<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): April 14, 1998
VOICE CONTROL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 0-10385 75-1707970
(State of (Commission File (IRS employment
incorporation) Number) identification no.)
14140 MIDWAY ROAD
SUITE 100
DALLAS, TEXAS 75244
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE 972-726-1200
Page 1 of 2 pages
Exhibit index on page 2
<PAGE> 2
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED
Audited financial statements of PureSpeech for the year ended December 31,
1996 and 1997.
(b) PRO FORMA FINANCIAL INFORMATION
(c) EXHIBITS.
23.1 CONSENT OF PRICE WATERHOUSE LLP
<PAGE> 3
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
VOICE CONTROL SYSTEMS, INC.
Date: August 31, 1998 By: /s/ Kim S. Terry
--------------------------------
Kim S. Terry,
Vice President
<PAGE> 4
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
23.1 CONSENT OF PRICE WATERHOUSE LLP
</TABLE>
<PAGE> 1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of PureSpeech, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in redeemable preferred stock and stockholders' deficit
and cash flows present fairly, in all material respects, the financial position
of PureSpeech, Inc. at December 31, 1996 and 1997, and the results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has negative working capital of approximately $3 million and has an
accumulated deficit of approximately $9.4 million at December 31, 1997. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Price Waterhouse LLP
Boston, Massachusetts
March 26, 1998, except for Note 10, which
is as of April 14, 1998
<PAGE> 2
PURESPEECH, INC.
BALANCE SHEET
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997 1998
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,184,629 $ 263,498 $ 11,335
Accounts receivable 114,166 244,520 118,713
Prepaid expenses and other current assets 30,680 23,555 28,855
------------ ------------ ------------
Total current assets 1,329,475 531,573 158,903
Fixed assets, net 277,927 261,326 239,481
Other assets 23,236 18,693 18,833
------------ ------------ ------------
$ 1,630,638 $ 811,592 $ 417,217
============ ============ ============
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable $ - $ 1,212,500 $ 1,500,000
Notes payable - related parties - 1,240,798 1,840,798
Accounts payable 83,651 171,334 285,744
Accrued compensation 90,500 74,500 99,500
Other accrued expenses 154,952 200,764 109,937
Interest payable - related parties - 62,000 93,000
Capital lease obligation 27,233 - -
Deferred revenue 537,803 538,054 554,453
------------ ------------ ------------
Total current liabilities 894,139 3,499,950 4,483,462
------------ ------------ ------------
Series A redeemable convertible preferred stock,
$1.00 par value; 825,000 shares authorized; 819,466 shares
issued and outstanding; at issuance cost plus accrued dividends 4,580,893 4,947,368 5,046,314
------------ ------------ ------------
Stockholders' deficit
Undesignated preferred stock, $1.00 par value; 675,000 shares
authorized; none issued or outstanding - - -
Common stock, no par value; 6,000,000 shares authorized;
3,566,325, 3,612,391 and 3,613,641 shares issued and outstanding
at December 31, 1996 and 1997 and March 31, 1998, respectively 1,269,012 1,302,649 1,302,911
Additional paid-in capital - 460,712 460,712
Accumulated deficit (5,113,406) (9,399,087) (10,876,182)
------------ ------------ ------------
Total stockholders' deficit (3,844,394) (7,635,726) (9,112,559)
------------ ------------ ------------
Commitments (Note 9) ------------ ------------ ------------
$ 1,630,638 $ 811,592 $ 417,217
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 3
PURESPEECH, INC.
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
1996 1997 1997 1998
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue:
Software license revenue $ -- $ 609,531 $ 65,700 $ 35,688
Royalty revenue 49,051 324,885 93,209 86
Royalty revenue - related party 576,301 20,499 5,170 --
Development and services revenue 105,839 185,362 90,932 --
Development and services revenue - related party 355,218 -- -- --
----------- ----------- ----------- -----------
1,086,409 1,140,277 345,011 35,774
----------- ----------- ----------- -----------
Costs and expenses:
Cost of revenue 514,316 22,626 3,478 5,414
Cost of revenue - related party 216,000 -- -- --
Research and development 2,043,447 1,159,060 278,498 393,992
Selling, general and administrative 1,973,339 3,401,574 923,325 921,362
----------- ----------- ----------- -----------
4,747,102 4,583,260 1,205,301 1,320,768
----------- ----------- ----------- -----------
Loss from operations (3,660,693) (3,442,983) (950,290) (1,284,994)
Interest income 99,220 27,474 12,424 1,345
Interest expense (3,858) (168,697) -- (94,500)
Interest expense - related parties (14,700) (335,000) -- --
----------- ----------- ----------- -----------
Net loss $(3,580,031) $(3,919,206) $ (937,866) $(1,378,149)
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 4
PURESPEECH, INC.
STATEMENT OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
1996 1997 1997 1998
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,580,031) $(3,919,206) $ (937,866) $(1,378,149)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization 109,427 156,460 34,499 42,062
Amortization of debt discount -- 423,212 -- 37,500
Stock issued for services -- 30,000 -- --
Changes in assets and liabilities:
Accounts receivable 163,821 (130,354) (20,663) 125,807
Prepaid expenses and other current assets 3,014 7,125 (206,311) (5,300)
Other assets 1,327 4,543 -- (140)
Accounts payable (75,511) 87,683 88,942 114,440
Accrued compensation -- -- (19,500) 25,000
Other accrued expenses 69,185 91,812 33,928 (90,827)
Interest payable - related parties -- -- -- 31,000
Deferred revenue 537,803 251 30,615 16,399
----------- ----------- ----------- -----------
Net cash used for operating activities (2,770,965) (3,248,474) (996,356) (1,082,208)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (263,004) (139,859) (61,686) (20,217)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligation (15,767) (27,233) (4,300) --
Proceeds from issuance of notes payable -- 1,250,000 -- 250,000
Proceeds from issuance of notes payable - related parties -- 1,240,798 -- 600,000
Proceeds from sale of preferred stock, net of issuance costs 4,140,001 -- -- --
Proceeds from issuance of common stock -- 3,637 -- 262
Repayment of notes payable - related party (50,000) -- -- --
----------- ----------- ----------- -----------
Net cash provided by (used for) financing activities 4,074,234 2,467,202 (4,300) 850,262
----------- ----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 1,040,265 (921,131) (1,062,342) (252,163)
Cash and cash equivalents at beginning of period 144,364 1,184,629 1,184,629 263,498
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 1,184,629 $ 263,498 $ 122,287 $ 11,335
=========== =========== =========== ===========
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
The Company converted $1,000,000 of senior convertible notes payable into
625,000 shares of common stock and $100,000 of demand convertible notes payable
into 19,048 shares of Series A redeemable preferred stock in February 1996 (Note
4). During the year ended December 31, 1996, the Company entered into a capital
lease of $43,000 for furniture. During the year ended December 31, 1996, accrued
interest of $11,077 payable on notes which had converted to common stock was
forgiven by the holders of the notes and added to the stated amount of common
stock.
The accompanying notes are an integral part of these financial statements.
<PAGE> 5
PURESPEECH, INC.
STATEMENT OF CHANGES IN REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REDEEMABLE PREFERRED STOCK STOCKHOLDERS' DEFICIT
-------------------------- ---------------------------
SERIES A
REDEEMABLE
PREFERRED STOCK COMMON STOCK
NUMBER OF NUMBER OF
SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
Balance at December 31, 1995 -- $ -- 2,941,325 $ 257,935
Issuance of Series A redeemable preferred
stock, issuance costs of $62,194 800,418 4,202,195 -- --
Conversion of demand convertible note payable to
preferred stock 19,048 100,000 -- --
Accrual of cumulative dividends on Series A
redeemable preferred stock -- 278,698 -- --
Conversion of senior convertible note payable to
common stock -- -- 625,000 1,000,000
Forgiveness of accrued interest on notes payable
converted to common stock -- -- -- 11,077
Net loss -- -- -- --
------- ----------- --------- -----------
Balance at December 31, 1996 819,466 4,580,893 3,566,325 1,269,012
Issuance of common stock upon exercise of
stock options -- -- 36,066 3,637
Issuance of common stock for services -- -- 10,000 30,000
Accrual of cumulative dividends on Series A
redeemable preferred stock -- 366,475 -- --
Issuance of common stock warrants -- -- -- --
Net loss -- -- -- --
------- ----------- --------- -----------
Balance at December 31, 1997 819,466 4,947,368 3,612,391 1,302,649
Issuance of common stock upon exercise of
stock options (unaudited) -- -- 1,250 262
Accrual of cumulative dividends on Series A
redeemable preferred stock -- 98,946 -- --
Net loss (unaudited) -- -- -- --
------- ----------- --------- -----------
Balance at March 31, 1998 (unaudited) 819,466 $ 5,046,314 3,613,641 $ 1,302,911
======= =========== ========= ===========
<CAPTION>
STOCKHOLDERS' DEFICIT
--------------------------------------------------------------
ADDITIONAL TOTAL
PAID-IN ACCUMULATED STOCKHOLDERS'
CAPITAL DEFICIT DEFICIT
<C> <C> <C> <C>
Balance at December 31, 1995 $ -- $ (1,192,483) $ (934,548)
Issuance of Series A redeemable preferred
stock, issuance costs of $62,194 -- (62,194) (62,194)
Conversion of demand convertible note payable to
preferred stock -- -- --
Accrual of cumulative dividends on Series A
redeemable preferred stock -- (278,698) (278,698)
Conversion of senior convertible note payable to
common stock -- -- 1,000,000
Forgiveness of accrued interest on notes payable
converted to common stock -- -- 11,077
Net loss -- (3,580,031) (3,580,031)
--------- ------------- ------------
Balance at December 31, 1996 -- (5,113,406) (3,844,394)
Issuance of common stock upon exercise of
stock options -- -- 3,637
Issuance of common stock for services -- -- 30,000
Accrual of cumulative dividends on Series A
redeemable preferred stock -- (366,475) (366,475)
Issuance of common stock warrants 460,712 -- 460,712
Net loss -- (3,919,206) (3,919,206)
--------- ------------- ------------
Balance at December 31, 1997 460,712 (9,399,087) (7,635,726)
Issuance of common stock upon exercise of
stock options (unaudited) -- -- 262
Accrual of cumulative dividends on Series A
redeemable preferred stock -- (98,946) (98,946)
Net loss (unaudited) -- (1,378,149) (1,378,149)
--------- ------------- ------------
Balance at March 31, 1998 (unaudited) $ 460,712 $ (10,876,182) $ (9,112,559)
========= ============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 6
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
PureSpeech, Inc. (the "Company") was incorporated in Massachusetts on March
31, 1994. The Company develops and markets state-of-the-art automated
speech technology software applications for the telephony environment. The
Company principally markets its software applications to corporate and
government customers in the United States. Although planned principal
operations commenced in 1996, revenue therefrom had not been significant
and accordingly, the Company was considered a development stage enterprise
at December 31, 1996, as defined in statement of Financial Accounting
Standards No. 7, "Accounting and Reporting by Development Stage
Enterprises." By December 31, 1997, the Company had derived significant
revenue from its planned principal operations and accordingly is no longer
considered to be in the development stage.
The Company incurred a net loss of approximately $3.9 million for the year
ended December 31, 1997, and at December 31, 1997, has negative working
capital of approximately $3 million and an accumulated deficit of
approximately $9.4 million. The Company requires additional financing to
meet anticipated cash requirements. Management is reviewing alternative
sources of financing; however, if additional financing is not obtained, the
Company may be unable to continue as a going concern. The financial
statements do not include any adjustments relating to the recoverability
and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The
Company invests excess cash primarily in U.S. government agency debt
securities and money market funds of major financial institutions. These
investments are subject to minimal credit and market risks.
At December 31, 1996 and 1997, the Company's cash equivalents are
classified as available-for-sale. At December 31, 1996, the Company's cash
equivalents consisted of $497,855 in a U.S. government agency security
which matured in January 1997 and $686,461 in money market funds. At
December 31, 1997, the Company's cash equivalents consisted of $119,404 in
money market funds. These securities are stated at cost plus accrued
interest, which approximates fair market value.
REVENUE RECOGNITION
Revenue from software licenses is recognized upon delivery when all
significant contractual obligations have been met and collection of the
related receivable is probable. In the event the Company has significant
post-delivery obligations or significant uncertainties remain, software
license revenue is deferred and recognized when such obligations are met or
uncertainties are resolved.
Royalty revenue is recognized when earned, as determined by reseller
reports of product shipments to end-users.
<PAGE> 7
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Company recognizes revenue from software development and services
agreements as the work is performed or defined milestones are attained.
Payments received under the agreements prior to the recognition of revenue
are recorded as deferred revenue.
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments which potentially expose the Company to
concentrations of credit risk include accounts receivable. The Company does
not require collateral but closely monitors amounts receivable from
customers. At December 31, 1996, 39%, 26% and 21% of the Company's accounts
receivable were due from three separate customers. At December 31, 1997,
54%, 12% and 10% of the Company's accounts receivable are due from three
separate customers.
The Company conducted business with a significant customer and stockholder
(Note 4) pursuant to a development and license agreement. For the years
ended December 31, 1996 and 1997, revenue from the customer accounted for
approximately 65% and 1% of total revenue, respectively. For the year ended
December 31, 1997, two customers accounted for 25% and 17% of total
revenue.
SOFTWARE DEVELOPMENT COSTS
Costs associated with the development of computer software are expensed
prior to establishing technological feasibility, as defined by Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise Marketed", and
capitalized thereafter until commercial release of the software products.
Software development costs eligible for capitalization have not been
significant to date.
SMALL BUSINESS INNOVATION RESEARCH GRANTS
Small Business Innovation Research ("SBIR") government grants to conduct
research and development are recorded as a reduction to research and
development expense as eligible costs are incurred up to the funding
limit. Eligible grant-related costs which have been incurred in advance of
cash receipts are recorded as receivables. For the years ended December
31, 1996 and 1997, SBIR grants amounted to approximately $354,900 and
$255,100, respectively.
FIXED ASSETS
Fixed assets are recorded at cost and depreciated using the straight-line
method over their estimated useful lives. Repair and maintenance costs are
expensed as incurred. Capital leases are amortized over the shorter of the
lease life or the estimated useful life of the asset.
INCOME TAXES
During the period from inception (March 31, 1994) through December 31,
1996, the Company was an S Corporation and was not required to pay income
taxes. S Corporation stockholders are required to report their respective
share of the Company's taxable income or loss on their individual tax
returns and are personally liable for the related tax. As a result of the
preferred stock financing (Note 6), the stockholders revoked the Company's
S Corporation status on January 1, 1996 and it is now a C Corporation. The
net loss incurred while the Company qualified as an S Corporation remains
with its stockholders. The loss incurred by the Company as a C Corporation
is to be carried forward by the Company (Note 8).
2
<PAGE> 8
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to its employees using the
intrinsic value based method prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. The Company has adopted the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", through disclosure only (Note
7).
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
INTERIM FINANCIAL DATA
The interim financial data as of March 31, 1998 and for the three months
ended March 31, 1997 and 1998 are unaudited; however, in the opinion of
the Company, the interim data include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair statement of the
financial position and results of operations for the interim periods. The
operating results for the three months ended March 31, 1998 are not
necessarily indicative of the results to be expected for the full year
ending December 31, 1998.
3. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIFE DECEMBER 31,
IN YEARS 1996 1997
<S> <C> <C> <C>
Computers and equipment 3 $ 322,628 $ 426,509
Computer software 3 50,770 83,445
Furniture and fixtures 3 60,367 63,670
Leasehold improvements lease term 8,760 8,760
---------- ----------
442,525 582,384
Less - accumulated depreciation
and amortization (164,598) (321,058)
---------- ----------
$ 277,927 $ 261,326
========== ==========
</TABLE>
At December 31, 1996, furniture and fixtures includes furniture of $43,000
held under a capital lease and accumulated amortization relating to such
furniture of approximately $15,800. This furniture was purchased in 1997
of the lease buy out option.
3
<PAGE> 9
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. BORROWINGS
NOTE PAYABLE
In November 1994, the Company issued a demand note payable to a related
party with a principal balance outstanding of $50,000 at December 31, 1995.
The note accrued interest at a rate of 10% per annum and was repaid in May
1996.
DEMAND CONVERTIBLE NOTE PAYABLE
In December 1995, the Company issued a demand convertible note payable (the
"Bridge Note") bearing interest at 8.75% per annum for $100,000. The Bridge
Note was convertible into Series A preferred stock at a conversion price of
$5.25 per share and was converted into 19,048 shares of Series A preferred
stock in February 1996. The Company granted 12,500 warrants to purchase
common stock in connection with the Bridge Note. The warrants were issued
with an exercise price of $0.004 per share and expire on December 18, 2000.
The Company has determined that the warrants had an insignificant value.
SENIOR CONVERTIBLE NOTE PAYABLE
In February 1995, the Company issued a senior convertible note payable (the
"Senior Note") bearing interest at 10% per annum for $1,000,000. The Senior
Note was payable in full on December 31, 1997. Interest on the Senior Note
was payable quarterly with the final interest due on the maturity date. The
Company had an option to defer interest which was compounded quarterly and
was repayable in subsequent quarters or at maturity. The Senior Note was
convertible into shares of common stock at the option of the holder if the
Company revoked or lost its elected status under Chapter S of the Internal
Revenue Code. The Company had granted the holder of the Senior Note a
senior security interest in all tangible and intangible assets of the
Company. In February 1996, the holder of the Senior Note elected to convert
the principal amount of $1,000,000 to 625,000 shares of common stock as a
result of the Company revoking its S Corporation status. Accrued interest
of approximately $101,100 was paid to the holder upon conversion.
SUBORDINATED NOTES PAYABLE
In May 1997, the Company issued subordinated notes payable (the "Notes") to
existing stockholders in exchange for cash totaling $1,240,798. All
principal and interest, accruing at an annual rate of 8%, relating to these
Notes becomes due and payable on December 31, 1997 and March 31, 1998,
respectively. All outstanding principal and accrued interest will become
immediately due and payable if the holders of at least 60% of the then
outstanding principal amount of the Notes request repayment. Upon the
closing of an offering and sale by the Company of its capital stock in
which gross proceeds equal or exceed $2,500,000 all outstanding principal
and accrued interest on the Notes will become immediately due and payable.
The Company may elect to i) repay the amount due with shares of capital
stock which were sold in the offering at the offering price per share, ii)
repay the amount due in full or iii) repay or convert in some combination.
In connection with the issuance of such notes payable, the Company issued
warrants to purchase 2,008,911 shares of the Company's common stock at an
exercise price of $.21 per share. The warrants expire on May 30, 2007.
These warrants were ascribed a value of approximately $273,000 which was
reflected as a debt discount and was amortized to interest expense over the
term of the note.
4
<PAGE> 10
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
BRIDGE LOAN
In September 1997, the Company entered into a $1,500,000 bridge loan
agreement with a financial institution maturing on January 31, 1998. The
loan bears interest at the bank's prime rate plus 1.5% (10% at December
31, 1997). The loan contains certain financial covenants, the more
restrictive of which require the maintenance of certain cash flows and
restrictions on the level of capital lease obligations. The Company was
in compliance with these covenants at December 31, 1997. A commitment fee
of 0.5% is owed on any unused portion of the loan. The loan has priority
over all other debt of the Company and is secured by substantially all of
the assets of the Company. At December 31, 1997, $1,250,000 was
outstanding relating to the bridge loan.
In connection with the issuance of the bridge loan, the Company issued
warrants to purchase shares of the Company's common stock. The exercise
price and number of shares will be determined based upon the price of the
next round of financing or $.42 per share if there is no qualified
financing prior to the exercise of the warrants. In the event there is a
qualified financing, as defined by the agreement, the number of warrants
will be determined by dividing $255,000 by the price of the next round of
financing. The exercise price of the warrants will be equal to the price
of the next round of financing. In the event there is no qualified
financing, the number of warrants will be 607,143 and the exercise price
will be $.42. The warrants will become exercisable upon the earlier of i)
September 1, 1998, ii) 10 business days prior to the completion of the
first liquidity event, as defined by the agreement or iii) the completion
of a qualified financing. The warrants expire on September 4, 2004.
These warrants were ascribed a value of $187,500 which is reflected as
a debt discount and is being amortized to interest expense over the term of
the note.
During February 1998, the terms of the bridge loan were amended to extend
the maturity date of the note to May 31, 1998. Concurrently with the
amendment of the bridge loan, the Company entered into an agreement with
the same financial institution to pay the principal sum of $58,000. The
note is non-interest bearing and becomes due and payable upon the earlier
of i) May 31, 1998, ii) the closing of a change in control transaction as
defined by the agreement, iii) the closing of any transaction involving
the sale of equity securities resulting in cash proceeds of at least $1.5
million or iv) the sale or transfer of assets constituting greater than
50% of the total fair market value of all the assets of the Company.
SUBORDINATED CONVERTIBLE NOTES PAYABLE
During January and March 1998, the Company issued subordinated convertible
notes payable to an existing stockholder in the aggregate amount of
$600,000 (the "Notes"). The Notes are due on demand and accrue interest at
an annual rate of 20%. All outstanding principal and accrued interest will
become immediately due and payable if the holders of at least 60% of the
then outstanding principal amount of the Notes request repayment.
If the Company does not consummate a sale of all or substantially all of
the capital stock, assets or business of the Company to a third party (a
"Sale Transaction") prior to May 31, 1998, the entire outstanding principal
amount of the Notes, together with accrued interest, shall be converted at
the option of the holder into shares of the Company's common stock at a
conversion rate equal to $.21 per share. If a Sale Transaction which is
not accounted for as a pooling-of-interests transaction is consummated
prior to May 31, 1998, the entire outstanding principal amount of the
Notes, together with accrued interest, shall be converted at the option
of the holder into shares of the Company's common stock at a conversion
rate equal to $.42 per share.
5
<PAGE> 11
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
VOTING RIGHTS
Stockholders of Series A redeemable convertible preferred stock (the
"Series A preferred stock") are entitled to one vote for each share of
common stock into which the Series A preferred stock is convertible.
DIVIDENDS
Preferred stockholders are entitled to receive, whether or not declared by
the Board of Directors, annual cumulative dividends accruing on a daily
basis at the per annum rate of $.42 per share plus 8% per annum of the
previously accrued but unpaid dividends from the preceding year. Cumulative
unpaid dividends of $645,173 on Series A preferred stock have been charged
to accumulated deficit and are included in the carrying value of the Series
A preferred stock at December 31, 1997.
CONVERSION
Each share of Series A preferred stock may be converted at any time, at the
option of the stockholder, into 2.5 common shares (subject to certain
anti-dilution adjustments). The Series A preferred stock is mandatorily
convertible into common stock upon the closing of an initial public
offering in which net proceeds equal or exceed $10,000,000, and in which
the price per common share to the public is at least $6.30 per share.
RIGHT OF FIRST REFUSAL
The holders of the Series A preferred stock have certain rights of first
refusal to purchase common stock from certain common stockholders.
REDEMPTION
Shares of Series A preferred stock are redeemable by the holders at a price
equal to $5.25 per share plus any accrued but unpaid dividends based on the
following redemption schedule. Required redemption amounts excluding any
cumulative but unpaid dividends are as follows:
<TABLE>
<CAPTION>
CUMULATIVE
REDEMPTION
REDEMPTION DATE AMOUNT
<S> <C>
February 15, 2001 $ 1,419,724
February 15, 2002 2,839,449
February 15, 2003 4,302,195
</TABLE>
LIQUIDATION
In the event of any liquidation, dissolution or winding up of the affairs
of the Company, the holders of the then outstanding shares of Series A
preferred stock are entitled to receive, prior to and in preference to
holders of the common stock, a payment of $5.25 per share plus any accrued
but unpaid dividends.
6
<PAGE> 12
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
6. COMMON STOCK
The holders of common stock are entitled to one vote for each share held at
all meetings of stockholders. Dividends on common stock may be paid out of
lawfully available funds as and when determined by the Board of Directors,
subject to any preferential dividend rights of the preferred stockholders.
At December 31, 1997, the Company did not have a sufficient number of
shares of common stock authorized for issue upon conversion of the
preferred stock (Note 5) and for the exercise of outstanding warrants and
options (Note 7). It is the intent of the Board of Directors to increase
the number of authorized shares of common stock.
STOCK SPLIT
In April 1996, the Company effected a 1.5-for-one stock split in the form
of a stock dividend. All common share and per share amounts included in the
accompanying financial statements and notes thereto have been retroactively
adjusted to reflect the stock split.
7. STOCK OPTION PLANS
1994 STOCK OPTION PLAN
On July 11, 1994, the Board of Directors adopted the Key Employee Stock
Option Plan (the "Plan") under which 818,750 shares of common stock are
reserved for issuance to employees, officers, directors and non-employees
upon the exercise of the options granted under the Plan. The Board of
Directors determines the term of each option, option price, number of
shares for which each option is granted and the rate at which each option
is exercisable. The term of each option generally cannot exceed ten years
(five years for options granted to holders of more than 10% of the voting
stock of the Company). The exercise price of incentive stock options shall
not be less than the fair market value of the common stock at the date of
grant (110% of fair market value for options granted to holders of more
than 10% of the voting stock of the Company). Non-qualified stock options
may be issued under the Plan at an option price determined by the Board of
Directors. The Plan allows the Board of Directors to grant restricted stock
to consultants to the Company. The Board of Directors determines, and may
modify or accelerate, the terms of restriction of the restricted stock.
1997 STOCK OPTION PLAN
On February 7, 1997, the Board of Directors adopted the 1997 Stock Option
Plan (the "1997 Plan") under which 2,892,000 shares of common stock are
reserved for issuance to employees, officers, directors and non-employees
upon the exercise of the options granted under the 1997 Plan. The Board of
Directors determines the term of each option, option price, number of
shares for which each option is granted and the rate at which each option
is exercisable. The term of each option generally cannot exceed ten years
(five years for options granted to holders of more than 10% of the voting
stock of the Company). The exercise price of incentive stock options shall
not be less than the fair market value of the common stock at the date of
grant (110% of fair market value for options granted to holders of more
than 10% of the voting stock of the Company). Non-qualified stock options
may be issued under the Plan at an option price determined by the Board of
Directors, but not less than 50% of the fair market value of the common
stock at the date of grant.
7
<PAGE> 13
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Company applies APB No. 25 and related interpretations in accounting
for its stock option plans. During the years ended December 31, 1996 and
1997, no compensation expense has been recognized under the plans. Had
compensation cost been determined based on the fair value of the options
at the grant date consistent with the provisions of SFAS No. 123, the
Company's net loss would not have been materially different. Because
options vest over several years and additional option grants are expected
to be made in future years, future years' results of operations may be
materially different if the provisions of SFAS No. 123 were applied.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions for grants in 1996 and 1997: no dividend yield for both years;
no volatility for both years; risk-free interest rates of 6.2% for 1996
and 6.4% for 1997; and expected lives of 5 years for both years.
A summary of the status of the Company's option plans as of December 31,
1996 and 1997, and changes during the years then ended is presented below:
<TABLE>
<CAPTION>
1996 1997
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C>
Outstanding at beginning of year 562,250 $ .62 815,875 $ .64
Granted 279,125 .66 2,520,453 .26
Exercised -- -- (36,066) .10
Canceled (25,500) .66 (1,163,809) .56
---------- ----------
Outstanding at end of year 815,875 .64 2,136,453 .23
========== ==========
Options exercisable at year-end 176,999 .59 248,737 .33
========== ==========
Weighted-average fair value of options
granted during the year -- all issued at
fair value of the underlying common
stock in 1997 and above fair value
for 1996 $ -- $ .06
========== ==========
Options available for future grant 713,231
----------
</TABLE>
8
<PAGE> 14
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
REMAINING NUMBER OF
NUMBER OF CONTRACTUAL OPTIONS
EXERCISE PRICE SHARES LIFE (YEARS) EXERCISABLE
<S> <C> <C> <C>
$.03 5,000 6.6 4,271
$.21 2,017,703 9.3 175,482
$.66 113,750 7.5 68,984
--------- ---------
2,136,453 248,737
========= =========
</TABLE>
During 1997, the Company's Board of Directors determined that, because
certain stock options held by employees of the Company had an exercise
price significantly higher than the fair value of the Company's common
stock, such stock options were not providing the incentive intended.
Accordingly, options to purchase 649,125 shares of common stock with an
exercise price of $.66 per share were canceled and reissued at a price of
$.21 per share.
8. INCOME TAXES
Deferred tax assets consist of the following:
<TABLE>
DECEMBER 31,
1996 1997
<S> <C> <C>
Net operating loss carryforwards $ 1,505,996 $ 2,806,687
Research and development credit carryforwards 47,274 105,083
Other temporary differences 25,443 312,978
------------ ------------
Net deferred tax assets 1,578,713 3,224,748
Deferred tax asset valuation allowance (1,578,713) (3,224,748)
------------ ------------
$ -- $ --
============ ============
</TABLE>
The Company has provided a full valuation allowance for the full amount of
its net deferred tax assets at December 31, 1996 and 1997 since it is more
likely than not that these future benefits will not be realized. If the
Company achieves future profitability these deferred tax assets could be
available to offset future income taxes.
At December 31, 1997, available federal and state net operating loss and
research and development tax credits carryforwards were approximately
$6,969,673 and $132,356, respectively. These carryforwards expire at
various dates through 2012.
9
<PAGE> 15
PURESPEECH, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Under the provisions of the Internal Revenue Code, certain substantial
changes in the Company's ownership may result in a limitation of the amount
of net operating loss carryforwards available annually to offset future
taxable income. The amount of this annual limitation is determined based
upon the Company's value prior to the ownership changes taking place.
9. COMMITMENTS
LEASE
The Company leases its office space under a non-cancelable operating lease.
At December 31, 1997, future minimum lease payments under operating leases
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, AMOUNT
<S> <C>
1998 $ 210,150
1999 210,150
2000 210,150
2001 17,512
------------
Total minimum lease payments $ 647,962
============
</TABLE>
Rent expense for the years ended December 31, 1996 and 1997 was
approximately $133,800 and $156,200, respectively.
EXECUTIVE BONUS PLAN
During 1997, the Board of Directors of the Company approved an executive
bonus plan designed to provide certain key executives with an incentive to
remain employed by the Company. Such compensation will be payable upon the
closing of a merger, consolidation or sale of all or substantially all of
the assets of the Company. The amount of the bonus will be based upon a
percentage of the consideration paid in such transaction.
10. SUBSEQUENT EVENT
On April 14, 1998, Voice Control Systems, Inc. ("VCS") acquired all of the
outstanding common stock of the Company in exchange for approximately
2,005,846 shares of VCS common stock. As a result of the merger, each
outstanding share of Company capital stock was converted (i) in the case of
Company common stock, into .1422 shares of VCS common stock, (ii) in the
case of Company Series A preferred stock (including accrued but unpaid
dividends thereon) into .9107 shares of VCS common stock. Each option
granted under the Company's 1997 stock option plan and warrants issued to
investors in May 1997 and to a financial institution in September 1997 were
assumed by VCS on the same terms and conditions in effect at the time of
the merger and are exercisable for, or convertible into, VCS common stock
at the above exchange ratio. In addition, the January 1998 bridge note was
converted into 70,121 shares of VCS common stock and the May 1997 and March
1998 bridge notes including accrued interest thereon were converted into
VCS common stock at a rate of $6.7544 per share.
10
<PAGE> 16
UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
The following unaudited pro forma condensed financial statements give
effect to the Merger of Voice Control Systems, Inc. (VCS) and PureSpeech Inc.
(PureSpeech) on the purchase basis. The pro forma condensed balance sheet as of
March 31, 1998 assumes the Merger took place on March 31, 1998 and combines the
unaudited March 31, 1998 balance sheets of PureSpeech and Voice Control Systems.
The pro forma condensed balance sheet as March 31, 1998, also assumes the
issuance of the common stock occurs immediately following the Merger. The pro
forma condensed statement of operations for the year ended December 31, 1997 and
for the three months ended March 31, 1998 was prepared based on the historical
financial statements of PureSpeech and VCS and gives the effect to the
acquisition as if it had been consummated on January 1, 1997.
The pro forma condensed financial statements should be read in conjunction
with the accompanying notes and the historical financial statements and notes of
PureSpeech and VCS included elsewhere herein. The unaudited pro forma condensed
statements of operations for the year ended December 31, 1997 and the quarter
ended March 31, 1998 are not necessarily indicative of future operations or the
actual results that would have occurred had the Merger been consummated as
presented. The purchase method of accounting allocates the aggregate purchase
price to the assets acquired and liabilities assumed based upon their respective
fair values. The determination of the allocation of the aggregate purchase price
is preliminary and is contingent upon studies and valuations that have not yet
been completed. Management is unable to predict whether any adjustments as a
result of the foregoing will have a material effect on the Pro Forma Financial
Statements.
<PAGE> 17
PRO FORMA STATEMENTS OF OPERATIONS
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------ ADJUSTMENTS PRO FORMA
PURESPEECH VCS (NOTE 2) COMBINED
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 1,140,277 $ 14,429,867 $ -- $ 15,570,144
Cost of Sales 22,626 3,221,629 -- 3,244,255
------------ ------------ ------------ ------------
Gross Profit 1,117,651 11,208,238 -- 12,325,889
Cost and expenses:
Operating expenses:
Research and development 1,159,060 5,252,801 6,411,861
Selling, general and administrative 3,401,574 7,143,619 537,000(B) 11,082,193
Interest expense (Income), net 141,223 (748,924) (607,701)
Interest related parties 335,000 -- 335,000
------------ ------------ ------------ ------------
Total expenses 5,036,857 11,647,496 537,000 16,684,353
------------ ------------ ------------ ------------
Net Loss $ (3,919,206) $ (439,258) $ (537,000) $ (4,895,464)
============ ============ ============ ============
Net Loss per share - Basic (0.04) (0.38)
============ ============
Weighted average shares outstanding - Basic 11,176,173 1,699,312 12,875,485
============ ============ ============
</TABLE>
<PAGE> 18
PRO FORMA BALANCE SHEET
(UNAUDITED)
FOR THE PERIOD ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------ ADJUSTMENTS
PURESPEECH VCS (NOTE 2) PRO FORMA
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 11,335 12,450,222 (2,500,000)(B) 9,961,557
Accounts receivable 118,713 3,675,745 3,794,458
Inventory 532,015 532,015
Prepaid expenses 28,855 184,398 213,253
----------- ------------ ------------ -------------
Total current assets 158,903 16,842,380 (2,500,000) 14,501,283
Net property and equipment 239,481 1,508,879 1,748,360
Goodwill 2,682,783 (B) 2,682,783
Other Assets 18,833 156,566 175,399
----------- ------------ ------------ -------------
$ 417,217 $ 18,507,825 $ 182,783 $ 19,107,825
=========== ============ ============ ============
Liabilities and Stockholders' Equity
Current:
Accounts payable and accrued expenses 588,211 $ 1,025,268 (73,553)(A) 1,539,926
Deferred revenue 554,453 717,631 1,272,084
Note Payable 3,340,798 -- (1,840,798)(A) 1,500,000
----------- ------------ ------------ -------------
Total current liabilities 4,483,462 1,742,899 (1,914,351) 4,312,010
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock 5,046,314 -- (5,046,314)(B) --
Common stock 1,302,911 114,454 1,914,351 (A)
(3,217,262)(B)
16,993 (B) 131,447
Paid-in capital 460,712 37,498,711 (460,712)(B)
8,013,896 (B) 45,512,607
Treasury stock (325,546) (325,546)
Receivable from stockholders (70,010) (70,010)
Accumulated Deficit (10,876,183) (20,452,683) 10,876,183 (B)
(10,000,000)(B) (30,452,683)
----------- ------------ ------------ -------------
TOTAL STOCKHOLDERS' EQUITY (4,066,245) 16,764,926 2,097,134 14,795,815
----------- ------------ ------------ -------------
$ 417,217 $ 18,507,825 $ 182,783 $ 19,107,825
=========== ============ ============ =============
</TABLE>
<PAGE> 19
PRO FORMA STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Period Ended March 31, 1998
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------------ ADJUSTMENTS
PURESPEECH VCS (NOTE 2) PRO FORMA
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 35,774 $ 3,772,067 $ -- $ 3,807,841
Cost of Sales 5,414 732,337 -- 737,751
----------- ------------ ------------ ------------
Gross Profit 30,360 3,039,730 -- 3,070,090
Cost and expenses:
Operating expenses:
Research and development 393,992 1,280,805 1,674,797
Selling, general and administrative 921,362 2,376,669 134,000 (B) 3,432,031
Interest expense (Income), net 93,155 (161,441) (68,286)
Interest related parties -- -- -- --
----------- ------------ ------------ ------------
Total expenses 1,408,509 3,496,033 134,000 5,038,542
Net Loss $(1,378,149) $ (456,303) $ (134,000) $ (1,968,452)
=========== ============ ============ ============
Net Loss per share Basic (0.04) (0.93)
============ ============
Weighted average shares outstanding - Basic 11,176,173 1,699,312 12,875,485
============ ============ ============
</TABLE>
<PAGE> 20
PURESPEECH, INC AND VOICE CONTROL SYSTEMS, INC.
Notes to Pro Forma Condensed Financial Statements
(Unaudited)
1. Merger
VCS acquired 100 percent of the stock of PureSpeech in return for VCS stock
and the rights to acquire VCS stock valued at approximately $8 million, the
assumption of PureSpeech liabilities in the amount of $2.6 million and cash
consideration of approximately $2.5 million including transaction costs.
Pursuant to the terms of the agreement, all shares of PureSpeech Common and
Preferred Stock outstanding immediately prior to the closing of the Merger
were converted into and exchanged for 1,316,555 shares of VCS Common Stock.
In addition, PureSpeech shareholder debt assumed by VCS was converted into
382,757 shares of VCS Common Stock. Options, warrants and other rights to
acquire PureSpeech common stock were converted to options and warrants to
acquire 619,561 shares of VCS common stock. The pro forma condensed balance
sheet as of March 31, 1998 assumes the Merger took place as of March 31,
1998. The pro forma condensed statement of operations for the year ended
December 31, 1997 and the three months ended March 31, 1998 assumes the
merger took place on January 1, 1997. The Merger was accounted for as a
purchase with VCS acquiring PureSpeech in the acquisition.
2. Pro forma adjustments
For purposes of this pro forma condensed statement of operations, the
write-off of the acquired in-process research and development has been
excluded due to its non-recurring nature.
The pro forma adjustments in the accompanying unaudited pro forma condensed
financial statements are listed below.
(A) Reflects the conversion of the PureSpeech shareholders debt and
accrued interest to equity.
(B) Reflects the issuance of 1,699,312 shares of VCS stock for the
outstanding preferred and common stock of PureSpeech and the payment
of $2.5 million in cash including transaction cost. The purchase price
was allocated as follows, based on preliminary estimates:
<TABLE>
<S> <C>
Goodwill $ 2,682,783
In-process Research and Development 10,000,000
Net Book Value of remaining assets 417,217
-----------
$13,100,000
===========
</TABLE>
The acquired research and development will be changed to expense
as research and development costs. Goodwill will be amortized
over its estimated useful life of five years.
VCS acquired PureSpeech with two major products under development, the Pure
Request and the Recite product lines. The Pure Request product is
automated attendant that is designed to handle up 10,000 names. The Recite
product is a natural language speech engine that is designed to recognize
up to 10,000 words or vocabularies. Both products require research and
development resources for market acceptance. VCS will have to spend
approximately $500,000 in Research and Development to complete the Pure
Request product for end user acceptance. Additional expenses will be
incurred to integrate the Recite engine into applications and end user
products. The majority of the research will be completed by year-end 1998,
with continued R&D in the future to meet the rapidly changing competitive
landscape. If developed successfully both product lines can become an
integral part of VCS's product line and revenue stream in future years.
(C) The pro forma net loss per share is computed assuming the 1,699,312
shares of VCS stock issued in connection with the acquisition were
outstanding during the entire period presented.
<PAGE> 21
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8, (Nos. 333-19309 and 33-65842) of Voice Control Systems,
Inc. of our report dated March 26, 1998, except for Note 10, which is as of
April 14, 1998, relating to the financial statements of PureSpeech, Inc. as of
December 31, 1996 and 1997 and for the two years then ended, which appears in
the Current Report on Form 8K/A of Voice Control Systems, Inc.
/s/ Price Waterhouse LLP
Boston, Massachusetts
August 31, 1998
