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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 September 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 November 8, 2002, the registrant had 33,109,536 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 September 30, 2002 and December 31, 2001 ......................... 1
Consolidated Statement of Operations for the Three and Nine Months Ended September 30,
2002 and 2001 ..................................................................................... 2
Consolidated Statement of Cash Flows for the Nine Months Ended September 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 ........................................ 31
Item 4. Controls and Procedures ........................................................................... 31
Part II--Other Information
Item 2. Changes in Securities and Use of Proceeds ......................................................... 31
Item 6. Exhibits and Reports on Form 8-K .................................................................. 32
Signatures ......................................................................................................... 33
SPEECHWORKS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
September 30, December 31,
--------------- --------------
2002 2001
--------------- --------------
(UNAUDITED)
(in thousands, except
share information)
ASSETS
Current assets:
Cash and cash equivalents ................................................................ $ 46,026 $ 55,534
Marketable securities .................................................................... 8,203 24,264
Accounts receivable, net of allowance for doubtful accounts of $1,009 and $1,428,
respectively .......................................................................... 10,188 12,725
Prepaid expenses and other current assets ................................................ 2,509 2,207
---------- ----------
Total current assets .................................................................. 66,926 94,730
Fixed assets, net ........................................................................... 6,168 6,719
Intangible assets, net ...................................................................... 7,591 10,271
Goodwill .................................................................................... 10,707 10,707
Other assets ................................................................................ 2,588 2,361
---------- ----------
Total assets .......................................................................... $ 93,980 $ 124,788
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................................... $ 687 $ 2,074
Accrued compensation ..................................................................... 1,541 3,574
Accrued expenses ......................................................................... 3,360 3,063
Deferred revenue ......................................................................... 7,820 6,125
Current portion of notes payable ......................................................... 628 892
---------- ----------
Total current liabilities ............................................................. 14,036 15,728
Notes payable, net of current portion ....................................................... 751 1,201
---------- ----------
Total liabilities ..................................................................... 14,787 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; 32,992,755, and
32,347,954 shares issued and outstanding, respectively ................................ 33 32
Additional paid-in capital ............................................................... 234,994 234,563
Deferred stock compensation .............................................................. (6,896) (13,889)
Accumulated other comprehensive loss ..................................................... (1) (46)
Accumulated deficit ...................................................................... (148,937) (112,801)
---------- ----------
Total stockholders' equity ............................................................ 79,193 107,859
---------- ----------
Total liabilities and stockholders' equity ............................................ $ 93,980 $ 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 Nine Months
Ended Ended
September 30, September 30,
---------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands, except per share data)
Revenues:
Product licenses ............................................................ $ 3,070 $ 6,908 $ 12,681 $ 18,806
Professional services ....................................................... 4,519 3,875 14,754 12,148
Other revenues .............................................................. 964 848 1,629 2,699
Non-cash stock compensation ................................................. (954) (686) (2,260) (1,604)
---------- ---------- ---------- ----------
Total revenues ........................................................... 7,599 10,945 26,804 32,049
---------- ---------- ---------- ----------
Cost of revenues:
Cost of product licenses .................................................... 75 145 220 272
Cost of professional services--non-cash stock compensation .................. 123 154 431 462
--all other expenses ........................... 3,184 3,161 9,825 10,190
Cost of other revenues ...................................................... 859 697 1,422 2,200
Amortization of completed technology ........................................ 343 283 909 849
---------- ---------- ---------- ----------
Total cost of revenues ................................................... 4,584 4,440 12,807 13,973
---------- ---------- ---------- ----------
Gross profit ................................................................... 3,015 6,505 13,997 18,076
---------- ---------- ---------- ----------
Operating expenses:
Selling and marketing-- non-cash stock compensation ......................... 462 979 2,486 3,391
-- all other expenses .................................. 6,635 7,797 22,166 22,567
Research and development-- non-cash stock compensation ...................... 133 140 413 420
-- all other expenses ............................... 3,376 4,335 11,577 13,062
General and administrative-- non-cash stock compensation .................... 78 106 290 318
-- all other expenses ............................. 2,885 4,075 8,715 11,712
Amortization of intangible assets ........................................... 958 1,627 2,874 4,881
Restructuring costs ......................................................... 2,066 -- 2,066 --
---------- ---------- ---------- ----------
Total operating expenses ................................................. 16,593 19,059 50,587 56,351
---------- ---------- ---------- ----------
Loss from operations ........................................................... (13,578) (12,554) (36,590) (38,275)
Interest income ................................................................ 234 784 810 3,339
Interest expense ............................................................... (19) (10) (57) (38)
Other expenses, net ............................................................ 7 (154) (222) (325)
---------- ---------- ---------- ----------
Loss before income taxes ....................................................... (13,356) (11,934) (36,059) (35,299)
Provision (benefit) for income taxes ........................................... (17) 42 77 23
---------- ---------- ---------- ----------
Net loss ....................................................................... $ (13,339) $ (11,976) $ (36,136) $ (35,322)
========== ========== ========== ==========
Basic and diluted net loss per common share .................................... $ (0.41) $ (0.37) $ (1.11) $ (1.11)
Shares used in computing basic and diluted net loss per common share ........... 32,869 32,153 32,632 31,867
The accompanying notes are an integral part of these consolidated financial
statements.
2
SPEECHWORKS INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
----------------------
2002 2001
----------- ----------
(in thousands)
Cash flows from operating activities:
Net loss .................................................................................... $(36,136) $(35,322)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................................... 2,420 2,202
Amortization of intangible assets ....................................................... 3,783 5,730
Stock compensation expense .............................................................. 5,880 6,195
Provision for doubtful accounts ......................................................... 181 836
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ................................................................. 2,356 (1,701)
Prepaid expenses and other current assets ........................................... (302) (439)
Other assets ........................................................................ (227) (152)
Accounts payable .................................................................... (1,387) 1,188
Accrued compensation ................................................................ (2,033) (1,973)
Accrued other expenses .............................................................. (101) (425)
Deferred revenue .................................................................... 1,695 (67)
-------- --------
Net cash used in operating activities ............................................. (23,871) (23,928)
-------- --------
Cash flows from investing activities:
Purchases of fixed assets ................................................................... (1,869) (2,739)
Cash paid to acquire business, including acquisition costs, net of cash acquired ............ (360) (5,379)
Purchases of marketable securities .......................................................... -- (69,606)
Maturities of marketable securities ......................................................... 16,084 45,255
-------- --------
Net cash provided by (used in) investing activities ............................... 13,855 (32,469)
-------- --------
Cash flows from financing activities:
Principal payments on notes payable ......................................................... (714) (375)
Proceeds from exercise of common stock options and warrants ................................. 1,200 1,443
-------- --------
Net cash provided by financing activities ......................................... 486 1,068
-------- --------
Effects of changes in exchange rates on cash ................................................ 22 (26)
-------- --------
Net decrease in cash and cash equivalents ......................................... (9,508) (55,355)
Cash and cash equivalents, beginning of period .............................................. 55,534 99,203
-------- --------
Cash and cash equivalents, end of period .................................................... $ 46,026 $ 43,848
======== ========
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 nine month periods ended September 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 nine-month
periods ended September 30, 2002 and 2001 does not include 7,360,128 and
6,815,459 potential shares of common stock equivalents, respectively, related to
outstanding common stock options and warrants.
3. Comprehensive Loss
For the three and nine months ended September 30, 2002 and 2001, total
comprehensive loss was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- ----
Net loss $(13,339) $(11,976) $(36,136) $(35,322)
Other comprehensive income (loss):
Changes in unrealized gain (loss) on
marketable securities 25 (15) 23 (5)
Foreign currency translation adjustment (3) 20 22 (27)
--------- -------- -------- --------
Total other comprehensive loss 22 5 45 (32)
-------- -------- -------- --------
Total comprehensive loss $(13,317) $(11,971) $(36,091) $(35,354)
======== ======== ======== ========
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 was 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 - non-cash stock
compensation expense. The amortization of the warrant value was recognized as
selling and marketing - non-cash stock compensation 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:
. 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
. 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 September 30, 2001
in excess of amounts previously recorded as a revenue offset, for the three and
nine months ended September 30, 2001, SpeechWorks reclassified an additional
$398,000 and $775,000, respectively, of previously recognized selling and
marketing non-cash stock compensation expense as an offset to revenue resulting
in a total offset of $686,000 and $1,604,000, respectively. For the three and
nine months ended September 30, 2002, the Company recognized $954,000 and
$2,260,000, respectively, as an offset to revenue associated with these
arrangements, in accordance with EITF 01-09. Amounts of $306,000 and $1,778,000,
which exceeded the amounts of cumulative revenue recognized under the
arrangements during the three and nine months ended September 30, 2002,
respectively, and amounts of $703,000 and $2,564,000 during the three and nine
months ended September 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
5
from July 1, 2002 to June 30, 2005.
5. Intangible Assets and Goodwill
The following table summarizes intangible assets:
September 30, 2002 December 31, 2001
------------------------ -----------------------
(in thousands)
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------------------------------------------------
Acquired intellectual property and
collaborative rights ................. $ 11,497 $ 8,623 $ 11,497 $ 5,748
Completed technology .................... 6,757 2,040 5,653 1,131
-------------------------------------------------
$ 18,254 $ 10,663 $ 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 royalty-free, perpetual 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 $2,874,000 for each three and nine
month period ended September 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 nine month period ended September 30, 2002 and 2001, the Company
recorded amortization expense for completed technology of $283,000 and $849,000,
respectively.
On July 22, 2002, the Company acquired certain technology and patent
rights related to speaker verification from SpeakEZ, Inc., a wholly owned
subsidiary of T-NETIX, Inc. In connection with the acquisition, the Company paid
$360,000 in cash and issued 120,924 shares of its common stock (valued at
$345,000 as of July 22, 2002); the Company is obligated to pay an additional
$40,000 and issue an additional 13,436 shares of its common stock (valued at
$38,000 as of July 22, 2002) on December 31, 2003, provided there has been no
breach of any representations or warranties by the seller, as set forth in the
purchase and sale agreement. Additionally, the Company assumed certain
liabilities totaling $320,000. The Company has allocated the entire purchase
price of $1.1 million to completed technology. The completed technology,
reported as an intangible asset, is being amortized on a straight-line basis
through July 2005. For the three months ended September 30, 2002, the Company
recorded amortization expense of $60,000.
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 nine months ended
September 30, 2001, the Company recorded $669,000 and $2,007,000, respectively,
of goodwill amortization. Under
6
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, if discrete financial information is prepared and regularly
reviewed by management, in which case such component is a reporting unit. The
Company has determined that it operates as one reporting unit. As a result, the
Company's impairment analysis during the second quarter of 2002 was completed by
comparing the Company's consolidated book value to its fair market value, as
determined by its common stock fair value as of January 1, 2002. 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, including as of December 31, 2002,
or more frequently when events and circumstances occur indicating that the
recorded goodwill might be impaired. In October 2002, the Company's market value
fell below its book value. If the market value remains below the book value, the
Company may be required to record an impairment of its goodwill and such amounts
may have a material adverse effect on its operating results.
The Company expects quarterly amortization of all intangible assets to
be $1.3 million through the quarter ending June 30, 2003; thereafter, the
Company expects quarterly amortization to be $375,000 through the quarter ending
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 Nine months ended
September 30, September 30,
--------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- ----
(in thousands, except per share data)
Reported net loss $ (13,339) $(11,976) $(36,136) $(35,322)
Goodwill amortization -- 669 -- 2,007
-----------------------------------------------
Adjusted net loss $ (13,339) $(11,307) $(36,136) $(33,315)
===============================================
Reported basic and diluted net loss per common share $ (0.41) $ (0.37) $ (1.11) $ (1.11)
Goodwill amortization -- 0.02 -- 0.06
-----------------------------------------------
Adjusted basic and diluted net loss per common share $ (0.41) $ (0.35) $ (1.11) $ (1.05)
===============================================
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
the current year presentation. As a result of adoption of EITF 01-14, the
Company has included $123,000 and $267,000 during the three and nine months
ended September 30, 2002, respectively, as well as $131,000 and $363,000 during
the three and nine months ended September 30, 2001, respectively, in
professional service revenues, with an equal amount in professional services
cost of revenues, for reimbursable out-of-pocket expenses.
7. Restructuring Costs
On July 3, 2002, the Company 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,
the Company recorded a $2.1 million charge to operating expenses during the
quarter ended September 30, 2002, relating primarily to severance and related
costs of terminated employees. The Company paid out $1.7 million of these costs
during
7
the three months ended September 30, 2002. The majority of the unpaid costs at
September 30, 2002 will be paid in the current fiscal quarter and will be funded
from working capital.
As a result of the restructuring, the Company reversed remaining deferred
compensation balances associated with unvested stock options held by terminated
employees of $1.1 million, resulting in a decrease to additional paid-in
capital.
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 that 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 technology solutions; 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 further detailed later in this Form 10-Q and in the
Company's previous 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. Our speaker verification technology
allows companies to increase the security of their applications by
authenticating the identity of callers.
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; OpenSpeech Server, a standards-based client-server architecture;
OpenSpeech Insight, a graphical tuning tool for reporting and analysis by
developers and operators. 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
9
technology product, Speech2Go, a recognizer that supports a 1,000 word
vocabulary with a footprint under 8MB. Our embedded TTS products include
ETI-Eloquence and Speechify Solo. Both of these products offer high quality,
natural sounding voices in a compact, efficient memory footprint.
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 September 30, 2002, two customers each
accounted for greater than 10% of our total revenue. For the three months ended
September 30, 2001, a different customer accounted for greater than 10% of our
total revenue. For the nine months ended September 30, 2002, no customer
accounted for greater than 10% of our total revenue; for the nine months ended
September 30, 2001, one customer accounted for greater than 10% of our total
revenue. International revenues represented 30.0% and 22.5% of total revenues
for the three and nine months ended September 30, 2002, respectively, and 7.9%
and 10.0% of total revenues for the three and nine months ended September 30,
2001, respectively.
Prior to January 1, 2002, general and administrative expenses included
all occupancy-related expenses and all depreciation expense. Effective January
1, 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 for project teams, 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 and technology acquired from SpeakEZ in July 2002. The
ETI technologies are being amortized over their expected useful life of 60
months, while the SpeakEZ technology is being amortized over 36 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 changes to our allowance for doubtful
accounts.
We receive interest income by investing the proceeds that we raised in
our initial public offering. Interest expense is
10
incurred primarily from amounts we owe under our line of credit and capital
equipment lines of credit.
Due to our operating losses, we have recorded no provision or benefit
for U.S. federal or state income taxes for any period since our inception. Based
on earnings of our foreign subsidiaries, we generally record a provision for
foreign income taxes. 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 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 recorded a
$2.1 million charge to operating expenses during the quarter ended September 30,
2002, relating primarily to severance and related costs of terminated employees.
Based upon cash savings expected from the restructuring plan that we
put in place during the quarter ended September 30, 2002, we believe that
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 the next 12
months. Management has the ability to implement additional actions to further
reduce costs. 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.
Critical Accounting Policies and Significant Judgments and Estimates
Our critical accounting policies and estimates are as follows:
. Revenue recognition;
. Estimating valuation allowances, specifically the allowance for
doubtful accounts;
. Valuation of long-lived and intangible assets and goodwill;
. Acquisition accounting; and
. 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 runs our
software, as well as facilities management services that are provided by
third-party call-centers. We 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:
. 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.
. 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 making the sale
notifies us.
. 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.
11
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:
. 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 professional services, based on the fee charged when professional
services are sold separately; all remaining amounts are recorded as
product license revenue.
. 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 reliable, 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.
. When we provide services on a time and materials basis, we recognize
revenue as we perform the services, based on actual time incurred.
. 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 the hardware is
delivered. 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
12
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.
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:
. 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
. 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.
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. See stock
compensation accounting section below for a summary of transactions which are
accounted for under EITF 01-09.
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 $10.2 million and $12.7 million, net of
allowance for doubtful accounts of $1.0 million and $1.4 million, as of
September 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:
. Significant underperformance relative to expected historical or projected
future operating results;
. Significant changes in the manner of our use of the acquired assets or the
strategy for our overall business; and
. Significant negative industry or economic trends.
When we determine that the carrying value of intangibles and long-lived
assets 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. For impairment tests of goodwill, we compare our
consolidated book value to our fair market value, as determined by the market
value of our common stock. We use this
13
method since management has assessed that we operate in one reporting unit. Net
intangible assets, long-lived assets, and goodwill amounted to $24.5 million and
$27.7 million as of September 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.
On July 22, 2002, we acquired certain technology and patent rights related
to speaker verification from SpeakEZ, Inc., a wholly owned subsidiary of
T-NETIX, Inc. We allocated the entire purchase price of $1.1 million to
completed technology. The completed technology, reported as an intangible asset,
is being amortized on a straight-line basis through July 2005. 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.
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 over the three-year term of the agreement. The warrant, which
has an exercise price of $12.46 per share, became 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 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
September 30, 2002 the remaining warrant to purchase up to 255,141 shares of
common stock was outstanding and 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.
As discussed above, we adopted EITF 01-09 when it became effective on
January 1, 2002 and 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 September 30, 2001 in excess of amounts previously recorded
as a revenue offset, for the three and nine months ended September 30, 2001, we
14
reclassified an additional $398,000 and $775,000, respectively, of previously
recognized selling and marketing non-cash stock compensation expense as an
offset to revenue resulting in a total offset of $686,000 and $1,604,000,
respectively. For the three and nine months ended September 30, 2002, we
recognized $954,000 and $2,260,000, respectively, as an offset to revenue
associated with these arrangements, in accordance with EITF 01-09. Amounts of
$306,000 and $1,778,000, which exceeded the amounts of cumulative revenue
recognized under each of the arrangements during the three and nine months ended
September 30, 2002, respectively, and amounts of $703,000 and $2,564,000 during
the three and nine months ended September 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.
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated as a percentage of our total revenues.
Three Months Nine Months
Ended Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Revenues:
Product licenses ................................................. 41% 63% 47% 59%
Professional services ............................................ 59 35 55 38
Other revenues ................................................... 13 8 6 8
Non-cash stock compensation ...................................... (13) (6) (8) (5)
------- ------- ------- -------
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 ..... 1 1 2 1
-- all other expenses .............. 42 29 37 32
Cost of other revenues ........................................... 11 7 5 7
Amortization of completed technology ............................. 5 3 3 3
------- ------- ------- -------
Total cost of revenues ........................................ 60 41 48 44
------- ------- ------- -------
Gross profit ........................................................ 40 59 52 56
------- ------- ------- -------
Operating expenses:
Selling and marketing -- non-cash stock compensation ............. 6 9 9 11
-- all other expenses ...................... 87 71 83 70
Research and development -- non-cash stock compensation .......... 2 1 2 1
-- all other expenses ................... 44 40 43 41
General and administrative -- non-cash stock compensation ........ 1 1 1 1
-- all other expenses ................. 38 37 32 36
Amortization of intangible assets ................................ 13 15 11 15
Restructuring costs .............................................. 27 -- 8 --
------- ------- ------- -------
Total operating expenses ...................................... 218 174 189 175
------- ------- ------- -------
Loss from operations ................................................ (178) (115) (137) (119)
Interest income ..................................................... 3 7 3 10
Interest expense .................................................... -- -- -- --
15
Other expenses, net .................................... -- (1) (1) (1)
------- ------- ------- -------
Loss before income taxes ............................... (175) (109) (135) (110)
Provision (benefit) for income taxes ................... -- -- -- --
------- ------- ------- -------
Net loss ............................................... (175)% (109)% (135)% (110)%
======= ======= ======= =======
Comparison of the Three and Nine Months Ended September 30, 2002 and 2001
Total revenues. Our total revenues, including reductions for non-cash stock
compensation, decreased by 30.6% to $7.6 million for the three-month period
ended September 30, 2002 from $10.9 million for the same period in 2001. For the
nine-month period ended September 30, 2002, our total revenues, including
reductions for non-cash stock compensation, decreased by 16.4% to $26.8 million
from $32.0 million for the same period in 2001. International revenues increased
by 163.8% to $2.3 million for the three-month period ended September 30, 2002
from $863,000 in the same period in 2001. For the nine-month period ended
September 30, 2002, international revenues increased 87.8% to $6.0 million from
$3.2 million in the same period in 2001. International revenue was 30.0% and
22.5% of our total revenue for the three and nine months ended September 30,
2002, respectively, and 7.9% and 10.0% of total revenues for the three and nine
months ended September 30, 2001, respectively. The increase in international
revenue reflects the growing acceptance of speech recognition software in
markets outside of the United States. We anticipate that international revenues
will represent 15% to 25% of our total revenues in the future, once economic
conditions improve.
Revenues from product licenses. Revenues from the licensing of proprietary
software decreased 55.6% to $3.1 million for the three-month period ended
September 30, 2002 from $6.9 million in the same period in 2001. For the
nine-month period ended September 30, 2002, revenues from product licenses
decreased 32.6% to $12.7 million from $18.8 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 total revenue for the three and nine month periods ended September
30, 2001. There were two different customers that each represented more than 10%
of our total revenue for the three months ended September 30, 2002, but these
customers were not sufficient to offset the decline in revenue from the other
reseller. We expect that revenues from product licenses will increase as a
percentage of our total revenues, once economic conditions improve and revenues
from our resellers return to historical levels.
Revenues from professional services. Revenues from fees we receive for
professional services increased 16.6% to $4.5 million in the three months ended
September 30, 2002 from $3.9 million in the same period in 2001. For the
nine-month period ended September 30, 2002, revenues from professional services
increased 21.5% to $14.8 million from $12.1 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. We
expect that revenues from professional services will represent 50% to 55% of our
total revenues, once economic conditions improve.
Other revenues. Other revenues which result from the resale of computer
hardware and facilities management services, were $964,000 for the three-month
period ended September 30, 2002 compared to $848,000 for the same period in
2001. For the nine-month period ended September 30, 2002, other revenues were
$1.6 million compared to $2.7 million for the same period in 2001. Other
revenues accounted for 12.7% of total revenues for the three-month period ended
September 30, 2002 and 7.7% of total revenues for the same period in 2001. For
the nine-month period ended September 30, 2002, other revenues represented 6.1%
of total revenues compared to 8.4% of total revenues for the same period in
2001. The decrease in other revenues for the nine-month period ended September
30, 2002 compared to the same period in 2001 reflects fewer hardware platforms
purchased directly from us as part of overall client projects. We expect that
other revenues will represent less than 10% of our total revenues, once economic
conditions improve.
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
16
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
on June 30, 2000 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. Prior to
January 1, 2002, amortization of this warrant was reflected in operating
expenses.
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 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. As we had recognized cumulative
revenue under these arrangements as of September 30, 2001 in excess of amounts
previously recorded as a revenue offset, for the three and nine months ended
September 30, 2001, we reclassified an additional $398,000 and $775,000,
respectively, of selling and marketing non-cash stock compensation expense as an
offset to revenue, resulting in a total offset of $686,000 and $1,604,000,
respectively. For the three and nine months ended September 30, 2002, we
recognized $954,000 and $2,260,000, respectively, as an offset to revenue
associated with these arrangements, in accordance with EITF 01-09. Amounts of
$306,000 and $1,778,000, which exceed the amount of cumulative revenue under
each of the arrangements during the three and nine months ended September 30,
2002, respectively, and amounts of $703,000 and $2,564,000 during the three and
nine months ended September 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
decreased by 48.3% to $75,000 for the three months ended September 30, 2002 from
$145,000 for the same period in 2001. This cost represented 2.4% and 2.1% of
product licenses revenues for the three months ended September 30, 2002 and
2001, respectively. For the nine-month period ended September 30, 2002, cost of
product licenses decreased 19.1% to $220,000 from $272,000 for the same period
in 2001. This cost represented 1.7% and 1.4% of product licenses revenues for
the nine months ended September 30, 2002 and 2001, respectively. The decrease in
absolute dollars in the cost of product licenses revenues for the three and
nine-month periods is due to the decrease in quarter-to-date and year-to-date
product license revenues. The increase in cost of product license revenue as a
percentage of product license revenues is due to the higher royalty rate owed to
IBM for the sale of ETI-Eloquence products, including a minimum royalty
guarantee of $200,000 per year. The IBM royalty rate is higher than the royalty
rate owed to MIT. The royalty rate owed to MIT will remain at its current level
of 1% of eligible license revenue until the next cumulative product sales
milestone is achieved. We expect our overall royalty rate to increase as we sell
more ETI-Eloquence products.
Cost of professional services revenues. Cost of professional services
revenues remained constant at $3.2 million for the three months ended September
30, 2002 and 2001. For the nine-month period ended September 30, 2002, cost of
professional services revenues decreased 3.6% to $9.8 million from $10.2 million
for the same period in 2001. The decrease in cost of professional services
revenues for the nine months ended September 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 70.5% and 81.6% of professional
services revenues for the three months ended September 30, 2002 and 2001,
respectively, and represented 66.6% and 83.9% of professional services revenues
for the nine months ended September 30, 2002 and 2001, respectively. The lower
cost of professional services as a percentage of related revenues reflects more
efficient delivery of
17
custom application services and a higher component of maintenance revenues,
which have higher margins.
Cost of other revenues. Cost of other revenues increased 23.2% to $859,000
for the three months ended September 30, 2002 from $697,000 for the same period
in 2001. For the nine-month period ended September 30, 2002, cost of other
revenues decreased 35.4% to $1.4 million from $2.2 million for the same period
in 2001. The cost of other revenues as a percentage of other revenues
represented 89.1% and 82.2% of other revenues for the three months ended
September 30, 2002 and 2001, respectively, and represented 87.3% and 81.5% of
other revenues for the nine months ended September 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
the nine-month period ended September 30, 2002 compared to the same period in
2001. The decline in the margin percentage for the three and nine months ended
September 30, 2002 compared to the same periods in 2001 is due to the delivery
of lower margin hardware and resold services on certain customer contracts
during the three and nine months ended September 30, 2002.
Amortization of completed 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 nine months ended September 30, 2002 and 2001,
amortization of completed technology of $283,000 and $849,000, respectively, for
each period was recorded as a cost of revenues.
On July 22, 2002, we acquired certain technology and patent rights related
to speaker verification from SpeakEZ, Inc., a wholly owned subsidiary of
T-NETIX, Inc, valued at $1.1 million. For the three months ended September 30,
2002, we recorded amortization expense of $60,000 as a cost of revenues.
Total operating expenses. Our total operating expenses decreased 12.9% to
$16.6 million for the three months ended September 30, 2002 from $19.1 million
for the same period in 2001. For the nine-month period ended September 30, 2002,
total operating expenses decreased 10.2% to $50.6 million from $56.4 million for
the same period in 2001. The decrease in spending for the three and nine months
ended September 30, 2002 compared to the same period in 2001 is a result of the
implementation of our restructuring plan in July 2002, which resulted in a
reduced headcount and related costs, as well as salary reductions during a one
month period for all employees, ongoing salary reductions for all executives,
lower spending on marketing programs, outside legal and recruiting fees, and
travel related costs as well as a smaller increase to the allowance for doubtful
accounts. As a result of the restructuring, total headcount was reduced to 328
during the quarter ended September 30, 2002 compared to headcount of 406 as of
September 30, 2001. As a percentage of total revenues, our operating expenses
were 218.4% for the three months ended September 30, 2002, and 174.1% for the
same period in 2001. For the nine-month periods ended September 30, 2002 and
2001, operating expenses as a percentage of total revenues were 188.7% and
175.8%, respectively. Total operating expenses include certain non-cash charges
for the three and nine months ended September 30, 2002 and 2001, as discussed
below.
Selling and marketing. Selling and marketing expenses decreased 14.9% to
$6.6 million for the three months ended September 30, 2002 from $7.8 million for
the same period in 2001. For the nine-month period ended September 30, 2002,
selling and marketing expenses decreased 1.8% to $22.2 million from $22.6
million for the same period in 2001. Selling and marketing expenses, as a
percentage of total revenues, were 87.3% for the three months ended September
30, 2002 and 71.2% for the same period in 2001. For the nine-month periods ended
September 30, 2002 and 2001, selling and marketing expenses as a percentage of
total revenues were 82.7% and 70.4%, respectively. The decrease in selling and
marketing expenses on a dollar basis resulted primarily from lower spending on
marketing programs along with lower salary and related benefit costs as a result
of the restructuring plan implemented in July 2002 and lower commissions as a
result of lower revenues. The number of sales personnel decreased to 72 from 85,
and the number of employees in marketing decreased to 24 from 30 at September
30, 2002 and 2001, respectively. We expect selling and marketing expenses to be
further reduced as the full effect of the restructuring is realized in future
periods.
Research and development. Research and development expenses decreased by
22.1% to $3.4 million for the three-month period ended September 30, 2002 from
$4.3 million for the same period in 2001. For the nine-month period ended
September 30, 2002, research and development expenses decreased 11.4% to $11.6
million from $13.1 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 as a result of
our restructuring. The number of personnel involved in research and development
decreased to 100 at September 30, 2002 from 124 at September 30, 2001. Research
18
and development expenses as a percentage of total revenues were 44.4% and 39.6%
for the three months ended September 30, 2002 and 2001, respectively. For the
nine-month periods ended September 30, 2002 and 2001, research and development
expenses as a percentage of total revenues were 43.2% and 40.8%, respectively.
We expect research and development expenses to be further reduced as the full
effect of the restructuring is realized in future periods.
General and administrative. General and administrative expenses decreased
29.2% to $2.9 million for the three-month period ended September 30, 2002 from
$4.1 million for the same period in 2001. For the nine-month period ended
September 30, 2002, general and administrative expenses decreased 25.6% to $8.7
million from $11.7 million for the same period in 2001. The decrease in spending
for the three and nine months ended September 30, 2002 compared to the same
periods in 2001 was due to lower spending on outside legal fees, recruiting
costs, travel-related costs and bad debt expense. General and administrative
expenses as a percentage of total revenues were 38.0% and 37.2% for the three
months ended September 30, 2002 and 2001, respectively. For the nine-month
periods ended September 30, 2002 and 2001, general and administrative expenses
as a percentage of total revenues were 32.5% and 36.5%, respectively. We expect
general and administrative expenses to be further reduced as the full effect of
the restructuring is realized in future periods.
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 $470,000 and $1.8 million for the three and nine months ended
September 30, 2002 and recorded amortization of $677,000 and $2.0 million for
the three and nine months ended September 30, 2001. We expect amortization of
deferred stock compensation will be approximately $470,000 per quarter through
2004. The decrease in quarterly stock compensation expense reflects the
cancellation of unvested options held by terminated employees. In connection
with the cancellations, we reversed the remaining deferred compensation balance
of approximately $1.1 million, during the third quarter of 2002, and recorded a
decrease in additional paid-in capital.
Selling and marketing expenses - non-cash stock compensation charges in the
three month periods ended September 30, 2002 and 2001 also include non-cash
stock compensation of $306,000 and $703,000, respectively, related to common
stock issued to AOL and Net2Phone at below fair market value and to a warrant
issued to AOL. For the nine-month periods ended September 30, 2002 and 2001,
sales and marketing expenses - non-cash stock compensation include non-cash
stock compensation of $1.8 million and $2.6 million, respectively, related to
common stock issued to AOL and Net2Phone at below fair market value and to a
warrant 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 recognized 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 royalty-free, perpetual
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 each of the three and nine months ended September
30, 2002 and 2001 was $958,000 and $2.9 million, 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. 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 nine months ended September 30, 2001, we recorded $669,000 and $2.0
million, 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
19
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, if discrete financial
information is prepared and regularly reviewed by management, in which case such
component is a reporting unit. We have determined that we operate as one
reporting unit. As a result, our impairment analysis during the second quarter
of 2002 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, including as of December 31, 2002, or more
frequently when events and circumstances occur indicating that the recorded
goodwill might be impaired. In October 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.
Restructuring costs. 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 recorded a $2.1 million charge to operating expenses during the
quarter ended September 30, 2002, relating primarily to severance and related
costs of terminated employees. We paid $1.7 million in severance and related
benefits during the three months ended September 30, 2002. The majority of the
unpaid costs will be paid during the current fiscal quarter and will be funded
from working capital. We expect that our cost savings from the restructuring
will be approximately $2.5 million per quarter as compared to our statement of
operations for the period ended June 30, 2002.
Interest income, interest expense and other income, net. Interest income
was $234,000 for the three months ended September 30, 2002 and $784,000 for the
same period in 2001. Interest expense was $19,000 for the three months ended
September 30, 2002 and $10,000 for the same period in 2001. For the nine-month
periods ended September 30, 2002 and 2001, interest income was $810,000 and $3.3
million, respectively. For the nine-month periods ended September 30, 2002 and
2001, interest expense was $57,000 and $38,000, respectively. The decrease in
interest income for the three and nine months ended September 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 represent other non-operating costs, including local and state
franchise taxes and foreign currency transaction gains and losses.
Provision for income taxes. We recorded a benefit from foreign income taxes
previously accrued of $17,000, based on refunds received during the quarter, and
a provision for foreign income taxes of $42,000 for the three-month periods
ending September 30, 2002 and 2001, respectively. For the nine-month periods
ended September 30, 2002 and 2001, a foreign income tax provision of $77,000 and
$23,000, respectively, was recorded.
Liquidity and Capital Resources
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 September 30,
2002, we had cash and cash equivalents of $46.0 million and marketable
securities of $8.2 million. Our revolving line of credit provides for available
borrowings up to $5.0 million, based upon certain eligible accounts receivable.
As of September 30, 2002, there was $3.7 million available for borrowings under
this line of credit, with $1.3 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 September 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 $23.9 million for each of the nine
months ended September 30, 2002 and 2001. The operating cash outflows for these
periods resulted primarily from our significant investment in sales and
marketing, research and development and infrastructure.
During the nine-month period ended September 30, 2002, our investing
activities included the redemption of $16.1 million of maturing marketable
securities. During the nine-month period ended September 30, 2001, our investing
activities included the net purchase of $24.4 million of marketable securities.
Capital expenditures for property and equipment were
20
$1.9 million for the nine-month period ended September 30, 2002 and $2.7 million
for the same period in 2001. These capital expenditures consisted primarily of
computer hardware and software costs related to upgrading our corporate
infrastructure. During the nine-month period ended September 30, 2002, our
investing activities included the payment of $360,000 to SpeakEZ, Inc. for the
acquisition of certain technology related to speaker verification. During the
nine-month period ended September 30, 2001, we made a 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 September 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 September 30,
2002, $1.4 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 September 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 September 30, 2002), and principal and interest under
the term loan are payable in 36 monthly installments through November 2002. As
of September 30, 2002, $28,000 was outstanding under this facility.
Our financing activities generated cash of $485,000 and $1.1 million for
the nine months ended September 30, 2002 and 2001, respectively. The issuance of
common stock through stock option and warrant exercises generated net proceeds
of $1.2 million and $1.4 million, for the nine months ended September 30, 2002
and 2001, respectively. Repayments of bank borrowings were $714,000 and $375,000
during the nine months ended September 30, 2002 and 2001, respectively.
As a result of the restructuring plan announced on July 3, 2002, we
committed to pay severance and related termination benefits to terminated
employees, along with other restructuring related expenses of approximately $2.1
million. As of September 30, 2002, we paid approximately $1.7 million. We expect
the remaining committed amounts will be paid during the current fiscal quarter
and will be funded through working capital.
Based upon cash savings expected from the restructuring plan that we put in
place during the quarter ended September 30, 2002, we believe that 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 the next 12 months. Management has
the ability to implement additional actions to further reduce costs. 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
September 30, 2002:
Contractual Obligation Payments Due by Period
(in thousands)
2007
Total 2002 2003 - 2004 2005 - 2006 and later
--------- --------- ----------- ----------- ---------
Long-Term Debt $ 1,379 $ 178 $ 1,201 $ -- $ --
Operating Leases 20,920 842 6,785 2,818 10,475
--------- --------- ----------- ----------- ---------
Total Contractual Cash ----------- ----------- ---------
Obligations $ 22,299 $ 1,020 $ 7,986 $ 2,818 $ 10,475
========= ========= =========== =========== =========
21
Other Commercial Commitments
The following table sets forth other financial commitments under
existing banking arrangements as of September 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)
2007
Total 2002 2003 - 2004 2005 - 2006 and later
----------- ----------- ----------- ----------- -----------
Standby Letters of Credit $ 1,276 $ 63 $ 384 $ 47 $ 782
----------- ----------- ----------- ----------- -----------
Royalty Commitments
In connection with our acquisition of certain technology and patent
rights from SpeakEZ, Inc., we assumed the royalty commitments to Rutgers
University for the sale of products developed at Rutgers University and licensed
to SpeakEZ, Inc. Under the terms of the agreement, there is a minimum annual
royalty owed to Rutgers of $10,000 through the end of 2015. 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. In addition, we are also
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 under these agreements, along with the
royalty rates as of September 30, 2002.
Amount of Minimum Royalty Commitment by Period
----------------------------------------------
(in thousands)
Royalty Commitments- Total 2002 2003 2004 2005 Thereafter
----- ---- ---- ---- ---- ----------
Royalty Rate-Rutgers 6% 6% 6% 6% 6%
----- ---- ---- ---- ---- ----------
Royalty Commitment - Rutgers $ 135 $ 5 $ 10 $ 10 $ 10 $ 100
----- ---- ---- ---- ---- ----------
Royalty Rate-IBM 11% 12% 12% 12% 12%
----- ---- ---- ---- ---- ----------
Royalty Commitment - IBM $ 950 $ 50 $200 $200 $500 $ --
----- ---- ---- ---- ---- ----------
Royalty Rate-MIT 1% 1% 1% 1% 1%
----- ---- ---- ---- ---- ----------
Royalty Commitment - MIT $ 200 $ -- $ 50 $ 50 $ 50 $ 50
----- ---- ---- ---- ---- ----------
Other Financial Commitments
As a result of the restructuring plan announced on July 3, 2002, we
committed to pay severance and termination benefits to terminated employees,
along with other related restructuring expenses of approximately $2.1 million.
As of September 30, 2002 we have paid approximately $1.7 million. We expect the
remaining committed amounts will be paid during the current fiscal quarter and
will be funded through working capital.
As a result of our acquisition of certain technology and patent rights
from SpeakEZ, Inc., we are obligated to pay an additional $40,000 and issue an
additional 13,436 shares of our common stock (valued at $38,000 as of July 22,
2002) on December 31, 2003, provided there has been no breach of any
representations or warranties by the seller, as set forth in the purchase and
sale agreement. Additionally, we assumed certain liabilities totaling $320,000
which will be paid no later than January 1, 2004.
Recent Accounting Pronouncements
22
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 that our adoption will have a material impact on our
financial position or results of operations.
23
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 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 $148.9 million at September 30, 2002, and
we expect to incur net losses for the foreseeable future. Net losses were $36.1
million for the nine months ended September 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:
. 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,
. the mix of domestic and international sales,
. the timing of product implementations, particularly large client
design projects,
. unexpected delays in introducing new products and services,
. variation in capital spending budgets of our clients and potential
clients,
. variation in our expenses, whether related to sales and marketing,
product development or administration,
. deferral of recognition of our revenue in accordance with applicable
accounting principles due to the time required to complete projects,
24
. the mix of product license and services revenue, and
. 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.
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.
25
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 reseller of ours accounted for 19.3% of our total
revenue in 2001 and 16.1% of our total revenue in 2000. There was a decline in
demand from this reseller, who previously had accounted for over 10% of our
revenue for the three and nine month periods ended September 30, 2001. For the
three months ended September 30, 2002, two customers each accounted for more
than 10% of our total revenue, but these customers were not sufficient to offset
the decline in revenue from the other reseller. Our speech-activated products
and services require significant expenditures by 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.
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.
For the nine months ended September 30, 2002, 49.3% of our total revenues
were attributable to our resellers and original equipment manufacturers, or
OEMs. In 2001, 55.7% of our total revenues were attributable to our resellers
and OEMs, especially InterVoice, Inc., which accounted for 19.3% of our total
revenues in 2001. For the three months ended September 30, 2002, there was one
different reseller 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.
We have expanded our international operations. Because of risks involved with
operating a business in foreign countries, we may not be successful in
maintaining our international business operations and our business could be
harmed.
Our international sales represented 22.5% of our revenue for the nine
months ended September 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 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:
. difficulties and costs of staffing and managing foreign operations,
26
. difficulties in establishing and maintaining an effective
international reseller network,
. the burden of complying with a wide variety of foreign laws,
particularly with respect to intellectual property and license
requirements,
. political and economic instability outside the United States,
. import or export licensing and product certification requirements,
. tariffs, duties, price controls or other restrictions on foreign
currencies or trade barriers imposed by foreign countries,
. potential adverse tax consequences, including higher marginal rates,
. unfavorable fluctuations in currency exchange rates, and
. 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 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:
. rapidly changing speech recognition and speech synthesis technology,
. evolving industry standards and practices,
. frequent new speech-activated service and product introductions and
enhancements, and
. 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.
27
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, text-to-speech technology and speaker
verification 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 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.
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
28
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.
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
29
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 upon the continued service and performance of a relatively small number
of senior management and key technical personnel. We may not be able to retain
or recruit necessary personnel, which could affect 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. 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.
30
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.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a
date within 90 days of the filing date of this Quarterly Report on Form 10-Q,
the Company's chief executive officer and chief financial officer have concluded
that the Company's disclosure controls and procedures are designed to ensure
that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and are
operating in an effective manner.
(b) Changes in internal controls. There were no significant changes in
the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their most recent evaluation.
PART II. OTHER INFORMATION
Items 1, 3, 4 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.
On July 22, 2002, the Company acquired certain technology and patent
rights related to speaker verification from SpeakEZ, Inc., a wholly owned
subsidiary of T-NETIX, Inc. In connection with the acquisition, the Company paid
$360,000 in cash and issued 120,924 shares of its common stock to one accredited
investor (valued at $345,000 as of July 22, 2002), and assumed certain
liabilities totaling $320,000. The Company is obligated to pay an additional
$40,000 and issue an additional 13,436 shares of its common stock (valued at
$38,000 as of July 22, 2002) on December 31, 2003, provided there has been no
breach of any representations or warranties by the seller, as set forth in the
purchase and sale agreement. These securities were offered and issued pursuant
to Rule 506 of Regulation D of the Securities Act of 1933,
31
as amended.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Index to Exhibits attached hereto, which Index is incorporated
herein by reference.
(b) Reports on Form 8-K
None.
32
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: November 14, 2002 By: /s/ Richard J. Westelman
Richard J. Westelman
Chief Financial Officer
(Chief Accounting Officer)
33
CERTIFICATIONS
I, Stuart R. Patterson, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SpeechWorks
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
By: /s/ Stuart R. Patterson
---------------------------
Dated: November 14, 2002 Stuart R. Patterson
Chief Executive Officer
34
I, Richard J. Westelman, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SpeechWorks
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
By: /s/ Richard J. Westelman
----------------------------
Dated: November 14, 2002 Richard J. Westelman
Chief Financial Officer
35
Index to Exhibits
Exhibit
Number Description
- ------- -----------
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
36