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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended June 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
Commission file number: 000-31097
SPEECHWORKS INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 04-3239151
(State or other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
695 Atlantic Avenue, Boston, MA 02111
(Address of Principal Executive Offices) (Zip Code)
(617) 428-4444
Registrant's Telephone Number, Including Area Code
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of August 9, 2002, the registrant had 32,861,845 shares of common stock,
par value $0.001 per share, outstanding.
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SPEECHWORKS INTERNATIONAL, INC.
INDEX
Page No.
Part I--Financial Information
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheet as of June 30, 2002 and December 31, 2001 ...................... 1
Consolidated Statement of Operations for the Three and Six Months Ended June 30, 2002
and 2001 .................................................................................. 2
Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2002 and 2001 ...... 3
Notes to Consolidated Financial Statements ................................................ 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations ................................................................................ 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk ................................ 30
Part II--Other Information
Item 2. Changes in Securities and Use of Proceeds ................................................. 30
Item 4. Submission of Matters to a Vote of Security Holders ....................................... 30
Item 6. Exhibits and Reports on Form 8-K .......................................................... 31
Signatures ................................................................................................. 32
SPEECHWORKS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
June 30, December 31,
2002 2001
---- ----
(UNAUDITED)
(in thousands, except
share information)
ASSETS
Current assets:
Cash and cash equivalents .................................................................. $ 46,257 $ 55,534
Marketable securities ...................................................................... 16,079 24,264
Accounts receivable, net of allowance for doubtful accounts of $907 and $1,428,
respectively ............................................................................ 13,617 12,725
Prepaid expenses and other current assets .................................................. 1,636 2,207
--------- ---------
Total current assets .................................................................... 77,589 94,730
Fixed assets, net ............................................................................. 6,855 6,719
Intangible assets, net ........................................................................ 7,790 10,271
Goodwill, net ................................................................................. 10,707 10,707
Other assets .................................................................................. 2,197 2,361
--------- ---------
Total assets ............................................................................ $ 105,138 $ 124,788
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................................... $ 1,151 $ 2,074
Accrued compensation ....................................................................... 1,999 3,574
Accrued expenses ........................................................................... 2,382 3,063
Deferred revenue ........................................................................... 7,971 6,125
Current portion of notes payable ........................................................... 670 892
--------- ---------
Total current liabilities ............................................................... 14,173 15,728
Notes payable, net of current portion ......................................................... 901 1,201
--------- ---------
Total liabilities ....................................................................... 15,074 16,929
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value; 10,000,000 shares authorized; zero shares issued and
outstanding ............................................................................. -- --
Common stock, $0.001 par value; 100,000,000 shares authorized; 32,685,055 and 32,347,954
shares issued and outstanding, respectively ............................................. 33 32
Additional paid-in capital ................................................................. 235,410 234,563
Deferred stock compensation ................................................................ (9,758) (13,889)
Accumulated other comprehensive loss ....................................................... (23) (46)
Accumulated deficit ........................................................................ (135,598) (112,801)
--------- ---------
Total stockholders' equity .............................................................. 90,064 107,859
--------- ---------
Total liabilities and stockholders' equity .............................................. $ 105,138 $ 124,788
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
1
SPEECHWORKS INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands, except per share data)
Revenues:
Product licenses ................................................... $ 5,016 $ 5,806 $ 9,611 $ 11,898
Professional services .............................................. 5,030 3,779 10,235 8,273
Other revenues ..................................................... 316 899 665 1,851
Non-cash stock compensation ........................................ (630) (244) (1,306) (918)
-------- -------- -------- --------
Total revenues .................................................. 9,732 10,240 19,205 21,104
Cost of revenues:
Cost of product licenses ........................................... 109 73 145 127
Cost of professional services -- non-cash stock compensation ....... 154 154 309 308
-- all other expenses ................ 3,463 3,325 6,641 7,029
Cost of other revenues ............................................. 198 752 563 1,503
Amortization of purchased technology ............................... 283 283 565 566
-------- -------- -------- --------
Total cost of revenues .......................................... 4,207 4,587 8,223 9,533
-------- -------- -------- --------
Gross profit .......................................................... 5,525 5,653 10,982 11,571
-------- -------- -------- --------
Operating expenses:
Selling and marketing -- non-cash stock compensation ............... 1,035 1,421 2,024 2,412
-- all other expenses ........................ 7,810 7,708 15,531 14,770
Research and development -- non-cash stock compensation ............ 140 140 280 280
-- all other expenses ..................... 4,180 4,620 8,201 8,727
General and administrative -- non-cash stock compensation .......... 106 106 212 212
-- all other expenses ................... 2,636 4,241 5,830 7,637
Amortization of intangible assets .................................. 958 1,627 1,916 3,254
-------- -------- -------- --------
Total operating expenses ........................................ 16,865 19,863 33,994 37,292
-------- -------- -------- --------
Loss from operations .................................................. (11,340) (14,210) (23,012) (25,721)
Interest income ....................................................... 276 1,051 576 2,555
Interest expense ...................................................... (21) (13) (38) (28)
Other expenses, net ................................................... (118) (141) (229) (171)
-------- -------- -------- --------
Loss before income taxes .............................................. (11,203) (13,313) (22,703) (23,365)
Provision (benefit) for income taxes .................................. 27 (45) 94 (19)
-------- -------- -------- --------
Net loss .............................................................. $(11,230) $(13,268) $(22,797) $(23,346)
======== ======== ======== ========
Basic and diluted net loss per common share ........................... $ (0.34) $ (0.41) $ (0.70) $ (0.74)
Shares used in computing basic and diluted net loss per common share .. 32,598 32,031 32,512 31,721
The accompanying notes are an integral part of these
consolidated financial statements.
2
SPEECHWORKS INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Six Months Ended
----------------
June 30,
--------
2002 2001
---- ----
(in thousands)
Cash flows from operating activities:
Net loss .................................................................................. $(22,797) $(23,346)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ......................................................... 1,624 1,462
Amortization of intangible assets ..................................................... 2,481 3,820
Stock compensation expense ............................................................ 4,131 4,130
Provision for doubtful accounts ....................................................... 62 196
Changes in operating assets and liabilities, net of effect of acquisition:
Accounts receivable ............................................................... (954) 964
Prepaid expenses and other current assets ......................................... 571 (200)
Other assets ...................................................................... 164 23
Accounts payable .................................................................. (923) 334
Accrued compensation .............................................................. (1,575) (1,771)
Accrued other expenses ............................................................ (681) (573)
Deferred revenue .................................................................. 1,846 (480)
-------- --------
Net cash used in operating activities ........................................... (16,051) (15,441)
-------- --------
Cash flows from investing activities:
Purchases of fixed assets ................................................................. (1,760) (2,096)
Cash paid to acquire business, including acquisition costs, net of cash acquired .......... -- (5,379)
Purchases of marketable securities ........................................................ -- (41,730)
Maturities of marketable securities ....................................................... 8,185 23,316
-------- --------
Net cash provided by (used in) investing activities ............................. 6,425 (25,889)
-------- --------
Cash flows from financing activities:
Principal payments on notes payable ....................................................... (522) (251)
Proceeds from exercise of common stock options and warrants ............................... 848 824
-------- --------
Net cash provided by financing activities ....................................... 326 573
-------- --------
Effects of changes in exchange rates on cash .............................................. 23 (46)
-------- --------
Net decrease in cash and cash equivalents ....................................... (9,277) (40,803)
Cash and cash equivalents, beginning of period ............................................ 55,534 99,203
-------- --------
Cash and cash equivalents, end of period .................................................. $ 46,257 $ 58,400
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
3
SPEECHWORKS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The unaudited consolidated financial statements have been prepared by the
Company in accordance with instructions to Form 10-Q and Article 10 of
Regulation S-X. The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated. In the opinion of management, all
adjustments, consisting only of normal recurring adjustments, considered
necessary for a fair presentation have been included. The results of operations
for the three and six month periods ended June 30, 2002 are not necessarily
indicative of the results to be expected for the full year or for any future
periods. Certain amounts in the prior year's financial statements have been
reclassified to conform to current year presentation. These reclassifications
had no effect on reported net loss. The accompanying consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements for the year ended December 31, 2001 contained in the Company's 2001
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
2. Net Loss Per Share
Basic and diluted net loss per common share is computed by dividing net
loss by the weighted average number of common shares outstanding. There is no
difference between basic and diluted net loss per share for all periods
presented since potential common shares from the exercise of common stock
options and warrants were anti-dilutive for all periods presented. The
calculation of diluted net loss per common share for the three- and six-month
periods ended June 30, 2002 and 2001 does not include 8,094,235 and 7,061,793
potential shares of common stock equivalents, respectively, related to
outstanding common stock options and warrants.
3. Comprehensive Loss
For the three and six months ended June 30, 2002 and 2001, total
comprehensive loss was as follows:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- ----------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net loss $ (11,230) $ (13,268) $ (22,797) $(23,346)
Other comprehensive income (loss):
Unrealized gain (loss) on investments 9 7 (2) 10
Foreign currency translation adjustment 108 (15) 25 (58)
--------- --------- --------- --------
Total other comprehensive loss 117 (8) 23 (48)
--------- --------- --------- --------
Total comprehensive loss $ (11,113) $ (13,276) $ (22,774) $(23,394)
========= ========= ========= ========
4
4. Deferred Stock Compensation
In connection with the sale of common stock in private placements to
America Online ("AOL") and Net2Phone, concurrent with the Company's initial
public offering in August 2000, the Company recorded deferred stock compensation
within stockholders' equity of $5.4 million. This amount represents the
difference between the price of the common stock of the Company sold in the
public offering of $20.00 per share and the $12.46 per share price paid by AOL
and Net2Phone. Additionally, on June 30, 2000, SpeechWorks issued a warrant to
purchase 765,422 shares of common stock to AOL in connection with a long-term
marketing arrangement. The estimated value of this warrant upon its issuance,
utilizing the Black-Scholes valuation model, of $11.2 million was recorded as
deferred stock compensation within stockholders' equity. The aggregate amount of
$16.6 million is presented as a reduction of stockholders' equity and is being
amortized to the statement of operations over the three-year term of the
concurrently entered arrangements. Prior to January 1, 2002, in each reporting
period, the amortization of the common stock issued below fair market value was
reflected first as a reduction of revenues resulting from the arrangements
during the reporting period. To the extent that the amortization exceeded such
revenues, the residual was reflected as selling and marketing expense. The
amortization of the warrant value was recognized as selling and marketing
expense.
Effective January 1, 2002, SpeechWorks adopted Emerging Issues Task Force
issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer or
a Reseller of the Vendor's Products ("EITF 01-09"). EITF 01-09 addresses whether
a vendor should recognize consideration, including equity instruments, given to
a customer as an expense or an offset to revenue being recognized from that same
customer. Consideration given to a customer is presumed to be a reduction of
revenue unless both the following conditions are met:
o SpeechWorks receives an identifiable benefit in exchange for the
consideration, and the identified benefit is sufficiently separable from
the customer's purchase of SpeechWorks' products and services such that
SpeechWorks could have purchased the products from a third party, and
o SpeechWorks can reasonably estimate the fair value of the benefit received.
If both of these conditions are met, consideration paid to the customer may
be recognized as expense. If consideration, including equity instruments, does
not meet the above criteria, SpeechWorks must characterize the recognition of
such consideration as a reduction of revenue, to the extent there is cumulative
revenue from such customer or reseller. Any amount in excess of cumulative
revenue being recognized from that customer or reseller for such consideration
is recorded as an expense.
Upon adopting EITF 01-09, SpeechWorks determined that the AOL and Net2Phone
arrangements were required to be accounted for in accordance with EITF 01-09.
The Company determined that these arrangements did not meet the condition that a
sufficiently separable benefit had been received from AOL and Net2Phone;
accordingly, recognition of the consideration must be recorded as a reduction of
cumulative revenue from the respective customer. Since SpeechWorks had
recognized cumulative revenue under these arrangements as of June 30, 2001 in
excess of amounts previously recorded as a revenue offset, for the three and six
months ended June 30, 2001, SpeechWorks reclassified an additional $15,000 and
$377,000, respectively, of previously recognized selling and marketing non-cash
stock compensation expense as an offset to revenue resulting in a total offset
of $244,000 and $918,000, respectively. For the three and six months ended June
30, 2002, the Company recognized $630,000 and $1,306,000, respectively, as an
offset to revenue associated with these arrangements, in accordance with EITF
01-09. Amounts of $758,000 and $1,472,000, which exceeded the amounts of
cumulative revenue recognized under each of the arrangements during the three
and six months ended June 30, 2002, respectively, and amounts of $1,145,000 and
$1,861,000 during the three and six months ended June 30, 2001, respectively,
were included as selling and marketing non-cash stock compensation expense.
In June 2002, the Company modified its arrangement with Net2Phone to, among
other items, extend the expiration date of the agreement for an additional two
years, to June 30, 2005. As a result of this amendment, the Company modified the
period over which the related deferred compensation is being recorded to reflect
the extended expiration date. Accordingly, on July 1, 2002, the Company began
recognizing the remaining deferred compensation balance over the period from
July 1, 2002 to June 30, 2005.
5
5. Intangible Assets and Goodwill
The following table summarizes intangible assets:
June 30, 2002 December 31, 2001
------------- -----------------
(in thousands)
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-----------------------------------------------------------------------
Acquired intellectual property and
collaborative rights $ 11,497 $ 7,664 $ 11,497 $ 5,748
Completed technology 5,653 1,696 5,653 1,131
-----------------------------------------------------------------------
$17,150 $ 9,360 $ 17,150 $ 6,879
=======================================================================
On June 5, 2000, the Company entered into a development and license
agreement with AT&T Corp. to develop and sell products that use AT&T speech
technology. Pursuant to this agreement, in exchange for 1,045,158 shares of the
Company's common stock, the Company received development and distribution
licenses to AT&T's speech software, text-to-speech software and certain other
technology related to computer processing of the human voice. In addition, the
parties agreed to collaborate in certain marketing efforts. In connection with
this agreement, the Company recorded $11,497,000 of acquired intellectual
property and collaborative rights, equal to the fair value of the common stock
issued, which is being amortized on a straight-line basis over a three-year
period. Amortization expense for the acquired intellectual property and
collaborative rights was $958,000 and $1,916,000 for each three and six month
period ended June 30, 2002 and 2001, respectively.
On January 5, 2001, the Company acquired all of the outstanding capital
stock of Eloquent Technology, Inc. ("ETI"), a supplier of speech synthesis, or
text-to-speech technology. In connection with the acquisition, the Company paid
$5,250,000 in cash and issued 299,873 shares of its common stock valued at
$13,457,000. Additionally, the Company incurred acquisition-related costs of
$132,000, which are included in the total purchase price for accounting
purposes. The acquisition was accounted for using the purchase method of
accounting. Accordingly, the fair market values of the acquired assets and
assumed liabilities have been included in the Company's consolidated financial
statements as of the acquisition date, and the results of operations of ETI have
been included in the Company's consolidated financial statements thereafter. The
purchase price of $18,839,000 was allocated to net tangible assets and
liabilities acquired of ($196,000), completed technology of $5,653,000 and
goodwill of $13,382,000. The completed technology, reported as intangible
assets, is being amortized on a straight-line basis through December 2005. For
each three and six month period ended June 30, 2002 and 2001, the Company
recorded amortization expense for completed technology of $283,000 and $566,000,
respectively.
As of January 1, 2002, the Company ceased amortization of goodwill in
compliance with Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets; for the three and six months ended June
30, 2001, the Company recorded $669,000 and $1,338,000, respectively, of
goodwill amortization. Under SFAS 142, the Company was required to test all
existing goodwill for impairment as of January 1, 2002, on a reporting unit
basis. As allowed by SFAS 142, the Company completed this transitional
impairment analysis during the second quarter of 2002. A reporting unit is an
operating segment, or one level below an operating segment, for which discrete
financial information is prepared and regularly reviewed by management, in which
case such component is the reporting unit. As of June 30, 2002, the Company
determined that it operates in one reporting unit. As a result, the Company's
impairment analysis was completed by comparing the Company's consolidated book
value to its fair market value, as determined by its common stock fair value.
Future impairment analyses will be completed on the same basis. Based on the
analysis completed, the Company determined that the goodwill recorded was not
impaired, and as such, no impairment charge has been recorded. Additional
impairment analyses will be completed at least annually, or more frequently when
events and circumstances occur indicating that the recorded goodwill might be
impaired. In August 2002, the Company's market value fell below its book value.
To the extent that the market value remains below the book value, the Company
may be
6
required to record an impairment of its goodwill and such amounts may be
material to its operating results.
The Company expects quarterly amortization of all intangible assets to be
$1.2 million through the quarter ended June 30, 2003; thereafter, the Company
expects quarterly amortization to be $283,000 through the quarter ended December
31, 2005.
The following summary reflects the results of operations as if SFAS 142 had
been applicable at the beginning of the periods presented:
Three months ended Six months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
(in thousands, except per share data)
Reported net loss $(11,230) $(13,268) $(22,797) $(23,346)
Goodwill amortization -- 669 -- 1,338
-----------------------------------------------
Adjusted net loss $(11,230) $(12,599) $(22,797) $(22,008)
===============================================
Reported basic and diluted net loss per common share $ (0.34) $ (0.41) $ (0.70) $ (0.74)
Goodwill amortization -- 0.02 -- 0.04
-----------------------------------------------
Adjusted basic and diluted net loss per common share $ (0.34) $ (0.39) $ (0.70) $ (0.70)
===============================================
6. Reimbursable Out-Of-Pocket Expenses
Effective January 1, 2002, the Company adopted EITF issue No. 01-14, Income
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred ("EITF 01-14"). EITF 01-14 requires that reimbursements
received for out-of-pocket expenses incurred be characterized as revenue in the
statement of operations with offsetting costs recorded as costs of revenue. The
Company's out-of-pocket expenses generally include, but are not limited to,
expenses related to airfare, mileage, hotel stays and out-of-town meals. Upon
adoption of EITF 01-14, the Company reclassified all prior periods to conform to
current year presentation. As a result of adoption of EITF 01-14, the Company
has included $76,000 and $144,000 during the three and six months ended June 30,
2002, respectively, as well as $106,000 and $232,000 during the three and six
months ended June 30, 2001, respectively, in professional service revenues, with
an equal amount of professional services cost of revenue, for reimbursable
out-of-pocket expenses.
7. Subsequent Events
On July 3, 2002, the Company announced a restructuring plan to decrease
costs over the next four quarters, including a reduction of its worldwide
workforce by approximately 17%, or 71 employees. In connection with this plan,
the Company expects to record an approximately $2 million charge to operating
expenses during the quarter ending September 30, 2002, relating primarily to
severance and related costs of terminated employees. The Company expects that
the majority of the costs associated with severance and related benefits to be
paid over the next six months and will be funded from working capital.
On July 22, 2002, the Company acquired certain technologies related to
speaker verification from SpeakEZ, Inc., a wholly owned subsidiary of T-NETIX,
Inc. Based upon the fair market value of the Company's common stock, cash and
the assumption of a long-term commitment to an unrelated third party, the
acquisition was valued at approximately $1.1 million.
8. Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring) ("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. The Company will adopt SFAS 146 beginning
in 2003 and does not expect its adoption will have a material impact on its
financial position or results of operations.
8
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and related notes included elsewhere in this
Quarterly Report on Form 10-Q. The results shown herein are not necessarily
indicative of the results to be expected for the full year or any future
periods.
This Quarterly Report on Form 10-Q contains forward-looking statements,
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act, including but not limited to our expectations for results over the
balance of the year, regarding expense trends, cash positions and our outlook
for the Company, as well as our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in this Quarterly
Report on Form 10-Q are based on information available to us on the date hereof,
and we assume no obligation to update any such forward-looking statements, even
if our estimates change. Important factors that could cause future results to
differ materially from such expectations include: spending patterns of our
domestic and international customers based upon economic conditions; the timing
of sales of the Company's products and services; market acceptance of the
Company's speech-activated systems; the Company's reliance on a limited number
of large orders for much of its revenue, including international orders;
uncertainties related to current economic, political and national security
conditions; the Company's ability to develop new products and services in the
face of rapidly evolving technology; the Company's ability to effectively
integrate operations of any acquired companies; the uncertainties related to the
Company's planned international operations; the Company's ability to manage
growth of its business; the Company's ability to protect its intellectual
property; the Company's reliance on resellers and original equipment
manufacturers for a significant portion of its sales; the Company's ability to
respond to competitive developments; and the Company's reliance on attracting,
retaining and motivating key technical and management personnel. These and other
important factors are detailed in the Company's filings with the Securities and
Exchange Commission. As a result of these and other important factors, there can
be no assurances that the Company will not experience material fluctuations in
future operating results on a quarterly or annual basis.
Overview
We are a leading provider of software products and professional services
that enable enterprises, carriers and voice portals to offer automated,
speech-activated services over any telephone. With our network-based speech
recognition solutions, consumers can direct their own calls, obtain information
and conduct transactions automatically, simply by speaking naturally over any
telephone, anytime. With our network-based text-to-speech ("TTS") solutions,
consumers can experience natural sounding synthesized speech that supports a
number of applications, including unified messaging. With our embedded
technologies in both speech recognition and TTS, SpeechWorks can enable
automobile and device manufacturers to support both speech recognition and TTS
on the device or in the automobile itself.
For network-based speech applications, we currently offer the OpenSpeech
product suite, a line of speech recognition solutions for over-the-telephone
applications designed to meet industry standards, with specific tuning for high
performance over wireless networks. The OpenSpeech Product line includes the
OpenSpeech Recognizer; OpenSpeech DialogModules, building blocks that support
VoiceXML standards; OpenSpeech Platform Integration Kit, a `get started' toolkit
for platform partners to accelerate support for VoiceXML; and OpenSpeech Server,
a standards-based client-server architecture. In addition to the OpenSpeech
line, we offer our industry leading legacy recognizer, SpeechWorks 6.5, and the
SpeechSite package. Our TTS, or speech synthesis network-based solution,
Speechify, allows callers to hear text read to them by a computer in a natural
sounding voice. Finally, we offer a speaker verification solution, called
SpeechSecure, which authenticates callers by their unique voiceprint. We
complement our suite of network-based products with a professional services
organization that offers a range of services, including application development
and project management.
Suitable for incorporation in mobile devices, automobiles and set-top
boxes, we offer our embedded speech technology product, Speech2Go, a recognizer
that supports a 1,000 word vocabulary with a footprint under 8MB. Our embedded
TTS product, ETI-Eloquence, is highly flexible and features a footprint of
approximately 1MB.
9
Since shipping our first products in 1996, we have received numerous awards
for our product capabilities and our industry leadership, including Industry
Week's Technology of the Year Award and Frost & Sullivan's Market Strategy
Leadership Award. To date, we have licensed our software to more than 500
clients worldwide in a variety of industries including retail, financial
services, pharmaceuticals, telecommunications, technology, distribution and
travel. Our clients include America Online, Amtrak, AT&T, Bell Canada,
Continental Airlines, Convergys, CSFB, E*TRADE, GMAC Commercial Mortgage,
Hyundai Securities, McKessonHBOC, National Weather Service, NetByTel, Nortel
Networks, The Hartford Insurance, United Airlines, Wachovia Corporation and
Yahoo .
We market our products and services primarily in North America, Europe, and
Asia-Pacific. We sell our products and professional services to our enterprise
and carrier clients through our direct sales force, and indirectly through
value-added resellers and original equipment manufacturers ("OEMs"). We also
sell our products and services to service bureaus, application service
providers, and portals that use them to offer speech-enabled services to their
customers. We currently have relationships with over 150 value-added resellers
and OEMs.
For the three months ended June 30, 2002, one customer accounted for over
10% of our total revenue. For the three months ended June 30, 2001, a different
customer accounted for over 10% of our total revenue. For the six months ended
June 30, 2002, no customer accounted for greater than 10% of our total revenue;
for the six months ended June 30, 2001, there was one customer that accounted
for greater than 10% of our total revenue. International revenues represented
21.4% and 19.3% of total revenues for the three and six months ended June 30,
2002, respectively, and 13.1% and 11.1% of total revenues for the three and six
months ended June 30, 2001, respectively.
Prior to 2002, general and administrative expenses included all occupancy
related expenses and all depreciation expense. Beginning in 2002, we are
allocating these shared costs to cost of professional services, selling and
marketing expense and research and development expense, based upon employee
headcount in these areas. We believe that this more accurately reflects our
results of operations. Prior year financial statements amounts have been
reclassified to conform to current year presentation. These reclassifications
had no effect on reported net loss.
Our cost of revenue consists of the cost of our product licenses, cost of
professional services and cost of resold hardware and services, including
SpeechSite hardware. Cost of product licenses consists of royalties that we pay
to Massachusetts Institute of Technology and International Business Machines
that are equal to a percentage of our product license revenue for automated
speech recognition and certain text-to-speech products, respectively, as well as
royalties paid to other vendors under specific technology licensing
arrangements. Cost of professional services revenue consists of our direct labor
and related benefits costs, taxes, project-specific travel expenses and
allocated corporate overhead costs. Cost of other revenue consists of the cost
of third-party hardware, which we resell, and payments to the third-party
providers of outsourced facilities management services and SpeechSite hardware.
Amortization of purchased technology represents expense recognition of
technology acquired in the purchase of Eloquent Technology, Inc. ("ETI") in
January 2001. These technologies are being amortized over their expected useful
life of 60 months.
Our selling and marketing expenses consist primarily of compensation and
related expenses, sales commissions and travel expenses, along with other
marketing expenses, including advertising, trade shows, public relations, direct
mail campaigns, seminars and other promotional expenses and allocated corporate
overhead costs. Our research and development expenses consist primarily of
compensation and related expenses for our personnel and, to a lesser extent,
independent contractors, who work on new products, enhancements to existing
products and the implementation of our products in new languages and allocated
corporate overhead costs. Our general and administrative expenses consist
primarily of compensation for our administrative, financial and information
technology personnel and company-wide professional fees, including recruiting,
legal and accounting fees, as well as increases to our allowance for doubtful
accounts.
We receive interest income by investing the proceeds that we raised in our
prior equity financings and our initial public offering. Interest expense is
incurred primarily from amounts we owe under our line of credit and capital
lease lines of credit.
Due to our operating losses, we have recorded no provision or benefit for
U.S. federal or state income taxes in relation to these losses for any period
since our inception. As of December 31, 2001, we had $47.3 million of net
operating loss carryforwards for federal income tax purposes, which expire
beginning in 2011. Our ability to use these net operating
10
losses in future periods is not sufficiently assured and, therefore, these tax
assets are carried at no value on the balance sheet.
On July 3, 2002, we announced a restructuring plan to decrease costs over
the next four quarters, including a reduction of our worldwide workforce by
approximately 17%, or 71 employees. In connection with this plan, we expect to
record an approximately $2 million charge to operating expenses during the
quarter ending September 30, 2002, relating primarily to severance and related
costs of terminated employees. We expect that the majority of the costs
associated with the severance and related benefits to be paid over the next six
months will be funded from working capital.
On July 22, 2002, we acquired certain technologies related to speaker
verification from SpeakEZ, Inc., a wholly owned subsidiary of T-NETIX, Inc.
Based upon the fair market value of our common stock, cash and the assumption of
a long-term commitment to an unrelated third party, the acquisition was valued
at approximately $1.1 million.
Critical Accounting Policies and Significant Judgments and Estimates
Our critical accounting policies and estimates are as follows:
o Revenue recognition;
o Estimating valuation allowances, specifically the allowance for
doubtful accounts;
o Valuation of long-lived and intangible assets and goodwill;
o Acquisition accounting; and
o Stock compensation accounting.
Revenue recognition. We derive our revenue from three sources. We sell
product licenses, either directly to clients or through third-party distribution
channels. To support the sale, installation and operation of our products, we
also provide professional services, consisting of developing custom software
applications, user interface design consulting, project management, training,
maintenance and technical support. We resell hardware products made by third
parties, including products such as voice-processing equipment that run our
software, as well as facilities management services that are provided by
third-party call-centers. We expect the resale component of our total revenues
to decrease as a percentage of our total revenues over time. We only resell
hardware or facilities management services when clients expressly request that
we do so and therefore, such revenue is considered other revenue.
We recognize revenue in accordance with Statement of Position 97-2 Software
Revenue Recognition ("SOP 97-2"), as amended by Statement of Position 98-9, and
the Securities and Exchange Commission's Staff Accounting Bulletin No. 101
Revenue Recognition in Financial Statements. We recognize revenue from the
licensing of software, provided that no significant obligations remain, evidence
of the arrangement exists, the fees are fixed or determinable, and
collectibility is reasonably assured, as follows:
o When we license our software and do not provide any professional
services, we recognize the license revenue when we ship the software
to the client.
o When OEM's license our software, we receive a royalty. We recognize
the revenue from these royalties upon delivery to the third party when
such information is available, or when the OEM of the sale notifies
us.
o When we license software in connection with custom software
applications developed by us, we recognize the revenue over the life
of the development project, concurrent with any related services fees
as described below.
Typically, we do not consider professional services, other than the
development of custom software applications, to be essential to the
functionality of the other elements of our software arrangements. We recognize
the revenue from professional services, provided that evidence of the
arrangement exists, the fees are fixed or determinable and collectibility is
reasonably assured, as follows:
o When we license software in connection with custom software
applications developed by us, we allocate the revenue between product
license revenue and professional services revenue using the fair value
of
11
professional services, based on the fee charged when professional
services are sold separately; all remaining amounts are recorded as
product license revenue.
o When we provide professional services for a fixed fee, we recognize
revenue from the fees for such services and any related software
licenses as we complete the project using the percentage-of-completion
method. We determine the percentage-of-completion by comparing the
labor hours we have incurred to date to our estimate of the total
labor hours required to complete the project based on regular
discussions with our project managers. This method is used because we
consider expended labor hours to be the most available measure of
progress on these projects. Adjustments to contract estimates are made
in the periods in which facts resulting in a change become known.
Significant judgments and estimates are involved in determining the
percent complete of each contract. Different assumptions could yield
materially different results.
o When we provide services on a time and materials basis, we recognize
revenue as we perform the services, based on actual time incurred.
o When we provide support and maintenance services, we recognize the
revenue ratably over the term of the related contracts, typically one
year.
Our sales frequently include, under related contracts, software licenses,
related professional services and a maintenance and support arrangement. The
total contract value is attributed first to the maintenance and support
arrangement based on its fair value, equal to its stated list price as a fixed
percentage of the related software product's price. The remainder of the total
contract value is then attributed to the software license and related
professional services, with the effect that discounts inherent in the total
contract value are attributed to the software license and related professional
services. For revenue classification, we allocate the contract value using the
fair value of professional services, based on the fee charged when services are
sold separately, and record that as professional services revenue; all
remaining amounts are recorded as product license revenue.
Under our maintenance and support arrangements, we offer unspecified
upgrades and enhancements on software products only on a when-and-if-available
basis. Typically, we do not contract in advance for specified upgrades,
enhancements or additional software products. In arrangements where we agree to
provide additional products, specified upgrades or enhancements, we allocate
revenue from the entire arrangement among all elements of the order, including
future deliverables, based on the relative fair values, based on the fee charged
when products are sold separately, of each element of the arrangement. We defer
recognition of revenue allocated to the specified future deliverable until
delivery has occurred and any remaining contractual terms relating to that
element have been met. In situations where fair value does not exist for all
elements to be delivered under the arrangement, we defer all revenue from the
arrangement until the earlier of the date when all elements have been delivered
or fair value exists for all undelivered elements. We do not offer rights of
return to our customers. In situations where negotiated contracts require rights
of return, we do not recognize revenue until all significant obligations have
been delivered and accepted by the client.
When we resell hardware, we recognize the revenue when we deliver the
hardware. We recognize the revenue from resold facilities management services in
the period that the services are provided.
At the time of the transaction, we assess whether the fee associated with
our revenue transaction is fixed or determinable based on the payment terms
associated with the transaction. If a significant portion of a fee is due after
our normal payment terms, which are 30 to 90 days from the invoice date, we
account for the fee as not being fixed or determinable. In these cases, we
recognize revenue as the fees become due.
We assess collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the customer
by reviewing credit reports from Dun and Bradstreet, as well as bank and trade
references. We do not request collateral from our customers. If we determine
that collection of a fee is not reasonably assured, we defer the fee and
recognize revenue at the time collection becomes reasonably assured, which is
generally upon receipt of cash. Significant judgments and estimates are involved
in assessing the collectibility of customer transactions. Different assumptions
could yield materially different results.
12
Allowance for doubtful accounts. Management must make estimates of any
uncollectibility of our accounts receivable resulting from the inability of our
customers to make payments. Management analyzes accounts receivable and analyzes
historical bad debts, customer concentrations, customer credit-worthiness,
current economic trends and changes in our customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts. We record the
allowance for doubtful accounts on a specific identification basis. If the
financial condition of our customers deteriorates after entering into a revenue
arrangement resulting in an impairment of their ability to make payments beyond
that estimated by management, additional allowances may be required. Our
accounts receivable balance was $13.6 million and $12.7 million, net of
allowance for doubtful accounts of $907,000 and $1.4 million, as of June 30,
2002 and December 31, 2001, respectively.
Long-lived assets. We assess the impairment of identifiable intangibles,
long-lived assets and goodwill whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors we consider
important which could trigger an impairment review include the following:
o Significant underperformance relative to expected historical or
projected future operating results;
o Significant changes in the manner of our use of the acquired assets or
the strategy for our overall business; and
o Significant negative industry or economic trends.
When we determine that the carrying value of intangibles, long-lived assets
and goodwill may not be recoverable based upon the existence of one or more of
the above indicators of impairment, we measure any impairment based on projected
undiscounted cash flows from these assets, considering a number of factors
including past operating results, budgets, economic projections, market trends
and product development cycles. Net intangible assets, long-lived assets, and
goodwill amounted to $25.4 million and $27.7 million as of June 30, 2002 and
December 31, 2001, respectively.
Acquisition accounting. In January 2001, we acquired Eloquent Technology,
Inc. (ETI) and determined the fair market value of assets acquired and
liabilities assumed. The principal asset acquired was completed technology
related to text-to-speech, and the tools used to further develop multiple
languages. The fair value of this asset was estimated based on the discounted
future cash flows from the sale of the completed technology. We estimated that
we would generate enough revenue from the licensing of this technology to meet
the minimum royalty payments owed to IBM under a development and royalty
agreement. This agreement with IBM has minimum royalties due through 2005. We
estimated that the useful life of the acquired technology would be five years.
Significant judgments and estimates are involved in determining the fair market
value of assets acquired and their useful lives. Different assumptions could
yield materially different results.
Stock compensation accounting. In connection with the grant of certain
options to employees through June 30, 2000, we recorded deferred stock
compensation within stockholders' equity of $10.7 million, representing the
difference between the estimated fair value of the common stock for accounting
purposes and the option exercise price of these options at the date of grant.
Such amount is presented as a reduction of stockholders' equity and is being
amortized over the vesting period of the applicable options.
Additionally, On August 1, 2000, in connection with the sale of common
stock in private placements to Net2Phone and America Online (AOL), concurrent
with our initial public offering, we recorded deferred stock compensation within
stockholders' equity of $5.4 million. This amount represents the difference
between the price of the public offering of $20.00 per share and the price paid
by Net2Phone and AOL of $12.46 per share. This amount is presented as a
reduction of stockholders' equity and is being amortized to the statement of
operations over the three-year term of the concurrently entered arrangements. In
each reporting period, such amortization is reflected as a reduction of revenues
resulting from the arrangements; to the extent that the amortization exceeds
such revenues, the residual is reflected in operating expenses.
On June 30, 2000, we issued a warrant to purchase up to 765,422 shares of
common stock to AOL in connection with a long-term marketing arrangement. In
accordance with EITF 96-18, the estimated value of this warrant upon its
issuance, utilizing the Black-Scholes valuation model, was $11.2 million, which
is being amortized to selling and marketing stock compensation expense over the
three-year term of the agreement. The warrant, which has an exercise price of
$12.46 per share, becomes exercisable upon the earlier of June 30, 2002 or in
three equal installments upon the achievement of certain performance targets.
The warrant may be exercised at the option of the holder, in whole or in part,
at any time on or
13
before the fifth anniversary from the date that portion of the warrant becomes
exercisable. As of December 31, 2000, in accordance with the original terms of
the warrant, AOL exercised a portion of their warrant for the purchase of
510,281 shares of common stock in a cashless exercise, resulting in the Company
issuing 365,248 shares of common stock. As of June 30, 2002 the remaining
warrant to purchase up to 255,141 shares of common stock was exercisable.
Significant judgments and estimates were involved in determining the proper
valuation of deferred stock compensation related to employee stock options
because at the time of grant there was no available market for our common stock.
Significant judgments and estimates were involved in determining the proper
valuation of stock issued at below fair market values and warrants, as well as
their useful lives. Different assumptions would have yielded materially
different results.
Effective January 1, 2002, we adopted Emerging Issues Task Force issue No.
01-09, Accounting for Consideration Given by a Vendor to a Customer or a
Reseller of the Vendor's Products ("EITF 01-09"). EITF 01-09 addresses whether a
vendor should recognize consideration, including equity instruments, given to a
customer as an expense or an offset to revenue being recognized from that same
customer. Consideration given to a customer is presumed to be a reduction of
revenue unless both the following conditions are met:
o We receive an identifiable benefit in exchange for the consideration,
and the identified benefit is sufficiently separable from the
customer's purchase of our products and services such that we could
have purchased the products from a third party, and
o we can reasonably estimate the fair value of the benefit received.
If both of these conditions are met, consideration paid to the customer may
be recognized as expense. If consideration, including equity instruments, does
not meet the above criteria, we must characterize the recognition of such
consideration as a reduction of revenue, to the extent there is cumulative
revenue from such customer or reseller. Any amount in excess of cumulative
revenue being recognized from that customer or reseller for such consideration
is recorded as an expense.
Upon adopting EITF 01-09, we determined that our arrangements with AOL and
Net2Phone were required to be accounted for in accordance with EITF 01-09. We
determined that these arrangements did not meet the condition that a
sufficiently separable benefit had been received from AOL and Net2Phone;
accordingly, recognition of the consideration must be recorded as a reduction of
cumulative revenue from the respective customer. Since we had recognized
cumulative revenue under these arrangements as of June 30, 2001 in excess of
amounts previously recorded as a revenue offset, for the three and six months
ended June 30, 2001, we reclassified an additional $15,000 and $377,000,
respectively, of previously recognized selling and marketing non-cash stock
compensation expense as an offset to revenue resulting in a total offset of
$244,000 and $918,000, respectively. For the three and six months ended June 30,
2002, we recognized $630,000 and $1,306,000, respectively, as an offset to
revenue associated with these arrangements, in accordance with EITF 01-09.
Amounts of $758,000 and $1,472,000, which exceeded the amounts of cumulative
revenue recognized under each of the arrangements during the three and six
months ended June 30, 2002, respectively, and amounts of $1,145,000 and
$1,861,000 during the three and six months ended June 30, 2001, respectively,
were included as selling and marketing non-cash stock compensation expense.
In June 2002, the Company modified its arrangement with Net2Phone to, among
other items, extend the expiration date of the agreement for an additional two
years, to June 30, 2005. As a result of this amendment, the Company modified the
period over which the related deferred compensation is being recorded to reflect
the extended expiration date. Accordingly, on July 1, 2002, the Company began
recognizing the remaining deferred compensation balance over the period from
July 1, 2002 to June 30, 2005.
Identifying transactions that are within the scope of EITF 01-09,
determining whether those transactions meet the criteria for recognition as an
expense and determining the methodology of cost recognition associated with
these arrangements, requires us to make significant judgments. If we reached
different conclusions, reported revenue could be materially different.
14
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated as a percentage of our total revenues.
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
Product licenses .................................................. 52% 57% 50% 56%
Professional services ............................................. 52 37 53 39
Other revenues .................................................... 3 8 3 9
Non-cash stock compensation ....................................... (7) (2) (6) (4)
---- ---- ---- ----
Total revenues ................................................. 100% 100% 100% 100%
---- ---- ---- ----
Cost of revenues:
Cost of product licenses .......................................... 1% 1% 1% 1%
Cost of professional services -- non-cash stock compensation ...... 2 2 2 1
-- all other expenses ............... 35 32 34 33
Cost of other revenues ............................................ 2 7 3 7
Amortization of purchased technology .............................. 3 3 3 3
---- ---- ---- ----
Total cost of revenues ......................................... 43 45 43 45
---- ---- ---- ----
Gross profit ......................................................... 57 55 57 55
---- ---- ---- ----
Operating expenses:
Selling and marketing -- non-cash stock compensation .............. 11 14 11 12
-- all other expenses ....................... 80 75 81 70
Research and development -- non-cash stock compensation ........... 1 1 1 1
-- all other expenses .................... 43 45 43 41
General and administrative -- non-cash stock compensation ......... 1 1 1 1
-- all other expenses .................. 27 42 30 36
Amortization of intangible assets ................................. 10 16 10 16
---- ---- ---- ----
Total operating expenses ....................................... 173 194 177 177
---- ---- ---- ----
Loss from operations ................................................. (116) (139) (120) (122)
Interest income ...................................................... 3 10 3 12
Interest expense ..................................................... (1) -- -- --
Other expenses, net .................................................. (1) (1) (1) (1)
---- ---- ---- ----
Loss before income taxes ............................................. (115) (130) (118) (111)
Provision (benefit) for income taxes ................................. -- -- 1 --
---- ---- ---- ----
Net loss ............................................................. (115)% (130)% (119)% (111)%
==== ==== ==== ====
Comparison of the Three and Six Months Ended June 30, 2002 and 2001
Total revenues. Our total revenues, including non-cash stock compensation,
decreased by 5.0% to $9.7 million for the three-month period ended June 30, 2002
from $10.2 million for the same period in 2001. For the six-month period ended
June 30, 2002, our total revenues, including non-cash stock compensation,
decreased by 9.0% to $19.2 million from $21.1 million for the same period in
2001. International revenues increased by 56.0% to $2.1 million for the
three-month period ended June 30, 2002 from $1.3 million in the same period in
2001. For the six-month period ended June 30, 2002,
15
international revenues increased 57.6% to $3.7 million from $2.3 million in the
same period in 2001. International revenues represented 21.4% and 19.3% of total
revenues for the three and six months ended June 30, 2002, respectively, and
13.1% and 11.1% of total revenues for the three and six months ended June 30,
2001, respectively.
Revenues from product licenses. Revenues from the licensing of proprietary
software decreased 13.6% to $5.0 million for the three-month period ended June
30, 2002 from $5.8 million in the same period in 2001. For the six-month period
ended June 30, 2002, revenues from product licenses decreased 19.2% to $9.6
million from $11.9 million in the same period in 2001. This decline in product
licenses revenues resulted primarily from a slowdown in the economy, most
noticeably in the carrier market, as telecommunication companies continue to
report downturns in their businesses. Additionally, there was a decline in
demand from one reseller, who previously had accounted for over 10% of our
revenue for the three and six month periods ended June 30, 2001. A different
reseller represented over 10% of our revenue for the three months ended June 30,
2002, but this was not sufficient to offset the decline in revenue from the
other reseller.
Revenues from professional services. Revenues from fees we receive for
professional services increased 33.1% to $5.0 million in the three months ended
June 30, 2002 from $3.8 million in the same period in 2001. For the six-month
period ended June 30, 2002, revenues from professional services increased 23.7%
to $10.2 million from $8.3 million in the same period in 2001. The growth in
revenues from professional services resulted primarily from the increased demand
for custom speech applications from existing and new clients and increased
maintenance revenues from an expanding installed license base.
Other revenues. Other revenues from the resale of computer hardware and
facilities management services were $316,000 for the three-month period ended
June 30, 2002 compared to $899,000 for the same period in 2001. For the
six-month period ended June 30, 2002, other revenues were $665,000 compared to
$1.9 million for the same period in 2001. Other revenues accounted for 3.2% of
total revenues for the three-month period ended June 30, 2002 and 8.8% of total
revenues for the same period in 2001. For the six-month period ended June 30,
2002, other revenues represented 3.5% of total revenues compared to 8.8% of
total revenues for the same period in 2001. The decrease in other revenues
reflects fewer hardware platforms purchased directly from us as part of overall
client projects during 2002 compared to the same period in 2001.
Non-cash stock compensation offset to revenues. In connection with the sale
of common stock in private placements to AOL and Net2Phone in August 2000,
concurrent with our initial public offering, we recorded deferred stock
compensation, within stockholders' equity, of $5.4 million. This amount
represents the difference between the price of our common stock sold in our
public offering of $20.00 per share and the $12.46 per share price paid by AOL
and Net2Phone. This amount is presented as a reduction of stockholders' equity
and is being amortized to the statement of operations over the three-year term
of the concurrently entered arrangements. Prior to January 1, 2002, in each
reporting period, the amortization of this amount was reflected first as a
reduction of revenues resulting from the arrangements during the reporting
period and to the extent that the amortization exceeded such revenues, the
residual was reflected in operating expenses. Additionally, we issued a warrant
to purchase 765,422 shares of common stock to AOL in connection with a long-term
marketing arrangement. The estimated value of this warrant upon its issuance,
utilizing the Black-Scholes valuation model, was $11.2 million, which is being
amortized over the three-year term of the agreement.
Effective January 1, 2002, we adopted Emerging Issues Task Force issue No.
01-09, Accounting for Consideration Given by a Vendor to a Customer or a
Reseller of the Vendor's Products ("EITF 01-09"). EITF 01-09 addresses whether a
vendor should recognize consideration, including equity instruments, given to a
customer as an expense or an offset to revenue being recognized from that same
customer. Upon adopting EITF 01-09, we determined that the AOL and Net2Phone
arrangements were required to be accounted for in accordance with EITF 01-09. We
determined that it did not meet the condition that a sufficiently separable
benefit had been received from AOL and Net2Phone; accordingly, recognition of
the consideration must be recorded as a reduction of cumulative revenue from the
respective customer. As we had recognized cumulative revenue under these
arrangements as of June 30, 2001 in excess of amounts previously recorded as a
revenue offset, for the three and six months ended June 30, 2001 we reclassified
an additional $15,000 and $377,000, respectively, of selling and marketing
non-cash stock compensation expense as an offset to revenue. For the three and
six months ended June 30, 2002, we recognized $630,000 and $1,306,000,
respectively, as an offset to revenue associated with these arrangements, in
accordance with EITF 01-09. Amounts of $758,000 and $1,472,000, which exceed the
amount of cumulative revenue under each of the arrangements during the three and
six months
16
ended June 30, 2002, respectively, and amounts of $1,145,000 and $1,861,000
during the three and six months ended June 30, 2001, respectively, were included
as selling and marketing non-cash stock compensation expense.
In June 2002, we modified our arrangement with Net2Phone to, among other
items, extend the expiration date of the agreement for an additional two years,
to June 30, 2005. As a result of this amendment, we modified the period over
which the related deferred compensation is being recorded to reflect the
extended expiration date. Accordingly, on July 1, 2002, we began recognizing the
remaining deferred compensation balance over the period from July 1, 2002 to
June 30, 2005.
Cost of product licenses revenues. Cost of product licenses revenues
increased by 49.5% to $109,000 for the three months ended June 30, 2002 from
$73,000 for the same period in 2001. This cost represented 2.2% and 1.3% of
product licenses revenues for the three months ended June 30, 2002 and 2001,
respectively. For the six-months period ended June 30, 2002, cost of product
licenses increased 14.3% to $145,000 from $127,000 for the same period in 2001.
This cost represented 1.5% and 1.1% of product licenses revenues for the six
months ended June 30, 2002 and 2001, respectively. The increase in the cost of
product licenses revenues and the percentage of license revenue is due to the
increase in royalties owed to IBM for the sale of ETI-Eloquence products. The
royalty rate is higher than and incremental to the royalties owed to MIT. We
expect the royalty rate owed to MIT to remain at its current level until the
next cumulative product sales milestone is achieved. We expect the overall
royalty rate to increase as we sell more ETI-Eloquence products.
Cost of professional services revenues. Cost of professional services
revenues increased 4.2% to $3.5 million for the three months ended June 30, 2002
from $3.3 million for the same period in 2001. For the six-month period ended
June 30, 2002, cost of professional services revenues decreased 5.5% to $6.6
million from $7.0 million for the same period in 2001. The increase during the
three-month period ended June 30, 2002 was due primarily to higher utilization
of application developers on customer projects compared to the same period in
2001, when underutilized staff were transferred to other functions. The decrease
in cost of professional services revenues for the six months ended June 30,
2002, compared to the same period in 2001, was primarily due to lower spending
on travel and training seminars during 2002. The cost represented 68.8% and
88.0% of professional services revenues for the three months ended June 30, 2002
and 2001, respectively, and represented 64.9% and 85.0% of professional services
revenues for the six months ended June 30, 2002 and 2001, repsectively. The
lower cost of professional services as a percentage of related revenues reflects
more efficient delivery and a higher component of maintenance revenues which
have higher margins.
Cost of other revenues. Cost of other revenues decreased 73.7% to $198,000
for the three months ended June 30, 2002 from $752,000 for the same period in
2001. For the six-month period ended June 30, 2002, cost of other revenues
decreased 62.5% to $563,000 from $1.5 million for the same period in 2001. The
cost of other revenues as a percentage of other revenues represented 62.7% and
83.6% of other revenues for the three months ended June 30, 2002 and 2001,
respectively, and represented 84.7% and 81.2% of other revenues for the six
months ended June 30, 2002 and 2001, respectively. The decrease in cost of other
revenues reflects fewer hardware platforms purchased directly from us as part of
overall client projects during 2002 compared to the same periods in 2001. The
improvement in the margin for the three months ended June 30, 2002 compared to
the same period in 2001 is due to the delivery of lower margin hardware on a
customer contract during the three months ended June 30, 2001.
Amortization of purchased technology. In connection with our acquisition of
ETI on January 5, 2001, we acquired completed technology valued at $5.6 million,
which we have incorporated with our products and will continue to sell to third
parties. During the three and six months ended June 30, 2002 and 2001,
amortization of completed technology of $283,000 and $565,000, respectively, for
each period was recorded as a cost of revenues.
Total operating expenses. Our total operating expenses decreased 15.1% to
$16.9 million for the three months ended June 30, 2002 from $19.9 million for
the same period in 2001. For the six-month period ended June 30, 2002, total
operating expenses decreased 8.8% to $34.0 million from $37.3 million for the
same period in 2001. These decreases primarily represent lower spending for
outside technical resources in research and development, as well as lower
spending on recruiting and outside legal costs. These reductions were offset by
increases in selling and marketing expenses. Total headcount grew slightly to
402 as of June 30, 2002, compared to headcount of 400 as of June 30, 2001. As a
percentage of total revenues, our operating expenses were 173.3% for the three
months ended June 30, 2002, and 194.0% for the same period in 2001. For the
six-month periods ended June 30, 2002 and 2001, operating expenses as a
percentage of total revenues were 177.0% and 176.7%, respectively. Total
operating expenses include certain non-cash charges for the three
17
and six months ended June 30, 2002 and 2001, as discussed below.
Selling and marketing. Selling and marketing expenses consist primarily of
compensation and related expenses, sales commissions and travel expenses, along
with other marketing expenses, including advertising, trade shows, public
relations, direct mail campaigns, seminars and other promotional expenses and
allocated corporate overhead costs. These expenses increased 1.3% to $7.8
million for the three months ended June 30, 2002 from $7.7 million for the same
period in 2001. For the six-month period ended June 30, 2002, selling and
marketing expenses increased 5.2% to $15.5 million from $14.8 million for the
same period in 2001. Selling and marketing expenses, as a percentage of total
revenues, were 80.3% for the three months ended June 30, 2002 and 75.3% for the
same period in 2001. For the six-month periods ended June 30, 2002 and 2001,
selling and marketing expenses as a percentage of total revenues were 80.9% and
70.0%, respectively. The increase in selling and marketing expenses resulted
primarily from our investment in sales and marketing personnel and marketing
programs. The number of sales personnel increased to 94 from 87, and the number
of employees in marketing increased to 34 from 33 at June 30, 2002 and 2001,
respectively. As a result of the restructuring action announced on July 3, 2002,
we expect selling and marketing expenses to decrease between 10% and 15%.
Research and development. Research and development expenses consist
primarily of compensation and related expenses for our personnel and, to a
lesser extent, independent contractors, who work on new products, enhancements
to existing products and the implementation of our products in new languages and
allocated corporate overhead costs. These expenses decreased by 9.5% to $4.2
million for the three-month period ended June 30, 2002 from $4.6 million for the
same period in 2001. For the six-month period ended June 30, 2002, research and
development expenses decreased 6.0% to $8.2 million from $8.7 million for the
same period in 2001. The decrease was driven by the decreased usage of outside
consultants on certain development projects, along with lower payroll and
related costs for fewer personnel. The number of personnel involved in research
and development decreased to 116 at June 30, 2002 from 121 at June 30, 2001.
Research and development expenses as a percentage of total revenues were 43.0%
and 45.1% for the three months ended June 30, 2002 and 2001, respectively. For
the six-month periods ended June 30, 2002 and 2001, research and development
expenses as a percentage of total revenues were 42.7% and 41.4%, respectively.
As a result of the restructuring action announced on July 3, 2002, we expect
research and development expenses to decrease between 20% and 25%.
General and administrative. General and administrative expenses consist
primarily of compensation for our administrative, financial and information
technology personnel and company-wide professional fees, including recruiting,
legal and accounting fees, as well as increases to our allowance for doubtful
accounts. These expenses decreased 37.9% to $2.6 million for the three-month
period ended June 30, 2002 from $4.2 million for the same period in 2001. For
the six-month period ended June 30, 2002, general and administrative expenses
decreased 23.7% to $5.8 million from $7.6 million for the same period in 2001.
The decrease in spending for the three and six months ended June 30, 2002
compared to the same periods in 2001 was due to lower spending on outside legal
fees, lower recruiting costs, lower travel related costs and lower bad debt
expense. General and administrative expenses as a percentage of total revenues
were 27.1% and 41.4% for the three months ended June 30, 2002 and 2001,
respectively. For the six-month period ended June 30, 2002 and 2001, general and
administrative expenses as a percentage of total revenues were 30.4% and 36.2%,
respectively. As a result of the restructuring action announced on July 3, 2002,
we expect general and administrative expenses to decrease between 10% and 15%.
Non-cash stock compensation. Non-cash stock compensation charges are being
recorded as identified components of professional services costs, selling and
marketing expenses, research and development expenses and general and
administrative expenses. In connection with the grant of certain options to
employees through June 30, 2000, we recorded deferred stock compensation within
stockholders' equity of $10.7 million, representing the difference between the
estimated fair market value of the common stock for accounting purposes and the
exercise price of these options at the date of grant. Such amount is presented
as a reduction of stockholders' equity and is being amortized over the vesting
period of the applicable options. We recorded amortization of deferred stock
compensation of $677,000 and $1,354,000 for the three and six months ended June
30, 2002 and 2001, respectively. As a result of the restructuring action
announced on July 3, 2002, we expect that the amortization of deferred stock
compensation will be approximately $470,000 per quarter through 2004. The
expected decrease in stock compensation expense reflects the cancellation of
unvested options held by terminated employees. In connection with the
cancellations, we will reverse the remaining deferred compensation balance of
approximately $1.1 million, during the third quarter of 2002, and record a
decrease in additional paid-in capital.
18
Sales and marketing expenses - non-cash stock compensation charges in the
three month periods ended June 30, 2002 and 2001 also include non-cash stock
compensation of $758,000 and $1,145,000, respectively, related to common stock
issued to AOL and Net2Phone at below fair market value and to warrants issued to
AOL. For the six-month periods ended June 30, 2002 and 2001 sales and marketing
expenses - non-cash stock compensation include non-cash stock compensations of
$1.5 million and $1.9 million, respectively, related to common stock issued to
AOL and Net2Phone at below fair market value and to warrants issued to AOL. In
accordance with EITF 01-09, deferred compensation is first recorded as an offset
to cumulative revenue recognized from the respective customer. To the extent
that amortization expense is in excess of cumulative revenue from the respective
customer relationship, the excess amount is recognized as expense. Amounts
reported in prior periods have been reclassified to conform to EITF 01-09
presentation.
Amortization of intangible assets. On June 5, 2000, we entered into a
development and license agreement with AT&T Corp. to develop and sell products
that use AT&T speech technology. Pursuant to this agreement, in exchange for
1,045,158 shares of our common stock, we received development and distribution
licenses to AT&T's speech software, text-to-speech software and certain other
technology related to computer processing of the human voice. In addition, the
parties agreed to collaborate in certain marketing efforts. In connection with
this agreement we recorded $11.5 million for the acquired intellectual property
and collaborative rights, equal to the fair market value of the common stock
issued, which is being amortized over a three-year period. Amortization expense
for the acquired intellectual property and collaborative rights for the three
and six months ended June 30, 2002 and 2001 was $958,000 and $1,916,000,
respectively, for each period.
On January 5, 2001, we acquired all of the outstanding capital stock of
ETI. The purchase price of $18.8 million has been allocated to net tangible
assets and liabilities acquired of ($196,000), completed technology of $5.6
million and goodwill of $13.4 million. The completed technology, reported as
intangible assets, is being amortized on a straight-line basis through December
2005. For each three and six-month period ended June 30, 2002 and 2001, we
recorded amortization expense for completed technology of $283,000 and $566,000,
respectively. As of January 1, 2002, we ceased amortization of the goodwill in
compliance with Statements of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets; for the three and six months ended June 30, 2001,
we recorded $669,000 and $1,338,000, respectively, of goodwill amortization.
Under SFAS No. 142, we were required to test all existing goodwill for
impairment as of January 1, 2002, on a reporting unit basis. As allowed by SFAS
No. 142, we completed this transitional impairment analysis during the second
quarter of 2002. A reporting unit is an operating segment, or one level below an
operating segment, for which discrete financial information is prepared and
regularly reviewed by management, in which case such component is the reporting
unit. As of June 30, 2002, we determined that we operate in one reporting unit.
As a result, our impairment analysis was completed by comparing our consolidated
book value to our fair market value, as determined by our common stock fair
value. Future impairment analyses will be completed on the same basis. Based on
the analysis completed, we determined that the goodwill recorded was not
impaired, and as such, no impairment charge has been recorded. Additional
impairment analyses will be completed at least annually, or more frequently when
events and circumstances occur indicating that the recorded goodwill might be
impaired. In August 2002, our market value fell below our book value. To the
extent that the market value remains below book value, we may be required to
record an impairment of our goodwill and such amount may be material to our
operating results.
Interest income, interest expense and other income, net. Interest income
was $276,000 for the three months ended June 30, 2002 and $1.1 million for the
same period in 2001. Interest expense was $21,000 for the three months ended
June 30, 2002 and $13,000 for the same period in 2001. For the six-month period
ended June 30, 2002 and 2001, interest income was $576,000 and $2.6 million,
respectively. For the six-month period ended June 30, 2002 and 2001, interest
expense was $38,000 and $28,000, respectively. The decrease in interest income
for the three and six months ended June 30, 2002 compared to the year earlier
period was due to lower cash balances available for investing along with lower
average interest rates earned on these investments. Other expenses include other
non-operating costs, including local and state franchise taxes and foreign
currency transaction gains and losses.
Provision for income taxes. We recorded a provision for foreign income
taxes of $27,000 and $94,000 for the three and six-month periods ending June 30,
2002, respectively. For the three and six-month periods ended June 30, 2001, a
tax benefit of $45,000 and $19,000, respectively, was recorded related to a
one-time credit for foreign taxes previously accrued.
Liquidity and Capital Resources
19
From inception through July 31, 2000, we funded our operations primarily
through private placements of convertible preferred stock totaling $60.0 million
and, to a lesser extent, through bank borrowings and capital equipment lease
financing. In August 2000, we raised approximately $109.0 million through the
completion of our initial public offering of common stock and the concurrent
private placements of common stock with AOL and Net2Phone. As of June 30, 2002,
we had cash and cash equivalents of $46.3 million and marketable securities of
$16.1 million. Our revolving line of credit provides for available borrowings up
to $5.0 million, based upon certain eligible accounts receivable. As of June 30,
2002, there was $3.6 million available for borrowings under this line of credit,
with $1.4 million committed under the line of credit for outstanding letters of
credit. Any amounts borrowed under this facility would be due as of December 1,
2002. Under the financing arrangement, we are required to comply with certain
financial covenants related to total tangible net worth. As of June 30, 2002, we
were in compliance with these financial covenants. Based on our financial
projections, we believe that we will continue to meet the financial covenants
required in the financing agreement. Our operating activities resulted in net
cash outflows of $16.1 million for the six months ended June 30, 2002 and $15.4
million for the same period in 2001. The operating cash outflows for these
periods resulted primarily from our significant investment in research and
development, sales and marketing and infrastructure.
During the six-month period ended June 30, 2002, our investing activities
included the redemption of $8.2 million of maturing marketable securities.
During the six-month period ended June 30, 2001, our investing activities
included the net purchase of $18.4 million of marketable securities. Capital
expenditures for property and equipment were $1.8 million for the six-month
period ended June 30, 2002 and $2.1 million for the same period in 2001. These
capital expenditures consisted primarily of computer hardware for new employees
and software costs related to upgrading our corporate infrastructure. During the
six-month period ended June 30, 2001, our investing activities included the
payment of $5.4 million for the acquisition of ETI, including
acquisition-related costs.
In December 2001, we entered into an equipment line of credit with a bank.
Under this agreement, we obtained the right to draw down up to $6.0 million to
finance purchases of fixed assets. Borrowings under this line are collateralized
by the fixed assets purchased and bear interest at the annual prime rate (4.75%
at June 30, 2002), which is payable monthly over a period of 36 months. During
December 2001, we borrowed $1.8 million under this line with monthly payments
beginning in January 2002 and ending December 2004. As of June 30, 2002, $1.5
million was outstanding under this facility. Under the financing agreement, we
are obligated to comply with certain financial covenants related to total
tangible net worth. As of June 30, 2002, we were in compliance with these
financial covenants. Based on our financial projections, we believe that we will
continue to meet the financial covenants required in the financing agreement.
We had an equipment line of credit that we converted into a term loan in
the amount of $1.5 million. The term loan bears interest at an annual rate of
prime plus 0.75% (5.5% at June 30, 2002), and principal and interest under the
term loan are payable in 36 monthly installments through September 2002. As of
June 30, 2002, $69,000 was outstanding under this facility.
Our financing activities generated cash of $326,000 and $573,000 for the
six months ended June 30, 2002 and 2001, respectively. The issuance of common
stock through stock option and warrant exercises generated net proceeds of
$848,000 and $824,000, for the six months ended June 30, 2002 and 2001,
respectively. Repayments of bank borrowings were $522,000 and $251,000 during
the six months ended June 30, 2002 and 2001, respectively.
As a result of the restructuring plan announced on July 3, 2002, we have
commitments to pay severance and other termination benefits to terminated
employees of approximately $2 million over the next six months, which we expect
will be funded through working capital.
As a result of our announced technology purchase from T-NETIX, Inc., we are
committed to issue cash, common stock and assume a long-term commitment to an
unrelated third party for a total of approximately $1.1 million beginning in
July 2002, with the final payments due no later than January 2004.
We believe that our existing cash and cash equivalents and marketable
securities and borrowings available under our bank financing agreements, will be
sufficient to meet our working capital and capital expenditure requirements for
at least
20
the next 12 months. In the event we require additional financing, we believe
that we would be able to obtain such funding, however, there can be no
assurances that we would be successful in doing so or that we could do so on
terms favorable to us.
Contractual Obligations
The following table sets forth future payments that we are obligated to
make under existing long-term debt and operating lease commitments as of June
30, 2002:
Contractual Obligation Payments Due by Period
(in thousands)
2003 and 2005 and 2007
Total 2002 2004 2006 and later
----- ---- ---- ---- ---------
Long-Term Debt $ 1,571 $ 670 $ 901 $ -- $ --
Operating Leases 21,809 1,731 6,785 2,818 10,475
------- ------ ------ ------ -------
Total Contractual Cash
Obligations $23,380 $2,401 $7,686 $2,818 $10,475
======= ====== ====== ====== =======
Other Commercial Commitments
The following table sets forth other financial commitments under existing
banking arrangements as of June 30, 2002. We currently have standby letters of
credit at a bank that are used as security deposits for various office leases.
In the event of default on these lease commitments, the landlord would be
eligible to draw down against their respective standby letter of credit. At
present we are not in default on any of our leased facilities.
Other Commercial Commitments Amount of Commitment Expiration by Period
-----------------------------------------
(in thousands)
2003 and 2005 and 2007
Total 2002 2004 2006 and later
----- ---- ---- ---- ---------
Standby Letters of Credit $1,350 $164 $352 $47 $787
------ ---- ---- --- ----
Royalty Commitments
Under the terms of the ETI acquisition, we assumed the royalty commitments
to IBM for the sale of software products developed under an agreement between
ETI and IBM. Under the terms of the agreement, the maximum amount of royalties
owed to IBM will be $5.0 million. As of December 31, 2001, we had reported the
first two years of minimum royalties, totaling $500,000, due under this
agreement. We are obligated to pay an annual minimum royalty of $50,000 to MIT
for the sale of software products developed using their technology. The
following table sets forth the future minimum royalties owed to IBM and MIT
under these agreements, along with the royalty rates.
Amount of Minimum Royalty Commitment by Period
----------------------------------------------
(in thousands)
Royalty Commitments- Total 2002 2003 2004 2005 Thereafter
----- ---- ---- ---- ---- ----------
Royalty Rate-IBM 11% 12% 12% 12% 12%
------ ---- ---- ---- ---- ------
Royalty Commitment - IBM $1,000 $100 $200 $200 $500 --
------ ---- ---- ---- ---- ------
Royalty Rate-MIT 1% 1% 1% 1% 1%
------ ---- ---- ---- ---- ------
Royalty Commitment - MIT $205 $5 $50 $50 $50 $50
------ ---- ---- ---- ---- ------
Other Financial Commitments
21
As a result of the restructuring plan announced on July 3, 2002, we have
commitments to pay severance and other termination benefits to terminated
employees of approximately $2 million over the next six months, which we expect
will be funded through working capital.
As a result of our announced technology purchase from T-NETIX, Inc., we are
committed to issue cash, common stock and assume a long-term commitment to an
unrelated third party for a total of approximately $1.1 million beginning in
July 2002, with the final payments due no later than January 2004.
Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring) ("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. We will adopt SFAS 146 beginning in 2003
and we do not expect our adoption will have a material impact on our financial
position or results of operations.
22
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Our actual results may differ significantly from the results discussed in
forward-looking statements. Important factors that could cause future results to
differ materially from such expectations include: spending patterns of our
domestic and international customers based upon economic conditions; the timing
of sales of our products and services; market acceptance of our speech-activated
systems; our reliance on a limited number of large orders for much of our
revenue, including international orders; uncertainties related to current
economic, political and national security conditions; our ability to develop new
products and services in the face of rapidly evolving technology; our ability to
effectively integrate operations of any acquired companies; the uncertainties
related to our planned international operations; our ability to manage growth of
our business; our ability to protect our intellectual property; our reliance on
resellers and original equipment manufacturers for a significant portion of our
sales; our ability to respond to competitive developments; and our reliance on
attracting, retaining and motivating key technical and management personnel.
These and other important factors are detailed in our filings with the
Securities and Exchange Commission. As a result of these and other important
factors, there can be no assurances that we will not experience material
fluctuations in future operating results on a quarterly or annual basis.
We have a history of losses and we expect to continue to incur net losses for
the foreseeable future that may depress our common stock price.
We had an accumulated deficit of $135.6 million at June 30, 2002, and we
expect to incur net losses for the foreseeable future. Net losses were $22.8
million for the six months ended June 30, 2002, $46.8 million for the year ended
December 31, 2001, $29.6 million for the year ended December 31, 2000 and $15.5
million for the year ended December 31, 1999. We anticipate continuing to incur
significant sales and marketing, research and development and general and
administrative expenses and, as a result, we will need to generate higher
revenues to achieve and sustain profitability. We cannot be certain we will
realize sufficient revenues to achieve profitability. Moreover, if we were to
achieve profitability, we may not be able to sustain or increase our
profitability on a quarterly or annual basis. Any additional financing that we
may require in the future may not be available at all or, if available, may be
on terms unfavorable to us. Failure to achieve or maintain profitability may
depress the market price of our common stock.
We expect our quarterly revenues and operating results to fluctuate. If our
quarterly operating results fail to meet the expectations of financial analysts
and investors, the trading price of our common stock may decline.
Our revenues and operating results are likely to vary significantly from
quarter to quarter. A number of important factors are likely to cause these
variations, including:
o the timing of sales of our products and services, particularly in
light of our dependence on a relatively small number of large orders,
including international orders,
o the timing of product implementations, particularly large client
design projects,
o unexpected delays in introducing new products and services,
o variation in capital spending budgets of our clients and potential
clients,
o variation in our expenses, whether related to sales and marketing,
product development or administration,
o the mix of domestic and international sales,
o deferral of recognition of our revenue in accordance with applicable
accounting principles due to the time required to complete projects,
23
o the mix of product license and services revenue, and
o costs related to possible acquisitions of technology or businesses.
Because of the volatility of our quarterly results and the difficulty in
predicting our future performance, our operating results may fall below the
expectations of analysts or investors and, as a result, the price of our common
stock may decline.
If the estimates we make, and the assumptions on which we rely, in preparing our
financial statements prove inaccurate, our actual results may vary from those
reflected in our projections and accruals.
Our financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of our assets, liabilities, revenues and expenses,
the amounts of charges accrued by us, such as those made in connection with our
restructurings, and related disclosure of contingent assets and liabilities. We
base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. There can be no
assurance, however, that our estimates, or the assumptions underlying them, will
be correct.
The slowdown in the economy has affected the market for information technology
products, and our future financial results will depend in part upon whether this
slowdown continues.
As a result of recent unfavorable economic conditions and reduced capital
spending by our customers and potential customers, demand for our products and
services has been adversely affected. This has resulted in decreased revenues
and a decline in our growth rate. Many of our customers are in the
telecommucations and airline industries, which have been strongly affected by
the current economic downturn. If the current economic conditions continue or
worsen, we may experience a material adverse impact on our business, operating
results and financial condition.
Some of our customers and partners are newly formed businesses or businesses
that are not yet profitable. If these companies fail or experience financial
difficulties, our business could be negatively affected.
Some of our customers and partners are financed by investments from venture
capital investors. Given the current general economic conditions and investment
climate, these companies could face difficulties in securing additional
financing to fund their operations. If these companies are not yet profitable or
self-sustaining based on their operations, they could be unable to satisfy their
commitments to us. Even if they are able to meet current obligations to us, they
may not be able to buy additional products and services from us. If these
companies cannot meet their current obligations to us or fail, our business
could be significantly harmed and our revenue could decline.
Speech-activated systems are relatively new products, and our success will
depend on our ability to continue to educate prospective clients on the
commercial viability of the products. If our potential clients and their
customers do not accept speech-activated systems, our business will be harmed.
Our business would be harmed if use of speech-activated, e-business
solutions does not continue to develop, or develops more slowly than we expect.
Our market is relatively new and rapidly evolving. Our future success depends on
the acceptance by current and future clients and their customers of
speech-activated services as an integral part of their businesses. The size of
our market will depend in part on consumer acceptance of automated speech
systems and the actual and perceived quality of these systems. The adoption of
speech-activated services could be hindered by the perceived costs of this new
technology, as well as the reluctance of enterprises that have invested
substantial resources in existing call centers, touch-tone-based systems or
internet-based infrastructures to replace or enhance their current systems with
this new technology. Accordingly, in order to achieve commercial acceptance, we
will have to educate prospective clients, including large, established
telecommunications companies, about the uses and benefits of speech-activated
services in general and our products in particular. If these efforts fail, or if
speech-activated software platforms do not achieve broad commercial acceptance,
our business could be significantly harmed and our revenues could decline. In
addition, the continued development of new and evolving wireless technologies
using a visual web browser interface could adversely affect the demand for
speech-activated services.
We currently rely on a limited number of large orders for a significant portion
of our revenues. As a result, our inability to secure additional significant
clients during a given period or the loss of one major client could cause our
quarterly results of operation to suffer. Our stock price may also be adversely
affected by unexpected quarterly revenue declines caused by delays in revenue
recognition.
Due to the nature of our business, in any quarter we are dependent upon a
limited number of orders that are relatively large in relation to our overall
revenues. For example, one customer of ours accounted for 19.3% of our total
revenue in 2001 and 16.1% of our total revenue in 2000. For the three months
ended June 30, 2002, one customer of ours accounted for more than 10% of our
total revenue. Our speech-activated products and services require significant
expenditures by
24
our clients and typically involve lengthy sales cycles. We may spend significant
time and incur substantial expenses educating and providing information to
prospective clients. Any failure to complete a sale to a prospective client
during a quarter could result in revenues and operating results for the quarter
that are lower than expected.
In addition, as a result of the significant time required to deliver or
perform a client order, we may be unable to recognize revenue related to a
client order until well after we receive the order. Our dependence on large
client orders and the delay in recognizing revenue relating to these orders
makes it difficult to forecast quarterly operating results. This could cause our
stock price to be volatile or to decline.
If we fail to develop new products and services in the face of our industry's
rapidly evolving technology, our future operating results may be adversely
affected.
Our growth and future operating results will depend, in part, on our
ability to keep pace with:
o rapidly changing speech recognition and speech synthesis technology,
o evolving industry standards and practices,
o frequent new speech-activated service and product introductions and
enhancements, and
o changing client requirements and preferences for their automated
speech systems.
Any delay or failure on our part in responding quickly, cost-effectively
and sufficiently to these developments could render our existing
speech-activated products and services noncompetitive or obsolete and have an
adverse effect on our competitive position. We may have to incur substantial
expenditures to modify or adapt our speech-activated products and services to
respond to technological changes. We must stay abreast of cutting-edge
technological developments and evolving service offerings to remain competitive
and increase the utility of our speech-activated services. We must be able to
incorporate new technologies into the speech-activated solutions we design and
develop to address the increasingly complex and varied needs of our client base.
If we are unable, for technological or other reasons, to develop and introduce
new and enhanced products and to respond to changing client requirements and
preferences in a timely manner, we may lose existing customers and fail to
attract new customers, which could result in a significant decline in our
revenues.
Development and commercial release of our new product line could impair our
ability to sell existing product lines, and result in a decrease in associated
services revenues.
The release of our OpenSpeech/TM/ products could have a negative effect on
sales of our existing speech recognition products, including our SpeechWorks
product, and the prices we could charge for these products. Additionally, in the
event of such a negative effect, the maintenance and support revenues associated
with the sales of these products, as well as any potential consulting services
revenues that would have been otherwise associated with certain sales of these
products, may be delayed or impaired. We may also divert sales and marketing
resources from our current products in order to promote and support our new Open
Speech product line. This diversion of resources could have a further negative
effect on sales of our current products and services.
Our application software may contain defects, which could result in delayed or
lost revenue, expensive corrections, liability to our clients and claims against
us.
We design, develop and implement complex speech-activated solutions that
are crucial to the operation of our clients' products and businesses. Defects in
the solutions we develop could result in delayed or lost revenue, adverse client
reaction and negative publicity about us or our products and services or require
expensive and time consuming corrections. Also, due to the developing nature of
speech recognition technology and text-to-speech technology, our products are
not currently and may never be accurate in every instance. In addition, third
party technology that is included in our products could contain errors or
defects. Clients who are not satisfied with our products or services could bring
claims against us for substantial damages, which, even if unsuccessful, would
likely be time consuming and could result
25
in costly litigation and payment of damages. Such claims could have an adverse
effect on our financial results and competitive position.
Our current and potential competitors in the speech-activated solutions market,
some of whom have greater resources and experience than we do, may offer
products and services that may cause demand for, and the prices of, our products
to decline.
A number of companies have developed, or are expected to develop, products
that compete with our products. Competitors in the speech recognition and
text-to-speech software market include AT&T, Elan, Fonix, IBM, Lucent
Technologies, Microsoft, Nuance Communications, Philips Communications,
Rhetorical, ScanSoft, and Phonetic Systems. Furthermore, we expect consolidation
in our industry, and other companies may enter our markets by acquiring or
entering into strategic relationships with our competitors. Current and
potential competitors have established, or may establish, cooperative
relationships among themselves or with third parties to increase the abilities
of their advanced speech and language technology products to address the needs
of our prospective customers.
Many of our current and potential competitors have longer operating
histories, significantly greater financial, technical, product development and
marketing resources, greater name recognition and/or larger client bases than we
do. Our present or future competitors may be able to develop speech-activated
products and services comparable or superior to those we offer, adapt more
quickly than we do to new technologies, evolving industry trends and standards
or client requirements, or devote greater resources to the development,
promotion and sale of their products and services than we do. Accordingly, we
may not be able to compete effectively in our markets, competition may intensify
and future competition may cause demand for and the prices of our products to
decline, which could adversely affect our sales and profitability.
If the standards we have selected to support are not adopted as the industry
standards for speech-activated software, businesses might not use our
speech-activated software platforms for delivery of applications and services,
and our revenues could be negatively affected.
The market for speech-activated services software is new and emerging and
industry software standards have not yet been fully established. We may not be
competitive unless our products support changing industry software standards.
The emergence of industry standards other than those we have selected to
support, whether through adoption by official standards committees or widespread
usage, could require costly and time consuming redesign of our products. If
these standards become widespread and our products do not support them, our
clients and potential clients may not purchase our products, and our revenues
could be adversely affected. Multiple standards in the marketplace could also
make it difficult for us to design our products to support all applicable
standards, which could also result in decreased sales of our products.
We have and intend to continue expanding our international operations. Because
of risks involved with operating a business in foreign countries, we may not be
successful and our business could be harmed.
Our international sales represented 19.3% of our revenue for the six months
ended June 30, 2002, 9.4% of our revenue in 2001, 13.8% in 2000 and 2.6% in
1999. We expanded our direct and indirect international sales force in 2001 with
the expectation of increasing international revenues. We have limited experience
in international operations and international product and service sales, and
there can be no assurance we will be successful in continuing to grow our
international business. We are subject to a variety of risks associated with
conducting business internationally, any of which could harm our business. These
risks include:
o difficulties and costs of staffing and managing foreign operations,
o difficulties in establishing and maintaining an effective
international reseller network,
o the burden of complying with a wide variety of foreign laws,
particularly with respect to intellectual property and license
requirements,
26
o political and economic instability outside the United States,
o import or export licensing and product certification requirements,
o tariffs, duties, price controls or other restrictions on foreign
currencies or trade barriers imposed by foreign countries,
o potential adverse tax consequences, including higher marginal rates,
o unfavorable fluctuations in currency exchange rates, and
o limited ability to enforce agreements, intellectual property rights
and other rights in some foreign countries.
In order to increase our international sales, we must develop localized versions
of our products. If we are unable to do so, we may be unable to grow our revenue
and execute our business strategy.
In order to expand our international sales, we intend to continue to invest
significant resources to create and refine different speech recognition and
synthesis models for particular languages or dialects. These speech-processing
models are required to create versions of our products that understand or
reproduce the local language or dialect. If we fail to develop localized
versions of our products, our ability to address international market
opportunities and to grow our business will be limited. In addition, we are
required to invest resources to develop these versions of our products in
advance of the receipt of revenues. We may be unable to recognize revenues
sufficient to render these products profitable.
If we do not manage our operations in accordance with changing economic
conditions, our resources may be strained, which could harm our ability to
become profitable.
Our business operations have changed due to volatility in our industry. We
experienced significant growth in the past. From December 31, 2000 to December
31, 2001 the number of our employees increased from 317 to 409. However, in July
2002, we reduced our workforce by approximately 17%. We may be required to
expand or contract our business operations in the future, and as a result may
need to expand or contract our management, operational, financial and human
resources, as well as management information systems and controls, to respond to
any such growth or contraction. Our failure to manage these types of changes
would place a burden on our business and our management team, which could cause
our business to suffer.
We rely on our intellectual property rights, and if we are unable to protect
these rights, we may face increased competition. Protection of our intellectual
property rights is uncertain and may be costly.
Intellectual property rights are important in our industry. We rely on a
combination of patent, copyright, trademark and trade secret laws, as well as
confidentiality, assignment of rights to inventions, and/or license agreements
with our employees, consultants and corporate or strategic partners to protect
our intellectual property rights. These legal protections afford only limited
protection and may be time-consuming and expensive to obtain and maintain.
Further, despite our efforts, we may be unable to prevent third parties from
unauthorized use of our intellectual property. Monitoring unauthorized use of
our intellectual property is difficult, and we cannot be certain that the steps
we have taken will be effective to prevent unauthorized use.
Litigation may be necessary to enforce our intellectual property rights and
trade secrets. These lawsuits, regardless of their success, would likely be time
consuming and expensive to resolve and would divert management's time and
attention away from our business.
We may undertake strategic acquisitions or investments in the future and any
difficulties from integrating such acquisitions or investments could damage our
ability to attain or maintain profitability. The anticipated benefits of
strategic acquisitions or investments may never be realized.
27
We may acquire or make significant investments in businesses and
technologies that complement or augment our existing business and technologies.
Integrating any newly acquired businesses or technologies could be expensive and
time-consuming and could divert management's time and attention away from our
on-going business. We may not be able to integrate any acquired business,
products, employees or technology successfully and our failure to do so could
harm our business. We cannot guarantee that we will realize any anticipated
benefits from such acquisitions or investments. Moreover, we may need to raise
additional funds through public or private debt or equity financing to acquire
or make significant investments in any businesses or technologies, which may
result in dilution to our current stockholders and the incurrence of
indebtedness. We may not be able to operate acquired businesses profitably.
We may expend significant resources to defend against claims of infringement by
third parties, and if we are not successful we may lose significant rights or be
required to enter into disadvantageous license or royalty agreements.
Currently, in the software industry there are frequent assertions of patent
infringement by owners of patents, and assertions of other violations of
intellectual property rights such as trademarks, copyrights, and trade secrets.
In addition, there are a large number of patents in the speech processing area.
Although we do not believe that we are infringing on any patent rights, the
holders of patents may claim that we are doing so. If any claim was made against
us, our business could be harmed, particularly if we are unsuccessful in
defending such claim. If we are forced to defend any claim, whether it is with
or without merit or is determined in our favor, then we may face costly
litigation, diversion of technical and management personnel, delays in future
product releases or injunctions preventing us from selling our products and
services. We may also be required to enter into costly and burdensome royalty
and licensing agreements. Any royalty or licensing agreements, if required, may
not be available on terms acceptable to us, or at all.
Our products incorporate technology we license from others. Our inability to
maintain these licenses could have a material adverse effect on our business.
Some of the technology included in, or operating in conjunction with our
products is licensed by us from others. For example, we currently license
certain text-to-speech technology from IBM, text-to-speech and other technology
relating to computer processing of the human voice from AT&T and software and
technology from MIT. Certain of these license agreements are for limited terms.
If for any reason these license agreements terminate, we may be required to seek
alternative vendors and may be unable to obtain similar technology on favorable
terms, or at all. If we are unable to obtain alternative license agreements, we
could be required to modify some features of our products, which could adversely
affect sales of our products and services.
We rely on resellers and original equipment manufacturers for a portion of our
sales. The loss of one or more significant resellers or original equipment
manufacturers could limit our ability to sustain and grow our revenues.
In 2001, 55.7% of our sales were attributable to our resellers and original
equipment manufacturers, or OEMs, especially InterVoice-BRITE which accounted
for 19.3% of our sales in 2001. For the six months ended June 30, 2002 there
were no customers that accounted for more than 10% of our total revenue. We
intend to increase our sales through resellers in the future. As a result, we
are in part dependent upon the continued success and viability of our resellers
and OEMs, as well as their continued interest in selling our products. The loss
of a key reseller or OEM or our failure to develop and sustain new reseller and
OEM relationships could limit our ability to sustain and grow our revenues.
Our contracts with our resellers and OEMs generally do not require them to
purchase our products. Our resellers and OEMs are independent companies over
which we have limited control. Our resellers and OEMs could cease to market our
products or devote significant resources to the sale of our products. Any
failure of our resellers or OEMs to successfully market and sell our products
could result in revenues that are lower than anticipated. In addition, our
resellers and OEMs possess confidential information concerning our products and
operations. Although we have nondisclosure agreements with our resellers and
OEMs, a reseller or OEM could use our confidential information in competition
with us, which could adversely affect our competitive position and revenues.
28
We rely upon the continued service and performance of a relatively small number
of senior management and key technical personnel. Moreover, competition for
qualified personnel is intense. We may not be able to retain or recruit
necessary personnel, which could impact the management and development of our
business.
Our future success depends on our retention of a small number of senior
management and key technical personnel, such as Stuart R. Patterson, our
President and Chief Executive Officer, and Michael S. Phillips, our Chief
Technology Officer and co-founder. We do not have key person life insurance
policies covering any of our employees. The loss of services of any of our
executive officers or key personnel could have a negative effect on our ability
to grow our business.
We need to attract and retain managerial and highly skilled technical
personnel for whom there is intense competition. If we are unable to attract and
retain managerial and qualified technical personnel, our operations could suffer
and we may never achieve profitability.
Our business will be harmed if we fail to hire or retain qualified sales
personnel, or if newly hired sales people fail to develop the necessary sales
skills or develop these skills more slowly than we anticipate.
Our financial success depends to a large degree on the ability of our
direct and indirect sales force to increase sales. Therefore, our ability to
increase revenue in the future depends considerably upon our success in
recruiting, training and retaining additional direct and indirect sales
personnel and the success of the sales force. Also, it may take a new
salesperson a number of months before he or she becomes a productive member of
our sales force.
29
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A portion of our business is conducted outside the United States through
our foreign subsidiaries and branches. We have foreign currency exposure related
to our operations in international markets where we transact business in foreign
currencies and accordingly, are subject to exposure from adverse movements in
foreign currency exchange rates. Currently, we do not engage in any foreign
currency hedging transactions. The functional currency of our foreign
subsidiaries is the local currency. Substantially all of our revenues are
invoiced and collected in U.S. dollars. Assets and liabilities of foreign
subsidiaries which are denominated in foreign currencies are remeasured into
U.S. dollars at rates of exchange in effect at the end of the period. Revenues
and expense amounts are remeasured using the average exchange rates for the
period. Net unrealized gains and losses resulting from foreign currency
remeasurement are included in other comprehensive loss, which is a separate
component of stockholders' equity. Net realized gains and losses resulting from
foreign currency transactions are included in the consolidated statement of
operations as other income or expense and have not been material to date.
We are exposed to market risk related to changes in interest rates
associated with our cash equivalents and marketable securities. Cash equivalents
and marketable securities are recorded on the balance sheet at market value,
with any unrealized gain or loss recorded in comprehensive income or loss. We
believe that the effect of any reasonably possible near-term changes in interest
rates would not have a material impact on the fair market value of these
instruments due to their short maturity.
PART II. OTHER INFORMATION
Items 1, 3 AND 5 NOT APPLICABLE.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On July 31, 2000, the Securities and Exchange Commission declared the
Company's Registration Statement on Form S-1 (File no. 333-35164) effective.
There has been no material change with respect to the Company's use of proceeds
from its initial public offering from the information discussed in its Annual
Report on Form 10-K for the period ended December 31, 2001.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the 2002 annual meeting of stockholders of the Company (the "Annual
Meeting") held on May 23, 2002, the following matters were acted upon by the
stockholders of the Company:
1. The election of Axel Bichara and Richard Burnes as Class II directors for
the ensuing three years;
2. Approval of an amendment to the Company's 2000 Employee, Director and
Consultant Stock Plan increasing from 5,000,000 to 7,000,000 the number of
shares of common stock authorized for issuance under such plan; and
3. Approval of an amendment to the Company's 2000 Employee Stock Purchase Plan
increasing from 200,000 to 350,000 the number of shares of common stock
authorized for issuance under such plan.
The number of shares of common stock outstanding and entitled to vote at
the Annual Meeting was 32,545,476. The other directors of the Company, whose
terms of office as directors continued after the Annual Meeting, are William J.
O'Farrell, Stuart R. Patterson, Michael S. Phillips, Robert Finch and John C.
Freker, Jr. The results of the voting on each of the matters presented to
stockholders at the Annual Meeting are set forth below:
30
- -----------------------------------------------------------------------------------------------------------------
Votes Broker
Matter Votes For Withheld/Against Abstentions Non-Votes
- -----------------------------------------------------------------------------------------------------------------
Election of Directors:
- -----------------------------------------------------------------------------------------------------------------
Axel Bichara 22,724,797 671,508 N/A None
- -----------------------------------------------------------------------------------------------------------------
Richard Burnes 22,724,797 671,508 N/A None
- -----------------------------------------------------------------------------------------------------------------
Approval of Amendment to the Company's 7,640,300 6,604,670 61,770 9,089,565
2000 Employee, Director and Consultant
Stock Plan
- -----------------------------------------------------------------------------------------------------------------
Approval of Amendment to the Company's 13,526,985 716,922 62,833 9,089,565
2000 Employee Stock Purchase Plan
- -----------------------------------------------------------------------------------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Index to Exhibits attached hereto.
(b) Reports on Form 8-K
None.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SPEECHWORKS INTERNATIONAL, INC.
Dated: August 14, 2002 By: /s/ Richard J. Westelman
----------------------------
Richard J. Westelman
Chief Financial Officer
(Chief Accounting Officer)
STATEMENT PURSUANT TO 18 U.S.C. ss.1350
Pursuant to 18 U.S.C. ss.1350, each of the undersigned certifies that this
Quarterly Report on Form 10-Q for the period ended June 30, 2002 fully complies
with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act
of 1934 and that the information contained in this report fairly presents, in
all material respects, the financial condition and results of operations of
SpeechWorks International, Inc.
By: /s/ Stuart R. Patterson
---------------------------
Dated: August 14, 2002 Stuart R. Patterson
Chief Executive Officer and President
By: /s/ Richard J. Westelman
----------------------------
Dated: August 14, 2002 Richard J. Westelman
Chief Financial Officer
32
Index to Exhibits
10.1 Amended and Restated 2000 Employee, Director and Consultant Stock Plan
(Filed as Appendix A to the Registrant's Definitive Proxy Statement on
Schedule 14A for the Registrant's Annual Meeting of Stockholders held May
23, 2002 (File No. 000-31097), and incorporated herein by reference.
10.2 Amended and Restated 2000 Employee Stock Purchase Plan (Filed as
Appendix B to the Registrant's Definitive Proxy Statement on Schedule 14A
for the Registrant's Annual Meeting of Stockholders held May 23, 2002
(File No. 000-31097), and incorporated herein by reference.