporation and Amended and Restated
By-laws of the Corporation, all as from time to time amended, and the Owner of
this Certificate by accepting the same expressly assents thereto. This
Certificate is not valid unless countersigned by the Transfer Agent and
registered by the Registrar.
IN WITNESS WHEREOF, the Corporation has caused this Certificate to be
signed by the facsimile signatures of its duly authorized officers and a
facsimile of its corporate seal to be hereunto affixed.
Date:___________
[SEAL]
/s/ Diane M. Hudson /s/ Janet M. Baker
Chief Financial Officer, Vice President, Chairman of the Board
Treasurer and Assistant Secretary and Chief Executive Officer
Countersigned and Registered:
BankBoston, N.A.
Transfer Agent and Registrar
Authorized Signature
<PAGE> 2
DRAGON SYSTEMS, INC.
THE CORPORATION IS AUTHORIZED TO ISSUE MORE THAN ONE CLASS OF STOCK.
THE CORPORATION WILL FURNISH WITHOUT CHARGE TO EACH STOCKHOLDER WHO SO REQUESTS
THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR
OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK OR SERIES THEREOF OF THE
CORPORATION, AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS OF SUCH
PREFERENCES AND/OR RIGHTS. SUCH REQUEST MAY BE MADE IN WRITING TO THE
CORPORATION OR THE TRANSFER AGENT.
The following abbreviations, when used in the inscription on the face
of this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations.
<TABLE>
<S> <C> <C>
TEN COM - as tenants in common UNIF GIFT MIN ACT - ................. Custodian..............
TEN ENT - as tenants by the entireties Under Uniform Gifts to Minors Act................................
JT TEN - as joint tenants with right of (State)
survivorship and not as
tenants in common
</TABLE>
Additional abbreviations may also be used though not in the above list.
For value received, ...........................hereby sell, assign and
transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
...............................................................................
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
...............................................................................
...............................................................................
...............................................................................
.........................................................................Shares
of the common stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
.......................................................................Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated:.......................................................
..............................................................
NOTICE: THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME
AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR,
WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER.
SIGNATURE(S) GUARANTEED:.......................................................
THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE GUARANTOR
INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS
AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE
GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report and to all references to our Firm included in or made a part of this
Registration Statement.
/s/ Arthur Andersen LLP
Boston, Massachusetts
March 4, 1999
<PAGE> 1
Exhibit 23.3
Fish & Richardson PC
Attorneys at Law
225 Franklin Street, Suite 3100
Boston, MA 02110-2804
TELEPHONE (617) 542-5070
FACSIMILE (617) 542-8906
March 4, 1999
Dragon Systems, Inc.
320 Nevada Street
Newton, Massachusetts 02160
Re: Dragon Systems, Inc.
Registration Statements on Form S-1
Dear Sirs:
We hereby consent to the reference to our firm under the caption "Experts"
in the Dragon Systems, Inc.'s Registration Statement on Form S-1.
BEST REGARDS,
FISH & RICHARDSON P.C.
By: /s/ Charles C. Winchester
-------------------------
Charles C. Winchester
