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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 8, 1999
REGISTRATION NO. 333-69211
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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DRAGON SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 7372 04-2764754
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
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320 NEVADA STREET
NEWTON, MA 02460
(617) 965-5200
(ADDRESS INCLUDING ZIP CODE, AND TELEPHONE NUMBER INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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JANET M. BAKER
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
DRAGON SYSTEMS, INC.
320 NEVADA STREET
NEWTON, MA 02460
(617) 965-5200
(NAME, ADDRESS INCLUDING ZIP CODE AND TELEPHONE
NUMBER INCLUDING AREA CODE, OF AGENT FOR SERVICE)
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COPIES TO:
PAUL P. BROUNTAS, ESQ. JOHN A. MELTAUS, ESQ.
HALE AND DORR LLP TESTA, HURWITZ & THIBEAULT, LLP
60 STATE STREET 125 HIGH STREET
BOSTON, MASSACHUSETTS 02109 BOSTON, MASSACHUSETTS 02110
TELEPHONE: (617) 526-6000 TELEPHONE: (617) 248-7000
TELECOPY: (617) 526-5000 TELECOPY: (617) 248-7100
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date hereof.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ]
If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS (Subject to Completion)
Issued January 8, 1999
Shares
DRAGON SYSTEMS LOGO
COMMON STOCK
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DRAGON SYSTEMS, INC. IS OFFERING SHARES OF ITS COMMON STOCK.
THIS IS OUR INITIAL
PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS FOR OUR SHARES.
WE ANTICIPATE THAT
THE INITIAL PUBLIC OFFERING PRICE WILL BE BETWEEN $ AND $
PER SHARE.
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WE HAVE FILED AN APPLICATION FOR THE COMMON STOCK TO BE QUOTED ON THE
NASDAQ NATIONAL MARKET UNDER THE SYMBOL "DRGN."
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INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 4.
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PRICE $ A SHARE
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UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS COMPANY
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Per Share........................... $ $ $
Total............................... $ $ $
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities, or determined if this Prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
Certain of Dragon's stockholders have granted the underwriters the right to
purchase up to an additional shares to cover over-allotments.
Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers on
, 1999.
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MORGAN STANLEY DEAN WITTER
HAMBRECHT & QUIST
SG COWEN
, 1999
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[gatefold artwork]
Description of Gatefold
Two page insert
Text: Dragon Systems was the first company to introduce general purpose,
large vocabulary continuous speech recognition. The company has a 16
year history of developing and providing advanced speech technologies,
worldwide. These technologies "humanize" the way people communicate
with computers, telephones, industrial systems and mobile devices.
SPEECH, PRODUCTS & TECHNOLOGY
Graphic: Picture of six company products on bottom half of page
Picture depicting various people using Dragon products on right side
of page
Company logo and a collage of international flags on bottom margin of
page.
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TABLE OF CONTENTS
PAGE
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Prospectus Summary................... 3
Risk Factors......................... 4
Use of Proceeds...................... 11
Dividend Policy...................... 11
The Company.......................... 11
Capitalization....................... 12
Dilution............................. 13
Selected Consolidated Financial
Data............................... 14
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 15
Business............................. 25
PAGE
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Management........................... 41
Certain Transactions................. 49
Principal Stockholders............... 50
Description of Capital Stock......... 52
Shares Eligible for Future Sale...... 54
Underwriters......................... 56
Legal Matters........................ 58
Experts.............................. 58
Additional Information............... 58
Index to Consolidated Financial
Statements......................... F-1
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In deciding whether to buy our common stock, you should only rely on the
information contained in this Prospectus. We have not authorized anyone to
provide you with information different from that contained in this Prospectus.
We are offering to sell, and seeking offers to buy, shares of our common stock
only in jurisdictions where such offers and sales are permitted. The information
in this Prospectus is accurate only as of the date on the cover of this
Prospectus, regardless of the time this Prospectus is delivered to you or any
sale of our common stock is made. In this Prospectus, the "Company," "Dragon,"
"we," "us" and "our" refer to Dragon Systems, Inc. and its subsidiaries.
Until , 1999, (25 days after the date of this Prospectus) all
dealers that buy, sell or trade in our common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This is
in addition to the dealers' obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
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The Dragon logo, DragonDictate, Dragon Systems and PhoneQuery are
registered trademarks of the Company. BestMatch, NaturallyMobile,
NaturallyOrganized, NaturallySpeaking, The Natural Speech Company, Point &
Speak, Select-and-Say, Vocabulary Builder and VoiceTool are trademarks of the
Company. All other trade names and trademarks referred to in this Prospectus are
the property of their respective owners.
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Except as set forth in the Consolidated Financial Statements or as
otherwise indicated, all information in this Prospectus (i) assumes no exercise
of the underwriters' over-allotment option; (ii) reflects the conversion of all
outstanding shares of the Company's convertible preferred stock into shares of
common stock; (iii) reflects the filing, as of the closing of the offering, of
the Amended and Restated Certificate of Incorporation of the Company (the
"Restated Certificate of Incorporation") and the adoption of the Amended and
Restated By-Laws of the Company (the "Restated By-Laws") implementing certain
provisions described below under "Description of Capital Stock -- Delaware Law
and Certain Charter and By-Law Provisions; Anti-Takeover Effects," and the
receipt of stockholder approval therefor; and (iv) reflects a 5-for-1 stock
split of the Company's common stock effected on December 1, 1998. See
"Description of Capital Stock," "Underwriters" and Note 5 of Notes to
Consolidated Financial Statements.
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PROSPECTUS SUMMARY
The following summary is qualified by the more detailed information and
Consolidated Financial Statements and Notes appearing elsewhere in this
Prospectus.
THE COMPANY
We are a leading developer and provider of advanced speech recognition
products and related speech technologies that "humanize" the way people
communicate with computers and other electronic devices. Our products and
technologies enable electronic devices to understand speech, the most natural
and effective means of communication. As a result, users of our products can
interact with electronic devices faster and more intuitively than with other
input methods such as the keyboard or computer mouse, thereby increasing
productivity. We market a variety of speech products worldwide, including our
Dragon NaturallySpeaking family of continuous dictation software products.
Dragon NaturallySpeaking products are currently available in six languages:
American-English, British-English, French, German, Italian and Spanish, with
Japanese and Mandarin versions scheduled for release in 1999. Since 1997, we and
our Dragon NaturallySpeaking products have received over 70 industry awards
worldwide.
We were the first to introduce products incorporating built-in PC speech
recognition (1984), large vocabulary, general purpose, discrete dictation
(1990), and software-only dictation supporting most Windows applications (1993).
In June 1997, we achieved an important milestone by introducing Dragon
NaturallySpeaking 1.0, the world's first large vocabulary, general purpose,
continuous speech dictation product. We are currently applying our technologies
beyond the PC to multiple platforms such as hand-held and mobile devices, and
are developing advanced applications for emerging speech markets such as
consumer electronics and telephony. We are also collaborating with major
corporations and federal agencies to speech-enable existing hardware and
software platforms.
Our end-users include individuals and companies that utilize our
leading-edge speech products and technologies for a wide range of applications,
including general purpose dictation, legal and medical dictation, inventory
management and in-bound customer telephone interactions. These end-users include
Bank of America FSB, The Boeing Company, the Los Angeles Police Department,
Peugeot S.A., and Wells Fargo & Company. We sell our products worldwide
predominantly through major distributors to retail channel accounts and
value-added resellers ("VARs").
THE OFFERING
Common stock offered by us in this offering................ shares
Common stock to be outstanding after this offering......... shares(1)
Use of proceeds............................................ For general corporate purposes, including working capital,
capital expenditures and potential acquisitions. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol..................... DRGN
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
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1993 1994 1995 1996 1997 1997 1998
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(UNAUDITED)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue................................................. $13,205 $14,138 $16,887 $17,038 $26,821 $15,428 $49,576
Gross profit................................................ 10,897 9,369 10,207 9,991 16,434 8,962 34,819
Operating income (loss)..................................... 3,552 (1,246) (3,498) (5,335) (4,978) (5,637) 5,280
Income (loss) from continuing operations.................... 2,153 (579) (2,092) (4,251) (2,277) (2,685) 4,033
Net income (loss)........................................... 2,153 (579) (5,162) (5,957) (5,296) (4,991) 8,673
Earnings per share:(2)
Income (loss) from continuing operations:
Basic................................................... $ .24 $ (.06) $ (.18) $ (.36) $ (.18) $ (.22) $ .30
Diluted................................................. $ .11 $ (.06) $ (.18) $ (.36) $ (.18) $ (.22) $ .13
Net income (loss):
Basic................................................... $ .24 $ (.06) $ (.43) $ (.50) $ (.43) $ (.41) $ .64
Diluted................................................. $ .11 $ (.06) $ (.43) $ (.50) $ (.43) $ (.41) $ .27
Weighted average shares outstanding(2):
Basic..................................................... 9,048 9,355 11,897 11,922 12,460 12,116 13,622
Diluted................................................... 19,604 9,355 11,897 11,922 12,460 12,116 31,844
AS OF SEPTEMBER 30, 1998
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ACTUAL AS ADJUSTED(3)
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(UNAUDITED)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments........... $12,438
Working capital............................................. 21,430
Total assets................................................ 38,278
Long-term obligations, net of current maturities............ --
Total stockholders' equity.................................. 23,656
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(1) Based on shares of common stock outstanding as of December 8, 1998. Excludes
shares of common stock issuable upon exercise of stock options outstanding
and reserved for future grant or award under the Company's 1999 Stock
Incentive Plan. See "Capitalization," "Management -- Benefit Plans,"
"Description of Capital Stock," "Shares Eligible for Future
Sale -- Options," and Notes 5 and 6 of Notes to Consolidated Financial
Statements.
(2) Computed on basis described in Note 2(g) of Notes to Consolidated Financial
Statements.
(3) As adjusted to reflect the sale of shares of common stock offered by
us hereby at an assumed initial public offering price of $ per share and
the application of the net proceeds therefrom. See "Use of Proceeds" and
"Capitalization."
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RISK FACTORS
You should consider carefully the risks described below before you decide
to buy our common stock. The risks and uncertainties described below are not the
only ones facing us. Additional risks and uncertainties that we do not presently
know about or that we currently believe are immaterial may also adversely impact
our business operations. If any of the following risks actually occur, our
business, financial condition or results of operations would likely suffer. In
such case, the trading price of our common stock could fall, and you may lose
all or part of the money you paid to buy our common stock.
This Prospectus also contains forward-looking statements that involve risks
and uncertainties. Our actual results could differ significantly from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks we face, as more fully described below in this section and
elsewhere in this Prospectus.
RECENT HISTORY OF OPERATING LOSSES
Although we have been profitable for a majority of our 16 years, as well as
the first nine months of 1998, we incurred losses from continuing operations of
approximately $579,000 in 1994, $2.1 million in 1995, $4.3 million in 1996 and
$2.3 million in 1997. The major portion of our losses for those years was
principally attributable to increased expenses in developing and marketing a
continuous speech recognition product. As prospective investors, you must
consider the risks, expenses and competitive pressures which affect companies
like ours, particularly the risks that:
- the market for our products will not continue to grow rapidly;
- new technological developments may limit demand for our products;
- we may not be able to develop, market and license new products and
technologies while effectively managing our operating expenses; and
- our competitors may market their products more effectively or at lower
prices than we can.
If any of the above risks occur, we may not be able to generate any profit
and the market price of our common stock could decline.
FLUCTUATIONS IN QUARTERLY RESULTS; SEASONALITY
Historically, our operating results have been volatile and hard to predict
and will continue to vary from period to period for a number of reasons. First,
like many other software companies, we typically sell more products during our
fourth quarter because of increased retail consumer spending during the holiday
shopping season. In addition, it is common for our corporate customers to defer
purchase decisions until the end of the year. Second, we ship our products
shortly after we receive orders. Thus, order backlog at the beginning of any
quarter may not represent a significant portion of that quarter's expected
revenue. As a result, product revenue in any given quarter largely depends on
orders booked and shipped through the distribution channel in that quarter. This
makes it difficult for us to predict revenue for any future quarter with any
degree of certainty. Third, if we sell significantly fewer products during any
quarter, our revenue will decline, causing our operating results to fluctuate.
For instance, our sales in Europe have historically declined during the summer
months. If our sales in Europe were to increase as a percentage of net revenue,
this seasonal effect would have a more significant impact on our overall sales.
Fourth, to the extent we sell a significant number of products earlier than we
expect, our operating results for subsequent quarters may be lower than
expected. Any shortfall in our revenue as a result of these factors would
directly impact our results of operations and net income, and such fluctuations
in quarterly results could affect the market price of our common stock in a
manner unrelated to our long term operating performance.
Our operating expenses, which include product development costs, and
selling, marketing, general and administrative expenses, are based on our
expectation of future orders and sales of our products. If we sell fewer
products or otherwise have lower revenue than we expect, we may not be able to
quickly reduce our spending in response. We may also choose to reduce prices or
increase spending in response to competition or to pursue new market
opportunities. In particular, our operating margins in the future may be
adversely
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affected if we invest more money in research and development or sales and
marketing efforts, or pursue more international market opportunities in order to
compete with new products introduced by our competitors.
COMPETITION
The market for speech recognition products is relatively new, intensely
competitive and subject to rapid technological change. To compete effectively we
must, among other things,
- establish favorable brand name recognition for our products,
- develop new products that consumers want to buy,
- introduce new versions of and enhancements to our existing products,
- develop new applications for speech technology,
- price our products at appropriate and competitive levels,
- provide strong marketing support to promote our products,
- gain and maintain access to retail outlets with sufficient shelf space,
and
- establish relationships with prominent distributors, VARs, and original
equipment manufacturers ("OEMs").
In the PC applications market, we compete with companies that are larger
and have greater financial resources, including our primary competitors,
International Business Machines Corporation ("IBM"), Lernout & Hauspie Speech
Products N.V. ("Lernout") and Philips Electronics N.V. ("Philips"). Microsoft
Corporation ("Microsoft") is also a significant potential competitor in this
market. As we expand into the telephony market, we will also face competition
from other large and well-capitalized companies such as AT&T Corp. ("AT&T"), GTE
Internetworking, a division of GTE Corporation ("GTE Internetworking"), Lucent
Technologies Inc. ("Lucent"), Nuance Communications, Inc. ("Nuance") Philips,
SpeechWorks International, Inc. (formerly Applied Language Technologies, Inc.)
("SpeechWorks"), and Voice Control Systems, Inc. ("Voice Control"). If we cannot
compete successfully with these companies, we could lose our share of the market
for PC-based speech applications or may have to increase our expenses or reduce
the price of our products. In addition, we may be unable to penetrate new
markets. Any of these developments could have a material adverse effect on our
future growth or financial condition.
Microsoft Windows is the leading desktop operating system for the PC.
Microsoft defines the various software developer standards that permit
interoperability within the Windows operating system including SAPI, its speech
application interface. Our success depends, in part, on the ability of our
products to run effectively on Windows. Recently, Microsoft publicly stated its
intention to bundle SAPI and its own competitive speech recognition technology,
known as "Whisper," into future releases of Windows. In addition, in September
1998, Microsoft made SAPI 4.0, which contains Whisper, widely available to the
Microsoft Developer Network free of charge. Microsoft also has taken steps to
make the new release of SAPI more restrictive to competitors' speech recognition
technologies. This could make it more difficult for us to market innovative
products. For example, SAPI requires the use of a computer mouse to correct
errors. This feature renders useless our voice-based error correction
capabilities. As a result, if Microsoft bundles Whisper with Windows, is
successful in influencing independent software developers to use Whisper when
speech-enabling their software applications, or continues to make SAPI more
restrictive with respect to non-Microsoft speech recognition technology, we will
sell fewer products and our future financial results will be materially and
adversely affected. Similarly, if other developers of operating systems offer
speech recognition technology embedded in their operating systems, or make their
systems incompatible with our technologies, our business could suffer
significantly.
In addition to being a potential competitor, Microsoft is a significant
stockholder of Lernout, one of our primary competitors, and has a representative
on Lernout's Board of Directors. Although we cannot definitively assess the
degree of current or future cooperation between Microsoft and Lernout, we
believe that a successful coordination of their activities would have an adverse
effect on our future financial results.
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DEPENDENCE ON DRAGON NATURALLYSPEAKING
Sales of the Dragon NaturallySpeaking product family accounted for
approximately 42% of our net revenue in 1997 and 80% of our net revenue for the
first nine months of 1998. We anticipate that sales of the Dragon
NaturallySpeaking product family will provide a large percentage of our net
revenue for the foreseeable future. Any decline in demand for these products,
whether as a result of new competitive products, price competition,
technological change or other factors, could materially and adversely affect our
future financial results.
EVOLVING DISTRIBUTION STRATEGY; DEPENDENCE ON DISTRIBUTION CHANNELS
To date, we have sold our products primarily through distributors and VARs
and, to a lesser extent, through OEMs. We plan to increase distribution of our
products by expanding our share of the mass market segment of the retail channel
and increasing sales in the VAR, independent software vendor ("ISV") and OEM
channels. However, we will sell fewer products if we cannot attract or retain
distributors, VARs and OEMs that can market our products effectively or that
will provide timely and cost-effective customer support. In addition, sales of
our products will drop if we fail to manage conflicts which might arise in our
distribution channels. Our two largest distributors are Ingram Micro Inc.
("Ingram Micro") and Tech Data Product Management, Inc. ("Tech Data"). Ingram
Micro accounted for approximately 5% of our net revenue in 1997 and 24% in the
first nine months of 1998. Tech Data accounted for approximately 9% of our net
revenue in 1997 and 39% in the first nine months of 1998.
An increasing number of companies compete for access to the distribution
channels we use, and our arrangements with our distributors and retailers
generally may be terminated by either party at any time. Retailers who carry our
products typically have a limited amount of shelf space and promotional
resources, for which there is intense competition. We cannot guarantee that
distributors and retailers will continue to purchase our products or provide us
with adequate levels of shelf space and promotional support. Any termination or
significant disruption of our relationship with any of our major distributors or
retailers, or a significant reduction in sales volume attributable to any of our
principal resellers, could adversely affect our day-to-day operating performance
and future financial results.
DEVELOPING MARKET AND UNCERTAIN ACCEPTANCE OF SPEECH PRODUCTS
Because the speech industry is relatively new and rapidly evolving, it is
difficult to accurately predict demand and market acceptance for our recently
introduced products. The speech industry currently has a limited number of
proven products and applications. Popular perceptions about the use of speech
recognition products (including reliability, cost, ease-of-use and quality) may
impact the growth of the market for such products, particularly for speech
products other than PC-based applications. While we believe that our speech
recognition technology offers significant advantages over competing products for
a broad range of commercial applications, we cannot guarantee that the market
for speech recognition products will grow significantly or that our products
will become widely accepted. Therefore, it is difficult to predict the size and
future growth rate, if any, of this market. In addition, our existing and future
products may become obsolete and unmarketable if competing products based on new
technologies are introduced to the market. From time to time, we and our
competitors may announce new products, capabilities or technologies that have
the potential to replace or limit the usefulness of our existing product
offerings. As a result, customers may refrain from purchasing any of our
existing products. If the market for our products does not develop as quickly as
we expect, or becomes more competitive, or if our new products do not achieve
market acceptance, our future financial results will be adversely affected.
MANAGEMENT OF GROWTH
Our rapid growth has placed a significant strain on our resources. As of
December 8, 1998, we had approximately 316 employees located in the United
States, England, France and Germany compared to
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approximately 185 employees in three locations on January 1, 1997. To continue
to manage this growth successfully, we must do the following:
- continue to implement and improve our operational and financial systems;
- maintain our research and development activities;
- expand, train and manage our employee base;
- expand our sales and marketing activities;
- implement and manage new distribution channels to penetrate different and
broader markets;
- leverage our core technology for new product applications;
- manage multiple relationships among various customers, suppliers,
resellers, licensors, strategic partners and other third parties; and
- expand our existing facilities or relocate to larger facilities.
We have tried to assess and address the costs and risks associated with our
recent and planned future expansion, but our systems, procedures and controls
may not support our current or future operations. In addition, it may be
difficult to simultaneously manage our planned expansion and successfully
exploit the market opportunity for our products in a timely and cost-effective
manner. If we fail to manage our planned expansion effectively, our business
could suffer significantly.
DEPENDENCE ON KEY PERSONNEL
Our future success depends on the continued services of a number of key
officers, including our co-founder, Chairman and Chief Executive Officer, Dr.
Janet M. Baker, and our President, John D. Shagoury. We do not have an
employment contract with any of our key personnel other than Mr. Shagoury. If
Dr. Janet Baker left our Company, the loss of her technological knowledge and
industry expertise could seriously impede our development of new products.
Moreover, the loss of one or a group of our key employees, particularly to a
competitor, and any resulting loss of customers to any such competitor, could
adversely affect our future financial results. After undergoing back surgery in
October 1998, our other co-founder, Dr. James K. Baker, the former Chairman and
Chief Executive Officer of our Company and the husband of Dr. Janet M. Baker,
resigned as a director, officer and employee of our Company, effective December
1, 1998. During his 16 years with the Company, he and his wife led the
development of our speech technology and current products. Dr. James K. Baker
has agreed to serve as Chairman of our Technical Advisory Board. See
"Management -- Technical Advisory Board."
COMPETITIVE MARKET FOR TECHNICAL PERSONNEL
Our future performance also depends upon our ability to attract and retain
highly-qualified scientific, technical, sales, marketing and managerial
personnel. There is intense competition for such personnel, particularly in the
field of software engineering. If we do not succeed in retaining our personnel
or in attracting new employees, our business could suffer significantly.
DEPENDENCE ON INTELLECTUAL PROPERTY
We believe that our success depends, in large part, on protecting our
intellectual property in the United States and in foreign countries by doing the
following:
- obtaining patent protection for our technology;
- defending our patents against any infringement;
- preserving our trade secrets and trademarks;
- operating without infringing the patents and intellectual property rights
of others; and
- requiring that each employee, consultant or advisor sign a
confidentiality agreement to prevent the unauthorized use or disclosure
of confidential information.
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However, we cannot guarantee that these measures will be adequate to
protect our intellectual property rights. Despite our efforts to protect our
intellectual property, we cannot prevent unauthorized third parties from trying
to copy our products or use our confidential information to develop competing
products.
We may experience additional difficulty in protecting our intellectual
property rights because we derive a major portion of our sales from licensing
our products under standardized "shrink wrap" agreements that our licensees do
not sign. If any of these agreements is deemed to be unenforceable, our
licensees could use our technology free of charge and without appropriate
limitations. Moreover, we have not embedded any copy protection in our software
because we do not believe that these mechanisms are practical or cost-effective.
At the same time, current United States laws that prohibit software copying
provide only limited protection from software "pirates," and the laws of many
other countries provide almost no protection against unauthorized copying.
Policing unauthorized use of our technology is difficult, expensive, and
time-consuming. We expect software piracy to be a persistent problem and
anticipate that our revenue, especially overseas, may be adversely affected as a
result of this problem.
In addition, we may also be subject to litigation to defend our
intellectual property rights from claims of infringement made by third parties.
An adverse legal decision affecting our intellectual property, or the use of
significant resources to defend against such a claim, could adversely affect our
operating results.
RISK OF SOFTWARE DEFECTS
Complex software products like those we develop may contain errors or
defects, especially when first implemented, that may be very costly to correct.
If any of our products contain defects or errors, our business could also suffer
significantly from potential adverse customer reaction, negative publicity
regarding our products and harm to our reputation.
RISKS ASSOCIATED WITH OPERATIONS OUTSIDE NORTH AMERICA
Net revenue from customers located outside North America accounted for
approximately 29% in 1996, 15% in 1997 and 10% in the first nine months of 1998
of our net revenue for such periods. Over time, we expect revenue from
international operations, principally in Europe, to increase as a percentage of
our net revenue. As a result, we are exposed to a number of risks customary for
international operations, including the following:
- difficulties relating to global administration of our business;
- difficulty in staffing and managing our foreign operations;
- currency fluctuations;
- limitations on sending the earnings of our foreign operations back to the
United States;
- the burdens of complying with a wide variety of foreign laws;
- the uncertainty of laws and enforcement in certain countries relating to
the protection of intellectual property rights;
- reductions in business activity during the summer months in Europe and
certain other parts of the world;
- export controls;
- multiple and possibly overlapping tax structures;
- changes in import/export duties and quotas;
- introduction of tariff or nontariff barriers; and
- economic or political changes in international markets.
In addition, a substantial portion of our operating expenses and costs
relating to our international operations are denominated in United States
dollars, while a majority of our international revenue is generated in foreign
currencies. As a result, we are exposed to fluctuations in the foreign exchange
rates between the United States dollar and foreign currencies. To date, we have
not used risk management techniques or
8
11
"hedged" the risks associated with fluctuations in foreign exchange rates. Our
business could suffer significantly from the realization of any of these risks.
RISKS ASSOCIATED WITH YEAR 2000
We believe we do not have any significant exposure to the Year 2000 issue
because our products and information systems accept four digit entries into
their year code fields. In addition, we believe that the information systems of
our distributors, OEMs, VARs and ISVs (as they relate to our business) comply
with Year 2000 requirements. However, if the information systems of any of our
customers or suppliers fail to comply with Year 2000 requirements, then the
operation of our information systems could be adversely affected. Furthermore,
customers may be forced to allocate greater resources to comply with Year 2000
requirements and as a result purchase fewer products from us, causing a
significant reduction in our net revenue. For additional information addressing
the Company's exposure to the Year 2000 issue, please see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Year
2000 Compliance."
CONTROL BY PRINCIPAL STOCKHOLDERS
Following this offering, Drs. Janet and James Baker, will hold an aggregate
of approximately % of the outstanding shares of our common stock ( % if
the underwriters' over-allotment option is exercised in full), and Seagate
Technology, Inc. ("Seagate") will hold approximately %. As a result, these
three stockholders acting together will be able to take any of the following
actions without the approval of our public stockholders:
- amend our charter in certain respects or approve a merger, sale of assets
or other major corporate transaction;
- defeat any non-negotiated takeover attempt that may be beneficial to our
public stockholders;
- determine the amount and timing of dividends paid to themselves and to
our public stockholders; and
- otherwise control our management and operations and the outcome of all
matters submitted for a stockholder vote, including the election of
directors, that could conflict with the interests of our public
stockholders.
NO PRIOR TRADING MARKET, POTENTIAL VOLATILITY OF STOCK PRICE
Before this offering, there was no public market for our common stock. The
underwriters and we have determined the initial public offering price of our
common stock based on negotiations among us concerning the valuation of our
common stock. Nevertheless, after this offering, you may not be able to resell
your shares at or above the initial public offering price due to a number of
factors, including:
- actual or anticipated fluctuations in our operating results;
- changes in securities analysts' financial estimates;
- changes in expectations as to our future financial performance;
- announcements of new technological innovations and alliances by
competitors; and
- the operating and stock price performance of our competitors and other
comparable companies.
In addition, the stock market in general has experienced extreme volatility
that often has been unrelated to the operating performance of particular
companies. These broad market and industry fluctuations may adversely affect the
trading price of our common stock, regardless of our actual operating
performance. You should read the "Underwriters" section of this Prospectus for a
more complete discussion of the factors that the underwriters and we considered
in determining the initial public offering price.
9
12
SHARES ELIGIBLE FOR FUTURE SALE
After this offering, we will have shares of common stock
outstanding and will have reserved an additional shares of common
stock for issuance pursuant to our stock option plans and stock purchase plan.
We intend to register for resale the shares of common stock reserved for
issuance under our stock option plans and stock purchase plan after the date of
this Prospectus. The federal securities laws impose certain restrictions on the
ability of stockholders to resell their shares.
We have entered into a registration rights agreement with Seagate which
permits Seagate, subject to certain conditions, to include shares of common
stock it holds in certain offerings of common stock made by us in the future.
Certain stockholders of the Company, including Seagate, and certain holders of
options to purchase our common stock have agreed that, for a period of 180 days
from the date of this Prospectus, they will not sell their shares without the
prior written consent of Morgan Stanley & Co. Incorporated. Accordingly, on
, shares of our common stock held by Seagate will be
available for immediate resale (subject to certain volume restrictions imposed
on Seagate by the federal securities laws).
If a large number of shares of our common stock were traded immediately
following this offering, the price of our common stock could decrease, impairing
our ability to obtain capital through another offering of our equity securities
and decreasing the value of your investment.
IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price of our common stock is substantially
higher than the pro forma net tangible book value per share of the outstanding
common stock. Accordingly, if you purchase any shares of common stock in this
offering you will incur immediate dilution of approximately $ in the
pro forma net tangible book value per share of the common stock from the price
you pay for our common stock.
POTENTIAL ADVERSE EFFECTS OF ANTI-TAKEOVER PROVISIONS; AVAILABILITY OF PREFERRED
STOCK FOR ISSUANCE
Our Restated Certificate of Incorporation and Restated By-Laws contain
anti-takeover provisions that could have the effect of delaying or preventing
changes in our management, even if such changes would benefit our public
stockholders. For example, following the closing of this offering, our Board of
Directors may issue up to 5,000,000 shares of preferred stock without any
further stockholder vote or action. The preferred stock could have voting,
liquidation, dividend and other rights superior to those of our common stock,
and, therefore, any issuance of preferred stock could adversely affect your
rights as a common stock holder. These factors could cause the market price of
the common stock to decrease.
NO EXPECTATION OF DIVIDEND PAYMENTS
We do not expect to pay cash dividends on our common stock in the
foreseeable future.
10
13
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares
of common stock offered by the Company in this offering are estimated to be
approximately $ at an assumed initial public offering price of $
per share and after deducting estimated underwriting discounts and commissions
and estimated offering expenses payable by the Company. If the over-allotment
option is exercised, the Company will not receive any proceeds from the sale of
the common stock by the selling stockholders granting the option.
The principal purposes of this offering are to establish a public market
for the Company's common stock, to increase the Company's visibility in the
marketplace, to facilitate future access by the Company to public capital
markets, to provide liquidity to existing stockholders and to obtain additional
working capital.
The Company expects to use the net proceeds for general corporate purposes,
including working capital and capital expenditures. The Company may also use a
portion of the net proceeds to acquire businesses, products or technologies that
are complementary to those of the Company, although no specific acquisitions are
currently planned and no portion of the net proceeds has been allocated for any
acquisition. Pending such uses, the net proceeds to the Company from this
offering will be invested in investment grade, interest-bearing securities.
DIVIDEND POLICY
The Company has never paid or declared any cash dividends on its common
stock or other securities and does not anticipate paying cash dividends in the
foreseeable future. The Company currently intends to retain all of its future
earnings, if any, for use in the operation of its business.
THE COMPANY
Our company was incorporated in Delaware in 1982. Our principal executive
offices are located at 320 Nevada Street, Newton, MA 02460. Our telephone number
is (617) 965-5200.
11
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1998: (i) on an actual basis, (ii) on a pro forma basis giving
effect to the conversion of all of the Company's outstanding convertible
preferred stock and (iii) on a pro forma basis as adjusted to reflect the
issuance and sale of the shares of common stock offered by the Company
hereby at an assumed initial public offering price of $ per share and the
application of the estimated net proceeds therefrom.
AS OF SEPTEMBER 30, 1998
-----------------------------------
PRO PRO FORMA
ACTUAL FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE DATA)
Stockholders' equity:(1)
Convertible preferred stock, $.04 par value; 5,000,000
shares authorized; 3,238,951 shares issued and
outstanding, actual; none issued and outstanding pro
forma and pro forma as adjusted..................... $ 130 $ -- $ --
Common stock, $.04 par value; 100,000,000 shares
authorized; 13,628,380 shares issued and
outstanding, actual; 29,823,135 shares issued and
outstanding pro forma; shares issued and
outstanding pro forma as adjusted(2)................ 545 1,193
Additional paid-in capital............................. 31,028 30,510
Retained deficit....................................... (8,045) (8,045)
Accumulated other comprehensive income................. (2) (2)
------- ------- -------
Total stockholders' equity.......................... 23,656 23,656
------- ------- -------
Total capitalization.............................. $23,656 $23,656 $
======= ======= =======
- ------------
(1) Gives effect to the filing of the Restated Certificate of Incorporation of
the Company immediately prior to the closing of the offering authorizing
5,000,000 shares of preferred stock, $.04 par value, and 100,000,000 shares
of common stock, $.04 par value.
(2) Excludes (i) 3,692,310 shares of common stock issuable upon exercise of
stock options outstanding as of December 8, 1998, of which options to
purchase 1,306,740 shares were then exercisable, and (ii) 3,000,000 shares
of common stock reserved for future grant or award under the Company's 1999
Stock Incentive Plan. See "Management -- Benefit Plans" and Notes 5 and 6 of
Notes to Consolidated Financial Statements.
12
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DILUTION
The pro forma net tangible book value of the Company as of September 30,
1998, giving effect to the conversion of all shares of convertible preferred
stock outstanding as of September 30, 1998 into common stock on the closing of
this offering, was approximately $23,656,000 or approximately $0.79 per share of
common stock. Pro forma net tangible book value per share represents the
Company's tangible net worth (tangible assets less total liabilities) divided by
the 29,823,135 shares of common stock outstanding after giving effect to the
conversion of the convertible preferred stock outstanding at September 30, 1998
into common stock. After giving effect to the issuance and sale of the
shares of common stock offered by the Company hereby (at an
assumed initial public offering price of $ per share)and the receipt and
application of the net proceeds therefrom, the Company's pro forma net tangible
book value at September 30, 1998 would have been $ , or $ per
share. This represents an immediate increase in pro forma net tangible book
value to existing stockholders of $ per share and an immediate dilution to
new investors of $ per share. The following table illustrates this per share
dilution:
Assumed initial public offering price per share............. $
Pro forma net tangible book value per share before this
offering............................................... $ .79
Increase in pro forma net tangible book value per share
attributable to new investors..........................
-----
Pro forma net tangible book value per share after this
offering..................................................
-------
Dilution per share to new investors......................... $
=======
The following table summarizes on a pro forma basis, giving effect to the
conversion of all outstanding shares of convertible preferred stock into common
stock on the closing of this offering, as of December 8, 1998, the difference
between the number of shares of common stock purchased from the Company, the
total consideration paid to the Company, and the average price per share paid by
existing stockholders and by new investors (at an assumed initial public
offering price of $ per share before deduction of estimated underwriting
discounts and commissions and estimated offering expenses payable by the
Company):
SHARES PURCHASED(1) TOTAL CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- ---------
Existing stockholders............... 29,823,135 % $31,703,000 % $1.06
New investors....................... -- -- -- --
---------- ----- ----------- -----
Total..................... 100.0% 100.0% $
========== ===== =========== =====
- ------------
(1) If the over-allotment option is exercised in full, sales by selling
stockholders will reduce the number of shares of common stock held by
existing stockholders to shares, or % of the total
number of shares of common stock to be outstanding after this offering and
will increase the number of shares of common stock held by new investors to
shares, or % of the total number of shares to be
outstanding after this offering. See "Principal Stockholders."
The table above assumes no exercise of stock options outstanding at
December 8, 1998. As of December 8, 1998, there were options outstanding to
purchase 3,692,310 shares of common stock at a weighted average exercise price
of $ per share and 3,000,000 shares reserved for future grant or award under
the Company's 1999 Stock Incentive Plan. To the extent any of these options are
exercised, there will be further dilution to new investors. To the extent all of
such outstanding options had been exercised as of December 8, 1998, net tangible
book value per share after this offering would be $ and total dilution
per share to new investors would be $ . See "Management -- Benefit
Plans," Note 6 of Notes to Consolidated Financial Statements, and "Risk
Factors -- Immediate and Substantial Dilution."
13
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SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and the Notes
thereto, and with Management's Discussion and Analysis of Financial Condition
and Results of Operations, included elsewhere in this Prospectus. The selected
consolidated statement of operations data set forth below for the three years in
the period ended December 31, 1997 and the selected consolidated balance sheet
data at December 31, 1996 and December 31, 1997 are derived from Consolidated
Financial Statements of the Company audited by Arthur Andersen LLP, independent
public accountants, which are included elsewhere in this Prospectus. The
selected consolidated balance sheet data at December 31, 1995 is derived from
Consolidated Financial Statements of the Company audited by Arthur Andersen LLP,
independent public accountants, which are not included in this Prospectus. The
selected consolidated financial data as of and for the years ended December 31,
1993 and December 31, 1994 are derived from Consolidated Financial Statements of
the Company audited by other independent public accountants, and which are not
included in this Prospectus. The selected consolidated financial data for the
nine months ended September 30, 1997 and as of and for the nine months ended
September 30, 1998 are derived from the Company's unaudited Consolidated
Financial Statements included elsewhere in this Prospectus. In the opinion of
management of the Company, the unaudited Consolidated Financial Statements have
been prepared on the same basis as the audited Consolidated Financial Statements
audited by Arthur Andersen LLP and include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the financial
position and results of operations for these periods. Results for the nine
months ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998 or any other future
period.
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------------- -----------------
1993 1994 1995 1996 1997 1997 1998
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net Revenue:
Software licenses......................................... $10,181 $ 7,720 $12,171 $11,479 $19,506 $10,222 $44,766
Development contracts..................................... 3,024 6,418 4,716 5,559 7,315 5,206 4,810
------- ------- ------- ------- ------- ------- -------
Total net revenue....................................... 13,205 14,138 16,887 17,038 26,821 15,428 49,576
------- ------- ------- ------- ------- ------- -------
Cost of revenue:
Cost of software licenses................................. 1,422 2,278 3,365 3,465 5,394 2,806 12,162
Cost of development contracts............................. 886 2,491 3,315 3,582 4,993 3,660 2,595
------- ------- ------- ------- ------- ------- -------
Total cost of revenue................................... 2,308 4,769 6,680 7,047 10,387 6,466 14,757
------- ------- ------- ------- ------- ------- -------
Gross profit............................................ 10,897 9,369 10,207 9,991 16,434 8,962 34,819
------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development.................................. 4,072 6,311 6,688 7,983 9,577 7,096 10,607
Selling and marketing..................................... 1,940 3,022 4,825 5,403 9,350 5,734 16,025
General and administrative................................ 1,333 1,282 2,192 1,940 2,485 1,769 2,907
------- ------- ------- ------- ------- ------- -------
Total operating expenses................................ 7,345 10,615 13,705 15,326 21,412 14,599 29,539
------- ------- ------- ------- ------- ------- -------
Operating income (loss)..................................... 3,552 (1,246) (3,498) (5,335) (4,978) (5,637) 5,280
Interest income........................................... 23 313 760 520 511 369 452
------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing operations before income
taxes................................................. 3,575 (933) (2,738) (4,815) (4,467) (5,268) 5,732
Provision for (benefit from) income taxes................... 1,422 (354) (646) (564) (2,190) (2,583) 1,699
------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing operations................ 2,153 (579) (2,092) (4,251) (2,277) (2,685) 4,033
------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued operations.................. -- -- (3,070) (1,706) (3,019) (2,306) 4,640
------- ------- ------- ------- ------- ------- -------
Net income (loss)....................................... $ 2,153 $ (579) $(5,162) $(5,957) $(5,296) $(4,991) $ 8,673
======= ======= ======= ======= ======= ======= =======
Earnings per share:
Income (loss) from continuing operations:
Basic................................................... $ .24 $ (.06) $ (.18) $ (.36) $ (.18) $ (.22) $ .30
Diluted................................................. $ .11 $ (.06) $ (.18) $ (.36) $ (.18) $ (.22) $ .13
Net income (loss):
Basic................................................... $ .24 $ (.06) $ (.43) $ (.50) $ (.43) $ (.41) $ .64
Diluted................................................. $ .11 $ (.06) $ (.43) $ (.50) $ (.43) $ (.41) $ .27
Weighted average shares outstanding
Basic................................................... 9,048 9,355 11,897 11,922 12,460 12,116 13,622
Diluted................................................. 19,604 9,355 11,897 11,922 12,460 12,116 31,844
AS OF DECEMBER 31, AS OF
------------------------------------------------ SEPTEMBER 30,
1993 1994 1995 1996 1997 1998
------ ------- ------- -------- -------- -------------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short term investments........... $2,353 $13,310 $ 9,582 $ 6,912 $ 12,321 $12,438
Working capital............................................. 2,763 16,135 11,136 5,936 13,481 21,430
Total assets................................................ 6,286 20,294 16,223 13,113 23,186 38,278
Long-term obligations, net of current maturities............ 64 43 43 -- -- --
Retained earnings (deficit)................................. 3,922 (303) (5,465) (11,422) (16,718) (8,045)
Total stockholders' equity.................................. 4,001 18,402 13,230 7,292 14,854 23,656
- ------------
(1) For an explanation of the determination of the number of shares used in
computing earnings per share, see Note 2(g) of Notes to Consolidated
Financial Statements.
14
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's Consolidated Financial Statements and related Notes included
elsewhere in this Prospectus.
OVERVIEW
The Company is a leading developer and provider of advanced speech
recognition products and related speech technologies. In 1997, Dragon became the
first company to develop, produce and market large vocabulary, general purpose,
continuous speech technology for commercial applications through the
introduction of its Dragon NaturallySpeaking dictation product.
The Company was founded in 1982 and has financed its activities through
income from operations and proceeds from the sale of equity securities to
Seagate in 1994 and 1997. At December 8, 1998, Seagate owned approximately 38%
of the Company's outstanding common stock on an as-converted basis. Although the
Company has been profitable for a majority of its 16 years of operation, during
1994, 1995, 1996 and 1997, the Company incurred aggregate losses from continuing
operations of approximately $9.2 million. These losses resulted principally from
a significant increase in operating expenses associated with developing and
marketing the Dragon NaturallySpeaking family of continuous speech products.
In 1995, the Company acquired an ownership interest in Articulate Systems,
Inc. ("Articulate"). In 1998, the Company sold its 38% interest in Articulate to
fonix corporation ("fonix") for cash, notes and fonix common stock valued in the
aggregate at $4.0 million. Accordingly, the results of operations of Articulate
have been included as discontinued operations in Dragon's Consolidated Financial
Statements for all periods presented. See Note 3 of Notes to Consolidated
Financial Statements.
The Company derives its revenue primarily from the sale of software
licenses through distributors to retail channel accounts and VARs, as well as
from royalty fees from OEMs which license the Company's software directly. The
Company also derives revenue from corporate development contracts and
government-funded research. The Company recognizes revenue from software license
sales at the time the products are shipped out of distribution to the retail
channel accounts and VARs. The Company recognizes revenue from OEM royalty fees
upon the shipment of units by the OEM. Revenue from corporate development
contracts and government-funded research is recognized on a
percentage-of-completion basis.
Since its introduction in June 1997, and through September 30, 1998, the
Dragon NaturallySpeaking product family has represented the Company's principal
source of revenue. The Company plans to expand its existing product offerings
through a series of new product introductions over the next twelve months. The
Company believes that its existing products, as well as the new products it
plans to introduce, will constitute the majority of its revenue for the
foreseeable future. The Company's future revenue growth is dependent, in part,
on continued acceptance of its existing products as well as market acceptance of
its new product introductions. Any decline in the market acceptance of the
Company's products, or in speech technology in general, would have a material
adverse effect on the Company's results of operations. In addition, because the
Company's products range from lower-priced, mass merchant software to
higher-priced, professional software and related mobile products (which combine
microphones and recorders with the Company's software), a shift in the revenue
mix of any of these products could have a material impact on the Company's gross
margins in any given period.
The Company sells its products worldwide, with the majority of its net
revenue coming from North America. North American revenue accounted for
approximately 85% of the Company's net revenue during 1997 and 90% of net
revenue during the first nine months of 1998. Revenue derived outside North
America declined as a percentage of net revenue in 1998 primarily due to the
substantial increase in revenue from the Company's Dragon NaturallySpeaking
product family in North America. The Company expects that net revenue derived
outside North America will increase as a percentage of net revenue in 1999.
Sales to the Company's two largest distributors constituted approximately
14% of net revenue in 1997 and 63% of net revenue for the first nine months of
1998. The Company believes that these two distributors
15
18
will remain among the Company's largest distributors. For the nine months ended
September 30, 1998, approximately 72% of the Company's net revenue was
attributable to sales to retail channel accounts through distribution. The
Company plans to expand its OEM relationships in 1999 and therefore expects that
its 1999 OEM-related revenue will increase significantly as a percentage of net
revenue as compared to 1998 levels.
At the time of sale, the Company provides for its expected sales returns,
sales commissions and post-sales support expense. In addition, the Company
creates reserves for the collectability of accounts receivable. While the
Company believes its provisions for sales returns, sales commissions, post-sales
support, and the collectability of accounts receivable are adequate, actual
results could differ from those estimates.
The Company's cost of software licenses primarily consists of expenses
incurred by the Company to manufacture, package and distribute its products and
related documentation. These costs include expenses for hardware, literature and
packaging, technical support, fulfillment and shipping, and shrinkage. Any
significant change in material component prices, increase or decrease in bundled
hardware component prices, or increase or decrease in fulfillment and shipping
costs could have a material effect on the Company's cost of software licenses.
The Company's cost of development contracts consists primarily of labor costs,
other direct expenses and related overhead associated with the performance of
these contracts. Since the beginning of 1997, the Company has not capitalized
any software development costs as such costs were immaterial. In addition, all
research and development costs have been charged to operations as incurred.
The Company has experienced seasonal fluctuations in its results of
operations. The Company began selling its products at retail in August 1997 and
based on its 1997 experience and software industry trends, the Company expects
sales to increase during the fourth quarter as a result of the holiday shopping
season. In addition, certain corporate customers tend to enter into sales
contracts at or near year-end resulting in higher demand during the fourth
quarter. Due to this seasonality, the Company expects to incur increased sales
and marketing expense (principally advertising costs, promotional expenses and
sales commission payouts) during the fourth quarter and any shortfall from
anticipated revenue in that quarter would have a disproportionately greater
adverse effect on the Company's operating results. In addition, sales in Europe
have historically declined during the summer months. If the Company's European
sales increase as a percentage of net revenue, this seasonal effect will have a
more significant impact on the Company's results from operations.
The Company employed 316 people at December 8, 1998, compared to 185 at
January 1, 1997. This increase in headcount resulted primarily from an increase
in sales and marketing personnel associated with the Company's efforts to market
and sell its Dragon NaturallySpeaking family of products. The Company expects to
continue to increase expenses associated with its sales and marketing
infrastructure in anticipation of continued sales growth. Additionally, the
Company expects to increase its headcount in research and development to support
its new product development efforts. Given the expected increase in headcount,
the Company anticipates that it will need to either expand its existing offices
or relocate to a larger facility within the next 12 to 18 months. The Company
believes that this expansion or relocation will result in an increase in total
facilities costs.
The Company's ability to grow will depend, in part, on its success in
adding sales, marketing and research and development personnel during 1999 and
in future periods. In addition, the Company's future success will depend in part
on its ability to attract, retain and motivate highly qualified technical and
management personnel, for whom competition is intense. The Company expects that
future expansion will continue to challenge the Company's ability to hire,
train, motivate, and manage its employees, and to attract and retain qualified
senior managers and technical staff, such as programmers and software engineers.
If the Company's revenue does not increase relative to its operating expenses,
the Company's management systems do not expand to meet increasing demands, the
Company fails to attract, assimilate and retain qualified personnel, or the
Company's management otherwise fails to manage the Company's expansion
effectively, the Company's business, financial condition and operating results
could be materially and adversely affected.
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RESULTS OF OPERATIONS
The following table sets forth selected consolidated financial information
included in the Company's consolidated statements of operations expressed as a
percentage of net revenue for the periods indicated and certain gross profit
data expressed as a percentage of software license revenue or development
contract revenue.
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
1995 1996 1997 1997 1998
------ ------ ------ ------ ------
Net Revenue:
Software licenses............................... 72.1% 67.4% 72.7% 66.3% 90.3%
Development contracts........................... 27.9 32.6 27.3 33.7 9.7
------ ------ ------ ------ ------
Total net revenue....................... 100.0 100.0 100.0 100.0 100.0
------ ------ ------ ------ ------
Cost of revenue:
Cost of software licenses....................... 19.9 20.3 20.1 18.2 24.5
Cost of development contracts................... 19.6 21.0 18.6 23.7 5.2
------ ------ ------ ------ ------
Total cost of revenue................... 39.5 41.3 38.7 41.9 29.7
------ ------ ------ ------ ------
Gross profit............................ 60.5 58.7 61.3 58.1 70.3
------ ------ ------ ------ ------
Operating expenses:
Research and development........................ 39.6 46.9 35.7 46.0 21.4
Selling and marketing........................... 28.6 31.7 34.9 37.2 32.3
General and administrative...................... 13.0 11.4 9.3 11.5 5.9
------ ------ ------ ------ ------
Total operating expenses................ 81.2 90.0 79.9 94.7 59.6
------ ------ ------ ------ ------
Operating income (loss)........................... (20.7) (31.3) (18.6) (36.6) 10.7
Interest income................................. 4.5 3.1 1.9 2.6 0.9
------ ------ ------ ------ ------
Income (loss) before income taxes....... (16.2) (28.2) (16.7) (34.2) 11.6
Provision for (benefit from) income taxes......... (3.8) (3.3) (8.2) (16.7) 3.4
------ ------ ------ ------ ------
Income (loss) from continuing
operations............................ (12.4) (24.9) (8.5) (17.5) 8.2
------ ------ ------ ------ ------
Gain (loss) on discontinued operations:
Loss from operations.................... (18.2) (10.0) (11.3) (14.9) (4.3)
Gain on sale............................ -- -- -- -- 13.7
------ ------ ------ ------ ------
Gain (loss) on discontinued
operations....................... (18.2) (10.0) (11.3) (14.9) 9.4
------ ------ ------ ------ ------
Net income (loss)............................... (30.6%) (34.9%) (19.8%) (32.4%) 17.6%
====== ====== ====== ====== ======
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NET REVENUE
Net revenue for the nine months ended September 30, 1998 was $49.6 million,
an increase of 221% over the $15.4 million of revenue generated for the nine
months ended September 30, 1997. The increase in net revenue during 1998 was
primarily attributable to higher sales of the Company's Dragon NaturallySpeaking
continuous speech product family, the first version of which was first released
in June 1997 and did not begin to generate revenue until the third quarter of
1997.
Software Licenses. Software license revenue for the nine months ended
September 30, 1998 was $44.8 million, an increase of 338% over the $10.2 million
reported in the comparable period in 1997. Growth in software license revenue
was primarily attributable to the introduction of the Company's Dragon
NaturallySpeaking product family. Since the introduction of Dragon
NaturallySpeaking, the Company has continued to increase its product offerings,
including products for multiple languages and telephony
17
20
applications, and developed several new versions of its core dictation product
designed to meet the needs of consumers, mobile users and medical, legal and
other professional and corporate users. Sales from software licenses accounted
for approximately 90% of net revenue for the nine month period ended September
30, 1998, compared to approximately 66% of net revenue for the comparable period
in 1997.
During 1998 and the latter part of 1997, the Company significantly expanded
its sales channels, both inside and outside North America, to respond to the
market demand for its software products. While the Company believes that its
revenue will continue to grow as it introduces new products with enhanced
capabilities and expands its penetration in the retail markets both domestically
and abroad, it expects to face significant product and price competition in the
future which could adversely impact revenue growth and profit margins.
Development Contracts. Development contract revenue for the nine months
ended September 30, 1998 was $4.8 million, a decrease of 7.6% from the $5.2
million reported in the comparable prior year. This decrease resulted from a
decline in government-funded research projects, partially offset by an increase
in commercial contracts. Development contract revenue accounted for
approximately 10% of net revenue for the nine month period ended September 30,
1998, compared to approximately 34% of net revenue for the comparable period in
1997. The Company expects development contract revenue to decrease as a
percentage of net revenue during future periods.
COST OF REVENUE
Software Licenses. Software license costs increased by $9.4 million, or
333%, from $2.8 million for the nine months ended September 30, 1997 to $12.2
million during the comparable period of 1998. As a percentage of software
license revenue, these costs were 27.2% for the nine months ended September 30,
1998 and 27.5% for the comparable period in 1997.
The absolute dollar increase in software license costs was due primarily to
increased materials costs associated with higher sales volumes, partially offset
by decreasing materials costs per unit. As a percentage of software license
revenue, cost of materials costs increased by 4.6% in 1998 primarily due to
revenue mix changes year to year, and, to a lesser degree, a reduction in the
selling prices of some products as the Company entered the competitive retail
channel in August 1997. In addition, the Company increased its investment in
technical support by $1.4 million, or 209%, from $644,000 for the nine months
ended September 30, 1997 to $2.0 million during the comparable period in 1998.
This increase was primarily due to increased unit sales and the resulting
increase in demand for technical support. The increase in shipping and receiving
costs of approximately $682,000 during the first nine months of 1998 was
primarily attributable to increased freight expense incurred as a result of
entering into contracts with two major national distributors.
Development Contracts. Costs of development contracts decreased by $1.1
million, or 29.1%, from $3.7 million for the nine months ended September 30,
1997 to $2.6 million in the comparable period in 1998. The decrease was
primarily due to a decline in government contracts, partially offset by an
increase in commercial contract work. Costs of development contracts were 70.3%
of development contract revenue for the nine months ended September 30, 1997 and
54% for the nine months ended September 30, 1998.
OPERATING EXPENSES
Research & Development. Research and development expenses consist
primarily of personnel costs, as well as travel and facilities and
equipment-related expenses associated with the Company's research and
development efforts. Research and development expenses increased by $3.5
million, or 49.5%, from $7.1 million during the nine months ended September 30,
1997 to $10.6 million in the comparable period in 1998. As a percentage of net
revenue, Company-funded research and development expenses were 46.0% of net
revenue for the nine months ended September 30, 1997 compared to 21.4% in the
same period in 1998. The absolute dollar increase in these periods was due
primarily to increases in research and development personnel.
In addition to Company-funded research and development, the Company incurs
research and development expenses relating to government and customer-funded
projects. These expenses are included in the cost of development contracts. For
the nine months ended September 30, 1998, research and development
18
21
costs, including government and customer-funded expenses, totaled $13.2 million
compared to $10.8 million in the comparable period of 1997, an increase of
22.7%.
The Company believes that continued investment in research and development
is critical to attaining its strategic objectives, and, as a result, expects
research and development costs to increase in absolute dollars in future
periods.
Selling and Marketing. Selling and marketing expenses consist primarily of
advertising and promotional expenses, compensation and related costs for sales
and marketing personnel, and tradeshow and travel expenses. Selling and
marketing expenses increased by $10.3 million, or 179%, from $5.7 million in the
nine months ended September 30, 1997 to $16.0 million in the comparable period
in 1998. These costs represented 32.3% of net revenue during the first nine
months of 1998 compared to 37.2% in the comparable period in 1997. The absolute
dollar increase in selling and marketing expenses was primarily due to increased
costs related to retail advertising and promotional campaigns which the Company
incurred in the first nine months of 1998 as part of its efforts to distribute
its products to retail channel accounts which began in August 1997.
General and Administrative. General and administrative expenses consist
primarily of salaries and other related costs for administrative employees,
professional fees and other general corporate expenses. General and
administrative costs increased by $1.1 million, or 64.3%, from $1.8 million in
the nine months ended September 30, 1997 to $2.9 million in the comparable
period in 1998. These costs represented 5.9% of net revenue for the first nine
months of 1998 compared to 11.5% in the comparable period in 1997. The absolute
dollar increase was primarily due to the addition of senior executive staff as
well as accounting and finance personnel needed to support the Company's
business expansion and, to a lesser extent, the increase in the Company's bad
debt reserve to support the increase in accounts receivable attributable to
increased software license revenue.
Interest Income. Interest income increased by $83,000, or 22.5%, from
$369,000 for the nine months ended September 30, 1997 to $452,000 in the
comparable period of 1998. The absolute dollar increase was due to higher cash
balances in investment accounts.
Provision for (Benefit from) Income Taxes. The Company had an income tax
benefit for the nine months ended September 30, 1997 of $2.6 million as a result
of the Company recognizing the benefit of its deferred tax assets. For the nine
months ended September 30, 1998, the Company had an income tax provision of $1.7
million based on an estimated effective tax rate of 29.6%.
Discontinued Operations. For the period through September 2, 1998, the
Company incurred an operating loss from discontinued operations of $2.1 million
compared to an operating loss of $2.3 million for the nine month period ending
September 30, 1997. On September 2, 1998, the Company sold its interest in
Articulate. This sale resulted in a gain of $6.8 million net of taxes of $1.4
million. See Note 3 of Notes to Consolidated Financial Statements.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
NET REVENUE
Net revenue increased slightly from 1995 to 1996 from approximately $16.9
million in 1995 to $17.0 million in 1996 and increased by $9.8 million, or
57.4%, to $26.8 million in 1997.
Software Licenses. Software license revenue decreased by $692,000, or
5.7%, from $12.2 million in 1995 to $11.5 million in 1996 and increased by $8.0
million, or 69.9%, to $19.5 million in 1997. The increase in software license
revenue for 1997 was primarily due to significant sales in the fourth quarter of
1997 of the Company's Dragon NaturallySpeaking dictation software product which
was first shipped to customers in June 1997.
Development Contracts. Development contract revenue increased by $843,000,
or 17.9%, from $4.7 million in 1995 to $5.6 million in 1996 and increased by
$1.8 million, or 31.6%, to $7.3 million in 1997. These increases were primarily
attributable to a combination of increased funding for existing projects and the
commencement of additional projects.
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22
COSTS OF REVENUE
Software Licenses. Software license costs increased by $100,000, or 3.0%,
from $3.4 million in 1995 to $3.5 million in 1996 and increased $1.9 million, or
55.7%, to $5.4 million in 1997. As a percentage of software license revenue,
these costs were 27.6% in 1995, 30.2% in 1996, and 27.7% in 1997. The absolute
dollar increase from 1996 to 1997 was due primarily to increased materials costs
associated with higher product sales resulting from the introduction of the
Dragon NaturallySpeaking product family. Increased software license costs in
1997 were offset by an $833,000 decrease in amortization costs.
Development Contracts. Development contract costs increased by $267,000,
or 8.1%, from $3.3 million in 1995 to $3.6 million in 1996 and increased by $1.4
million, or 39.4%, to $5.0 million in 1997. As a percentage of development
contract revenue, these costs were 70.3% in 1995, 64.4% in 1996, and 68.3% in
1997. The absolute increase was due principally to increased labor expense
associated with two large United States government projects.
OPERATING EXPENSES
Research and Development. Research and development expenses increased by
$1.3 million, or 19.4%, from $6.7 million in 1995 to $8.0 million in 1996 and
increased by $1.6 million, or 20.0%, to $9.6 million in 1997. As a percentage of
net revenue, these expenses represented 39.6% in 1995, 46.9% in 1996 and 35.7%
in 1997. The absolute dollar increases in each year were principally
attributable to costs associated with increased headcount, primarily product
development personnel, associated with the commercialization of the Company's
Dragon NaturallySpeaking product family. The Company had 135 employees engaged
in research and development activities on December 31, 1997 compared to 125 on
December 31, 1996 and 96 on December 31, 1995.
Total research and development costs, including government and
customer-funded efforts, was $10.0 million in 1995, $11.6 million in 1996 and
$14.6 million in 1997. As a percentage of net revenue, these expenses
represented 59.2% for 1995, 67.9% for 1996 and 54.3% for 1997.
Selling and Marketing. Selling and marketing expenses increased by
$578,000, or 12.0%, from $4.8 million in 1995 to $5.4 million in 1996 and
increased by $3.9 million, or 73.1%, to $9.4 million in 1997. As a percentage of
net revenue, these expenses represented 28.6% in 1995, 31.7% in 1996 and 34.9%
in 1997. The absolute dollar increase in selling and marketing expense from 1995
to 1996 was primarily due to incremental expenses associated with the first full
year of operation of the Company's German sales office which was established in
August 1995. The increase in selling and marketing expense in absolute dollars
between 1996 and 1997 was primarily due to the costs associated with increased
retail advertising and promotions in connection with the release of the
Company's Dragon NaturallySpeaking product family, increased sales personnel and
increased sales commissions.
General and Administrative. General and administrative expenses decreased
by $252,000, or 11.5%, from $2.2 million in 1995 to $1.9 million in 1996 and
increased by $545,000, or 28.1%, to $2.5 million in 1997. As a percentage of net
revenue, these expenses represented 13.0% in 1995, 11.4% in 1996 and 9.3% in
1997. The absolute dollar decrease from 1995 compared to 1996 was primarily
related to the decrease in bad debt expense. The absolute dollar increase from
1996 compared to 1997 was primarily due to increased expenses associated with
additional finance and administrative staff and infrastructure necessary to
support increased sales.
Interest Income. Interest income decreased by $240,000, or 31.6%, from
$760,000 in 1995 to $520,000 in 1996 and remained relatively constant between
1996 and 1997. The absolute dollar decrease from 1995 to 1996 was primarily due
to lower average cash balances.
Provision for (Benefit from) Income Taxes. As a result of the Company's
ability to utilize its net operating losses, the Company had an income tax
benefit of $646,000 in 1995, $564,000 in 1996 and $2.2 million in 1997.
Discontinued Operations. The Company incurred an operating loss from
discontinued operations of $3.1 million in 1995, $1.7 million in 1996 and $3.0
million in 1997. On September 2, 1998, the Company sold its interest in
Articulate. See Note 3 of Notes to Consolidated Financial Statements.
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23
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial
information both in absolute dollars and as a percentage of net revenue for the
each of the Company's last seven quarters. This information is derived from the
Company's unaudited consolidated financial statements and has been prepared on
the same basis as the Company's annual consolidated financial statements which
appear elsewhere in this Prospectus. In the opinion of the Company's management,
this information reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of such information. These
unaudited quarterly results should be read in conjunction with the Company's
Consolidated Financial Statements and related Notes appearing elsewhere in this
Prospectus. The results for any quarter are not necessarily indicative of future
quarterly results of operations, and the Company believes that period-to-period
comparisons should not be relied upon as an indication of future performance.
QUARTER ENDED
------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1997 1997 1997 1997 1998 1998 1998
--------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PERCENTAGES)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue:
Software licenses............................... $ 3,309 $ 3,187 $ 3,726 $ 9,284 $12,262 $13,754 $18,750
Development contracts........................... 1,920 1,607 1,679 2,109 1,350 1,503 1,957
------- ------- ------- ------- ------- ------- -------
Total net revenue............................. 5,229 4,794 5,405 11,393 13,612 15,257 20,707
------- ------- ------- ------- ------- ------- -------
Cost of revenue:
Cost of software licenses....................... 854 1,134 818 2,588 3,216 3,330 5,616
Cost of development contracts................... 1,171 1,087 1,402 1,333 801 827 967
------- ------- ------- ------- ------- ------- -------
Total cost of revenue......................... 2,025 2,221 2,220 3,921 4,017 4,157 6,583
------- ------- ------- ------- ------- ------- -------
Gross profit.................................. 3,204 2,573 3,185 7,472 9,595 11,100 14,124
------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development........................ 2,127 2,469 2,500 2,481 3,247 3,475 3,885
Selling and marketing........................... 1,546 1,860 2,328 3,616 3,853 4,953 7,219
General and administrative...................... 558 549 662 716 941 924 1,042
------- ------- ------- ------- ------- ------- -------
Total operating expenses...................... 4,231 4,878 5,490 6,813 8,041 9,352 12,146
------- ------- ------- ------- ------- ------- -------
Operating income (loss).......................... (1,027) (2,305) (2,305) 659 1,554 1,748 1,978
Interest income................................. 104 100 165 142 156 149 147
------- ------- ------- ------- ------- ------- -------
Income (loss) before income taxes............. (923) (2,205) (2,140) 801 1,710 1,897 2,125
Provision for (benefit from) income taxes........ (453) (1,081) (1,049) 393 507 562 630
------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing operations........ (470) (1,124) (1,091) 408 1,203 1,335 1,495
------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued operations:
Loss from operations............................ (599) (907) (800) (713) (851) (675) (616)
Gain on sale, net of taxes of $1,420............ -- -- -- -- -- -- 6,782
------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued operations........ (599) (907) (800) (713) (851) (675) 6,166
------- ------- ------- ------- ------- ------- -------
Net income (loss)............................. $(1,069) $(2,031) $(1,891) $ (305) $ 352 $ 660 $ 7,661
======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF NET REVENUE:
Net revenue:
Software licenses............................... 63.3% 66.5% 68.9% 81.5% 90.1% 90.1% 90.5%
Development contracts........................... 36.7 33.5 31.1 18.5 9.9 9.9 9.5
------- ------- ------- ------- ------- ------- -------
Total net revenue............................. 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of software licenses....................... 16.3 23.7 15.1 22.7 23.6 21.8 27.1
Cost of development contracts................... 22.4 22.7 25.9 11.7 5.9 5.4 4.7
------- ------- ------- ------- ------- ------- -------
Total cost of revenue......................... 38.7 46.4 41.0 34.4 29.5 27.2 31.8
------- ------- ------- ------- ------- ------- -------
Gross profit.................................. 61.3 53.6 59.0 65.6 70.5 72.8 68.2
------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development........................ 40.7 51.5 46.3 21.8 23.9 22.8 18.8
Selling and marketing........................... 29.6 38.8 43.1 31.7 28.3 32.5 34.9
General and administrative...................... 10.7 11.5 12.2 6.3 6.9 6.1 5.0
------- ------- ------- ------- ------- ------- -------
Total operating expenses...................... 81.0 101.8 101.6 59.8 59.1 61.4 58.7
------- ------- ------- ------- ------- ------- -------
Operating income (loss).......................... (19.7) (48.2) (42.6) 5.8 11.4 11.4 9.5
Interest income................................. 2.0 2.1 3.1 1.2 1.1 1.0 0.7
------- ------- ------- ------- ------- ------- -------
Income (loss) before income taxes............. (17.7) (46.1) (39.5) 7.0 12.5 12.4 10.2
Provision for (benefit from) income taxes........ (8.7) (22.5) (19.4) 3.4 3.7 3.7 3.0
------- ------- ------- ------- ------- ------- -------
Income (loss) from continuing operations........ (9.0) (23.6) (20.1) 3.6 8.8 8.7 7.2
------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued operations:
Loss from operations............................ (11.5) (18.9) (14.8) (6.3) (6.3) (4.4) (3.0)
Gain on sale, net of taxes of $1,420............ -- -- -- -- -- -- 32.8
------- ------- ------- ------- ------- ------- -------
Gain (loss) on discontinued operations........ (11.5) (18.9) (14.8) (6.3) (6.3) (4.4) 29.8
------- ------- ------- ------- ------- ------- -------
Net income (loss)............................. (20.5)% (42.5)% (34.9)% (2.7)% 2.5% 4.3% 37.0%
======= ======= ======= ======= ======= ======= =======
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In the last seven quarters, expenses and operating income as a percentage
of net revenue have varied primarily due to increased revenue from the Company's
Dragon NaturallySpeaking family of products. During the quarter ended September
30, 1998, selling and marketing expense increased in absolute dollars, as the
Company spent $2.1 million to advertise with an Internet content provider. In
addition, cost of software licenses increased as a percentage of net revenue in
the quarter ended September 30, 1998 primarily as a result of the introduction
of and increased sales of Dragon Point & Speak, a lower-priced, mass market
consumer product.
The Company's quarterly operating results have fluctuated in the past, and
will likely continue to fluctuate in the future, as a result of a number of
factors, many of which are outside the Company's control. These factors include:
- the demand for the Company's software products and services;
- the level of product and price competition that the Company encounters,
including the frequency of changes in pricing policies;
- the timing of new product introductions and product enhancements by the
Company or its competitors;
- market acceptance of new products;
- the Company's ability to retain and hire research and development and
sales personnel;
- the mix of products and services sold;
- seasonality of purchasers;
- expansion of the Company's international operations; and
- budgeting cycles of the Company's customers.
The Company's software products are typically shipped when orders are
received and consequently, backlog at the beginning of any quarter has in the
past represented only a small portion of that quarter's expected revenue. Since
the Company's operating expenses are based on anticipated revenue levels and
because a high percentage of the Company's expenses are relatively fixed in the
near term, any shortfall from anticipated revenue could result in significant
variations in operating results from quarter to quarter.
Based on these factors, the Company believes that future revenue, expenses
and results of operations could vary significantly from quarter-to-quarter. As a
result, quarter-to-quarter comparisons of its results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance. Due to all of the foregoing factors, it is possible that in some
future quarter the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the market price of the
Company's common stock could be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
From its inception until 1994, the Company funded its operating activities
primarily through cash provided from operations. The Company received $14.5
million in July 1994 and $12.0 million in September 1997 of net cash from the
sale of common and convertible preferred stock to Seagate. In January 1995, the
Company purchased an interest in Articulate for $1.9 million. In September 1998,
the Company sold its 38% interest in Articulate to fonix for cash, notes and
fonix common stock valued in the aggregate at $4.0 million.
Cash used in operating activities totaled $2.3 million during 1995, $1.6
million during 1996, $6.5 million during 1997 and $2.2 million for the nine
month period ended September 30, 1998. The increase in cash used in 1997 was
primarily attributable to an increase in the Company's operating loss related to
its investment in its product development and infrastructure.
Net cash used in investing activities was $3.3 million during 1995, $2.5
million during 1996 and $5.1 million during 1997 and net cash provided by
investing activities was $3.8 million for the nine months ended September 30,
1998. Net cash used in investing activities in all fiscal periods was primarily
related to purchases of property and equipment needed to support the Company's
expansion and short-term investment activity. The net cash provided by investing
activities for the nine month period ended September 30, 1998 was primarily a
result of the cash received from the sale of the Company's interest in
Articulate.
22
25
Net cash provided by financing activities was $12.9 million for 1997 and
$61,000 for the nine months ended September 30, 1998. Net cash provided by
financing activities in 1997 was primarily related to the sale of common and
convertible preferred stock to Seagate.
The Company has no debt. In December 1998, the Company entered into an
agreement with Fleet National Bank providing for a domestic credit facility of
up to $6 million, which includes $4 million for revolving loans and $2 million
for letters of credit. The actual amounts available under this credit facility
will be determined by an accounts receivable based borrowing formula. This
credit facility is secured by the United States inventory and accounts
receivable of the Company and bears interest at Fleet's prime rate of interest.
The Company's cash and cash equivalent balances were $4.9 million at
December 31, 1997 and $6.6 million at September 30, 1998. Working capital
increased to approximately $21.4 million at September 30, 1998 compared to $13.5
million at December 31, 1997. This increase in working capital was due primarily
to an increase in accounts receivable and inventory, partially offset by
increases in accounts payable and accrued expenses. While management believes
that the risks associated with collection of accounts receivable have been
adequately addressed in the Company's reserves and credit and collection
policies, there can be no assurance that the Company's reserves will be
adequate.
The Company expects that its requirements for facilities, equipment and
other capital expenditures will grow as demand for the Company's products
increases. The Company plans to hire additional researchers and development
engineers in the future to accelerate its new product offerings. Additionally,
the Company plans to hire additional sales and marketing personnel to support
anticipated sales growth. As a result of this planned growth, the Company
anticipates incurring additional capital and other expenditures during future
periods.
The Company believes that the net proceeds from this offering, together
with its current cash balances and income from operations, will be sufficient to
fund its working capital and capital expenditures for at least the next 12
months. To the extent that the Company is unable to fund its operations from
cash flows, the Company may need to obtain financing from external sources in
the form of additional equity, indebtedness, or both. There can be no assurance
that additional financing will be available at all, or that, if available, such
financing will be obtainable on terms favorable to the Company.
To date, inflation has not had a significant impact on the Company's
results of operations.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the year code field. These
systems and software products will need to accept four digit entries to
distinguish 21st century from 20th century dates. As a result, computer systems
and/or software used by many companies and governmental agencies may need to be
upgraded to comply with Year 2000 requirements or risk system failure or
miscalculations causing disruptions to normal business activities.
State of Readiness. The Company has completed its assessment of its
products and information technology systems. The Company believes that its
software products are Year 2000 compliant. The Company has begun its assessment
of the information technology systems of its principal vendors, suppliers and
customers as well as its own non-information technology systems (such as
microcontrollers embedded in machinery and equipment). Based on representations
of the Company's principal vendors, suppliers and customers, the Company
believes that the information technology systems of such third parties, as they
relate to the Company, do not pose significant operational issues. In addition,
the Company does not believe its embedded systems pose Year 2000 concerns
because the Company believes it has identified all of its software and hardware
that require Year 2000 updates or modifications. Dragon has no proprietary
systems.
Costs. To date, the Company has not spent material sums in connection with
its Year 2000 risk assessment and remediation activities. The Company's costs
associated with replacing or modifying its information systems to address Year
2000 concerns have not been material. The Company believes that an additional
$100,000 will be required to complete the replacement or modification of its
information systems. The Company has funded these activities principally through
income from operations.
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26
Risks. The Company believes that the principal Year 2000 risks it faces
relate to potential disruptions in materials or component supply and in order
processing and fulfillment by third parties in the event that the information
systems of third parties are materially and adversely affected by Year 2000
related software failures.
Contingency Plan. To date, the Company has not formulated contingency
plans relating to third-party Year 2000 disruptions because it believes the
probability of such disruptions to be relatively remote. As discussed above, the
Company is engaged in ongoing assessment and remediation activities and the
responses received from third-party vendors and suppliers will be taken into
account in determining the nature and extent of any contingency plans.
RECENT ACCOUNTING PRONOUNCEMENTS
In March, 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 is
effective for the year ended December 31, 1999 and provides guidance for the
accounting treatment of costs of computer software developed or obtained for
internal use. The Company does not expect adoption of this statement to have a
material impact on its consolidated financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). The statement is effective for the year
ending December 31, 2000. SFAS 133 establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities. The Company does not expect adoption of this statement to
have a material impact on its consolidated financial position or results of
operations.
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27
BUSINESS
Dragon is a leading developer and provider of advanced speech recognition
products and related speech technologies that "humanize" the way people
communicate with computers and other electronic devices. The Company's products
and technologies enable electronic devices to understand speech, the most
natural and effective means of communication. As a result, users of the
Company's products can interact with electronic devices faster and more
intuitively than with other input methods, such as the keyboard or computer
mouse, thereby increasing productivity. The Company markets a variety of speech
products worldwide, including its Dragon NaturallySpeaking family of continuous
dictation products. Dragon NaturallySpeaking products are currently available in
six languages: American-English, British-English, French, German, Italian and
Spanish, with Japanese and Mandarin versions scheduled for release in 1999. In
addition, third parties have used the Company's speech technology to develop
small vocabulary products in other languages, including Hebrew and Swedish.
Since 1997, the Company and its Dragon NaturallySpeaking products have received
over 70 industry awards and citations including:
- BYTE, Best of COMDEX: Best of Show (Spring 1997)
- PC/Computing, 1997 MVP Winner: Input Device (January 1998)
- Innovation 98 Info PC, iT/COMDEX France: Best Development Tool (February
1998)
- BYTE Espana, 1997 Award of Excellence, Spain (February 1998)
- PC Professional, Innovation of the Year 1997-1998: Best of CeBIT Software
Category, Germany (April 1998)
- PC World, World Class Award: Best Voice Recognition Software (June 1998)
- PC World, World Class Award: Most Promising Software Newcomer (June 1998)
- Retail Vision: Six awards including Best Vendor and Best Retail Strategy
(August 1998)
- PC Magazine, Editor's Choice: Best Speech Dictation Product (October
1998)
- SMAU, 31st Premio Industrial Design Award: Business Software Category,
Italy (October 1998)
- PC World, Best New Handheld Device (November 1998)
- PC Magazine Australia, Editor's Choice, Australia (December 1998)
Since its founding in 1982, the Company has developed and commercialized
successive versions of high-quality speech products and technologies and has
been the first to market a number of innovative products. The Company was the
first to introduce products incorporating built-in PC speech recognition (1984),
large vocabulary, general purpose, discrete dictation (1990), and software-only
dictation supporting most Windows applications (1993). In June 1997, the Company
achieved an important milestone by introducing Dragon NaturallySpeaking 1.0, the
world's first large vocabulary, general purpose, continuous speech dictation
product. From its inception, the Company has funded its research and development
and other activities primarily through funds generated from operations. In
addition, its financial resources have been supplemented by Seagate, which made
significant equity investments in the Company in 1994 and 1997.
The Company is applying its technologies beyond the PC to multiple
platforms such as hand-held and mobile devices and developing advanced
applications for emerging speech markets such as consumer electronics and
telephony. The Company is also collaborating with major corporations and federal
agencies to voice-enable existing hardware and software platforms. For example,
the Company led the development of a speech recognition system for a global
package company that increases worker productivity by allowing package handlers
to enter data using speech instead of the keyboard.
Dragon's end-users include individuals and companies which utilize the
Company's leading-edge speech products and technologies for a wide range of
applications, including general purpose dictation, legal and medical dictation,
inventory management and in-bound customer telephone interactions. These
end-users include Bank of America, Boeing, the Los Angeles Police Department,
Peugeot and Wells Fargo. The Company sells its products worldwide predominantly
through major distributors to retail channel accounts and VARs, and directly to
OEMs and ISVs.
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INDUSTRY OVERVIEW
Although speech is the most natural and effective means of human
communication, historically it has not been used as a primary means of
interaction between people and machines. Basic speech recognition technology has
existed for a number of years and effectively addressed certain specialized
applications, such as limited data entry and retrieval. However, its widespread
use has been constrained by technical limitations and inadequate PC processing
power. For example, until recently, speech recognition products had limited
vocabularies and required users to speak discretely, pausing after each word,
rather than naturally and continuously. These technical constraints limited the
widespread use of speech technology. As a result, the development of speech
technology capable of recognizing natural and continuous speech and suitable for
widespread commercial application has been an attractive but, until recently,
elusive goal.
In June 1997, Dragon became the first company to develop, produce and
market large vocabulary, general purpose, continuous speech recognition
technology for commercial applications. The introduction of this technology
represented the culmination of a series of technological breakthroughs by Dragon
over the past two decades. The Company believes that the advent of continuous
speech recognition technology and the increased availability of powerful,
low-cost microprocessors and memory are creating a wide range of commercial
applications for speech-based products. As hardware platforms shrink and devices
become more portable, sacrificing keyboard space, the Company believes that
speech will become the preferred and most efficient interface for operating
electronic devices.
Currently available speech recognition products allow PC users to use
speech in addition to the keyboard to significantly increase the speed with
which they can generate, edit and format text in popular word processing,
contact management and e-mail programs. Until the introduction of Dragon
NaturallySpeaking, commercially available speech technology required users to
speak discretely, and was unable to recognize natural and continuous speech. As
a result, early speech recognition products did not provide the accuracy, speed,
ease-of-use and functionality required for widespread market acceptance.
According to a Voice Information Associates report, the market for continuous
speech dictation products alone is expected to reach $3.0 billion by the year
2001 as manufacturers incorporate such speech technology into PCs and other
electronic devices.
The increasing use and growing complexity of computers and sophisticated
electronic devices, along with the broad deployment of software applications,
has created a need for a faster, easier to use and more intuitive method of
interacting with machines. This need is driving the development of an increasing
number of applications for speech recognition technology, ranging from consumer
electronics to enterprise-wide applications, that will enable individuals to
interact with machines more productively. For instance, as speech recognition
technology has become more prevalent, speech-enabled applications and systems
have been deployed to enhance productivity in a variety of commercial
environments beyond PC-based dictation applications, including package handling,
order taking and call center management.
In addition, the Company believes there is increasing demand for a broad
range of speech-enabled products that will not be dependent on end-user PC
platforms. Although the personal computer will remain an important speech
technology platform, the Company believes that speech recognition technology
will lead to the development of a broad market of mobile, networked and consumer
"information appliances," including hand-held computers and wireless
communication devices that will transmit information quickly and effectively in
response to speech. Some of these appliances will provide telephone and Internet
access as well. The Company expects strong growth in the demand for a range of
platforms from hand-held personal organizers and wireless communicators to
multi-user, server-based systems with vertical and enterprise-wide applications.
The Company also expects strong growth in the demand for embedded systems such
as automobile command/control and navigation devices and server-based platforms
which will support customized transcription and audio indexing devices. However,
to exploit successfully the opportunity that these platforms represent for the
speech industry, speech recognition products and technologies operating on these
platforms must continue to offer high levels of accuracy, speed and ease-of-use.
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THE DRAGON SOLUTION
The Company is a leading developer and provider of advanced speech
recognition technologies and products that are highly accurate, easy to use and
operate on a variety of platforms. The Company believes that its award-winning
products and technologies offer the following benefits which will promote the
adoption of speech as a standard user interface between people and machines and
expand the market for speech technology and products:
Increased Productivity. The Company's products significantly increase
productivity by allowing users to generate, edit and format documents, e-mail
messages and other text faster and with greater accuracy than existing data
entry methods, such as typing. Several published product comparisons have
identified the Dragon NaturallySpeaking product family as an industry leader in
speech recognition accuracy and have awarded these products their highest
ratings on a words-per-minute basis. In addition, the Company's mobile products
enable users to record text, documents and e-mail messages while away from the
workplace for later processing and transcription by the users' PCs. The Company
expects to continue to introduce new speech products and technologies which will
enhance productivity including: (i) an enterprise-wide speech application
integrated with word processing and time and contact management software, and
(ii) audio file search products, which will permit rapid search and retrieval of
spoken words contained in audio and multimedia recordings. See "-- Products" and
"-- Research and Development."
Ease-of-Use. The Company's products are designed to enable people to
interact intuitively and easily with a variety of PCs, server platforms,
telephones and other electronic devices. Included in Dragon's patent portfolio
are patents covering usability features which are incorporated into the design
of each of the Company's products and applications. For example, the Company's
natural language commands and text editing features permit the correction of
entire phrases, as well as individual words, by issuing a single intuitive
verbal command instead of carrying out a series of manual steps using a keyboard
or computer mouse. The Company believes that as consumers become more aware of
the benefits of speech technology and its ease-of-use attributes, demand for
speech-enabled products and applications will continue to grow substantially.
Product Design that Facilitates Product Family Expansion. The Company's
speech recognition technology is based on a modular architecture that permits
rapid product family expansion to additional targeted markets after a product is
initially released. For example, soon after introducing Dragon NaturallySpeaking
for general dictation use, the Company modified the product by integrating
specialized vocabularies and language models to create both Dragon
NaturallySpeaking Legal Suite and Medical Suite. In addition, the Company's core
speech recognition technology is not dependent on any specific language. This
feature has enabled the Company to release British-English, French, German,
Italian and Spanish language versions of products shortly after the commercial
release of the American-English version.
Superior Technological Capabilities. The Company's products offer users
leading-edge speech technology. The Company employs a highly qualified staff of
scientific and technical personnel in its research and development organization.
More than 91 of the Company's employees hold either doctorates or masters
degrees and the majority of the Company's personnel have significant technical
expertise in speech technologies. In addition, the Company's co-founder, Dr.
Janet Baker, has more than 25 years of experience in the field of speech
technology and is recognized as a pioneer in the industry. The Company believes
it has assembled a team of professionals with superior technical knowledge in a
number of computer and linguistic fields which will enable the Company to
maintain its position as an innovative industry leader.
Product and Application Versatility. The Company's speech technology can
be easily adapted to operate on multiple operating systems and hardware
platforms. In an effort to increase the commercial appeal of its products, the
Company seeks to make its products compatible with widely-used software products
from Corel Corporation ("Corel"), Microsoft, Symantec Corporation ("Symantec")
and other leading software developers. The Company's products currently operate
on Windows 3.1, Windows 95, Windows 98, Windows NT, UNIX and other operating
systems, and on hardware platforms including PCs and workstations for certain
custom applications.
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Sophisticated Application Development Tools. In an effort to increase
product license revenue and to establish the Company's speech technology as the
industry standard, the Company markets a suite of sophisticated application
development tools (NaturallySpeaking Developer Tools Suite). These tools allow
software developers to easily integrate advanced speech recognition and output
capabilities into their software applications and to create a wide variety of
continuous dictation, data entry, and command and control applications. In
addition, the Company markets Dragon PhoneQuery SDK which enables developers to
create caller-friendly, interactive telephony systems that allow callers to
access information using natural and continuous speech without wading through
more complex discrete speech and push-button menus.
STRATEGY
The Company's objective is to enhance its position as a leading worldwide
developer and provider of advanced speech products and technologies. The key
elements of the Company's strategy are:
Extend Technological Leadership. The Company believes that its core speech
recognition technology is the world's most accurate and highest performing and
positions the Company as a world leader in speech technology for current and
emerging applications. The Company plans to continue to develop and enhance its
speech recognition and related technologies, including its comprehensive,
high-quality acoustic and language data to extend its technological leadership.
The Company also intends to continue to build on its patent portfolio to protect
its future innovations in speech and related technologies. In addition, the
Company intends to continue to attract superior technical personnel and may seek
to acquire complementary technologies and businesses. The Company believes that
this strategy is essential to the development and delivery of leading-edge
speech recognition and related technologies for emerging applications.
Identify and Develop Emerging Markets for Speech Technology. The Company
continually analyzes emerging market opportunities for speech technology. The
Company focuses its product development efforts on products and applications
that, among other things,
- address a large or rapidly growing market,
- represent a technically viable extension of the Company's technology,
- can be marketed cost-effectively through the Company's current and future
distribution channels, and
- operate within the computational and memory capabilities of commonly used
electronic devices.
The Company has identified, and is in the process of applying its core
speech recognition technology to, a number of existing and emerging applications
in the following areas:
- consumer electronics (mobile computing and dictation products);
- embedded systems, including automotive products;
- industrial machinery products;
- large scale business enterprises (server-based speech products);
- telephony applications;
- broadcast media (transcription and audio indexing products); and
- vertical market applications (enhanced dictation products for targeted
markets).
Maintain Reputation for Being First to Market With Quality Speech
Products. The Company believes that it has earned a reputation for consistently
being first to develop and market innovative, high-quality speech products. By
being first to market with high-quality products, the Company increases its
brand-name recognition, reinforces its market leadership position and captures
additional market share. In addition, the Company believes that its market
position facilitates the formation of cooperative product development
relationships with other technology leaders and co-marketing agreements with
well-known software and consumer product companies. These relationships enable
the Company to share technical and industry knowledge and to co-develop, and
generate demand for, a variety of speech-enabled applications.
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Increase Market Penetration Through Multiple Distribution Channels. A key
component of the Company's strategy is to expand market penetration of its
speech technology by increasing its multi-channel sales effort. To achieve this
objective, the Company plans to expand its direct sales operations, leverage its
position of market leadership to add additional distributors and VARs, and
increase its use of e-commerce. These efforts will be supplemented with targeted
marketing campaigns, preferred training programs and in-store product
demonstrations. To increase demand for its technology, the Company also will
continue to provide software development tools to OEMs, VARs and ISVs to
encourage them to speech-enable their products. The Company also expects to
enter into additional joint marketing relationships and product bundling
arrangements with leading ISVs and OEMs which offer complementary products or
services. The Company believes that a multi-channel sales effort will broaden
customer awareness of the Company's products and will allow it to effectively
target a wide variety of industries that would benefit from the Company's
solutions.
Expand Global Presence through Product Introductions and Increased
Worldwide Marketing. The Company intends to capitalize on its products'
adaptability and language independence to introduce product family extensions
for international markets. In addition, through increased worldwide marketing
and sales programs, coupled with increased use by international consumers of PCs
with sufficient computational and memory capabilities, the Company believes that
global acceptance of its products will increase significantly. The Company
currently has subsidiaries in the United Kingdom and Germany and a sales office
in France. Dragon NaturallySpeaking products are currently available in six
languages: American-English, British-English, French, German, Italian and
Spanish, with Japanese and Mandarin language versions scheduled for release in
1999.
Expand Strategic Alliances. The Company believes that it can rapidly
expand and penetrate markets by collaborating with industry-leading hardware and
software companies. By integrating its technology with leading products
manufactured or developed in cooperation with third parties, the Company can
provide solutions offering enhanced capabilities that are targeted to customers
in existing and new markets. The Company has such relationships with Corel,
Genie Telecommunication, Inc., GoldMine Software Corporation ("GoldMine"), Intel
Corporation, Seagate, Sony Corporation and others. Products and technologies
arising from these relationships are typically made available by one or both
parties through multiple distribution channels.
TECHNOLOGY
Since its founding in 1982, the Company has been recognized as a pioneer
and leader in speech recognition technology. The Company's core speech
recognition technology uses complex models that represent crucial underlying
patterns found in speech and language. The Company believes that Dr. James
Baker, co-founder of the Company, in 1971 became one of the first to use Hidden
Markov models, now the speech industry standard, as the basis for his research
in the field of speech recognition. This technique and other sophisticated
methods, when combined with the Company's extensive collection of high-quality
acoustic and language data, form the basis for the development of the Company's
proprietary high-performance speech recognition technology. In addition to its
proprietary technology, the Company licenses third-party technology such as
text-to-speech capabilities in developing its products.
Dragon's speech recognition technology is based on the use of three kinds
of information: a lexicon (the set of words to be recognized together with their
pronunciations), a language model (which specifies the relative likelihood of a
sequence of words), and an acoustic model (which specifies the acoustic
correlates of a given pronunciation). Dragon has derived its lexicon and
language and acoustic models from its extensive internal data resources which
include: hundreds of hours of recordings of the speech of many different
speakers in a variety of languages, hundreds of millions of words of computer
readable text in those languages, and lengthy human-edited lists of words and
their pronunciations. Furthermore, Dragon's software and algorithms have been
designed to be task and language independent, permitting easy development of
products in new languages or for new applications.
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Automatic speech recognition algorithms must evaluate a large number of
hypotheses in order to determine the most plausible transcription of a given
utterance. This evaluation is a computationally intensive task. For this reason,
most of the Company's research and engineering has been directed specifically
towards issues of computational efficiency and recognition accuracy.
The following chart depicts Dragon's core speech recognition technologies
and illustrates their operation:
[CHART]
[Pick Up EDGAR information from PCN 950]
The Company's core speech recognition technology enables its products to
recognize naturally spoken continuous speech, as opposed to isolated words or
discrete speech. The Company's technology is capable of high-quality speaker
independent recognition. However, it is capable of achieving even higher
performance through the use of speaker dependent recognition, whereby the
technology automatically customizes its language and acoustic models and lexicon
to a particular speaker using sample speech or text that the speaker provides.
Using Dragon's speaker adaptation techniques, it is possible for the recognition
performance to continually improve with usage.
The Company is also using its core speech recognition technology to develop
future applications beyond the PC platform. These include applications which
will permit users to operate speech-based products outdoors or in commercial
environments presenting significant technological challenges such as poor signal
quality, high background noise and reduced signal bandwidth. In addition, the
Company is adapting its core technology to create speech-enabled mobile
dictation devices, speech-enabled telephony solutions and audio indexing
products. The Company is continuing to develop software that is capable of
recognizing informal or spontaneous speech transmitted over diverse signal
channels, such as radio or television broadcasts (where there may be background
music or noise) or the telephone, including wireless transmissions (where there
is reduced audio signal bandwidth). For some applications, such as the Company's
new audio indexing products, the resulting text can be very useful even if not
perfectly transcribed because it allows accurate and rapid location of specified
words and topics in audio recordings.
PRODUCTS
The Company has marketed various generations of speech products since 1983.
The Company currently offers products that address demand in six principal
markets: consumer, professional/corporate, mobile, telephony, OEM and developer
tools. The following table lists certain information relating to the Company's
principal current products:
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- --------------------------------------------------------------------------------
PRODUCT KEY FEATURES FIRST RELEASE DATE LANGUAGES AVAILABLE
- ---------------------------------------------------------------------------------------------------------
CONSUMER PRODUCTS
Dragon Point & Continuous speech recognition; May 1998 - American-English
Speak dictate text into most Windows - British-English
applications; vocabulary
building to easily add
thousands of new words, names
and specialized terms
Dragon All Dragon Point & Speak November 1997 - American-English
NaturallySpeaking features, plus dictate, - British-English
Standard NaturallySpeaking edit and
format words and phrases by
voice, Standard using
Select-and-Say technology,
BestMatch tech-
nology, Natural Language
Commands
Dragon All Dragon NaturallySpeaking November 1997 - American-English
NaturallySpeaking Standard features, plus Dragon - British-English
Preferred NaturallyMobile software to - French
transcribe dictation from a - German
specialized recorder including - Italian
additional mobile software; - Spanish
dictation playback;
text-to-speech
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Standard features in a package
for Teens specifically designed for
teenage voices and
vocabularies. Includes an
updated user interface
DragonDictate Discrete speech recognition; March 1990 - American-English
hands-free PC & mouse - British-English
operation; voice macros; - French
specialty vocabularies - German
available for legal, medical, - Italian
journalism, technology and - Spanish
business professionals - Swedish
- ---------------------------------------------------------------------------------------------------------
PROFESSIONAL/
CORPORATE PRODUCTS
Dragon All Dragon NaturallySpeaking October 1997 - American-English
NaturallySpeaking Preferred features, plus macro - British-English
Professional language capability for - French
sophisticated speech commands; - German
targeted for serious business - Italian
users - Spanish
Dragon All Dragon NaturallySpeaking May 1998 - American-English
NaturallySpeaking Professional features, plus - British-English
Legal Suite extensive legal vocabulary; - German
targeted for attorneys and
other legal professionals
Dragon All Dragon NaturallySpeaking May 1998 - American-English
NaturallySpeaking Professional features, plus - British-English
Medical Suite extensive medical vocabulary;
targeted for doctors and other
medical professionals
- ---------------------------------------------------------------------------------------------------------
MOBILE PRODUCTS
Dragon All Dragon NaturallySpeaking October 1998 - American-English
NaturallySpeaking Preferred features, packaged - British-English
Mobile with specialized mobile - French
software and hand-held digital - German
recorder; targeted for serious - Italian
business users - Spanish
- ---------------------------------------------------------------------------------------------------------
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- --------------------------------------------------------------------------------
PRODUCT KEY FEATURES FIRST RELEASE DATE LANGUAGES AVAILABLE
- ---------------------------------------------------------------------------------------------------------
Dragon All Dragon NaturallySpeaking September 1998 - American-English
NaturallySpeaking Legal Suite features, packaged - British-English
Mobile Legal Suite with specialized mobile
software and a customized
recorder; targeted for
attorneys and other legal
professionals
Dragon All Dragon NaturallySpeaking September 1998 - American-English
NaturallySpeaking Medical Suite features, - British-English
Mobile Medical Suite packaged with specialized
mobile software plus a
customized recorder; targeted
for doctors and other medical
professionals
- ---------------------------------------------------------------------------------------------------------
TELEPHONY PRODUCT
Dragon All Dragon NaturallySpeaking March 1998 - American-English
NaturallySpeaking Professional features, plus a
Call Center switch box designed to allow
the speaker to talk over the
telephone or into the dictation
system
- ---------------------------------------------------------------------------------------------------------
OEM PRODUCTS
Dragon All Dragon Point & Speak June 1997 - American-English
NaturallySpeaking features, plus dictate, edit - British-English
Personal and format words and phrases by - French
voice - German
- Italian
- Spanish
Dragon Dragon NaturallySpeaking June 1998 - American-English
NaturallySpeaking Personal designed for use with - British-English
WordPerfect Edition Corel WordPerfect 8; vocabulary - French
building to easily add - German
thousands of new words, names - Italian
and specialized terms - Spanish
- ---------------------------------------------------------------------------------------------------------
DEVELOPER TOOLS
Dragon All Dragon NaturallySpeaking August 1998 - American-English
NaturallySpeaking Professional features, plus
Developer Tools Suite software tools that allow for
the integration of speech into
custom applications
Dragon VoiceTool Software tools that allow for April 1995 - American-English
the integration of speech - British-English
commands and discrete dictation - French
into custom applications - German
- Italian
- Spanish
Dragon Phone Query SDK Speech recognition for building February 1998 - American-English
interactive voice response
systems over the telephone;
natural voice response; speaker
independence, multi-port
telephony server support
- ---------------------------------------------------------------------------------------------------------
In addition, the Company plans to introduce the following products during
the first quarter of 1999:
- --------------------------------------------------------------------------------
PRODUCT KEY FEATURES LANGUAGES AVAILABLE
- ------------------------------------------------------------------------------------------------------
Dragon Permits network-based administration of Dragon - American-English
NaturallySpeaking NaturallySpeaking application software user files
Network Edition and data for enterprise-wide application
Dragon Voice-enables various personal information - American-English
NaturallyOrganized management software programs such as ACT
- ------------------------------------------------------------------------------------------------------
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AWARDS AND CITATIONS
Set forth below is a partial list of selected major industry awards and
citations of recognition received by Dragon NaturallySpeaking products during
the last two years:
1999
PC World, Best Buy (January 1999)
PC World New Zealand, Readers Choice
Business Software: Speech
Recognition Category, New Zealand (December 1998/January 1999)
1998
Fortune, Annual Product Review/Technology Buyer's Guide-Product to Watch:
Software/ Cool Stuff Category (Winter 1998)
BusinessWeek, The Best New Products: Software to Watch in 1998 (January 1998)
PC/Computing, Usability Hall of Fame (January 1998)
PC/Computing, 1997 MVP Winner: Usability Achievement of the Year (January 1998)
PC/Computing, 1997 MVP Winner: Input Device (January 1998)
Time, The Best Cybertech of 1997
(January 1998)
BYTE Espana, 1997 Award of Excellence, Spain (February 1998)
Innovation 98 Info PC, iT/COMDEX France: Best Development Tool (February 1998)
CTI, 1997 Product of the Year: Speech Recognition Category (February 1998)
CallCenter Magazine, Best of CT EXPO 98 (March 1998)
PC Professional, Innovation of the Year 1997-1998: Best of CeBIT Software
Category, Germany (April 1998)
Telebusiness, 1998 Awards for Excellence: The Philip Shipman Award for
Innovative Technology, United Kingdom (June 1998)
PC World, World Class Award: Most
Promising Software Newcomer (June 1998)
PC World, World Class Award: Best Voice Recognition Software (June 1998)
PC/Computing, Time Capsule -- The 12 Best PC Products on the Planet: Input
Device Category (August 1998)
Retail Vision: Six awards including Best Vendor and Best Retail Strategy (August
1998)
PC Magazine, Editor's Choice: Best Speech Dictation Product (October 1998)
SMAU, 31st Premio Industrial Design Award: Business Software Category, Italy
(October 1998)
PC World, Best New Handheld Device (November 1998)
WIN, Top Product, Germany (November 1998)
Home Office Computing, The HOC 100 Gold Award Winner-Software: Business
Productivity Category (December 1998)
Newsweek, The Top 50 CD-ROMs of 1998 (Winter 1998)
PC Magazine Australia, Editor's Choice, Australia (December 1998)
1997
BYTE, Best of COMDEX: Best of Show (Spring 1997)
PC IT 97, Best Pro Award: Best Personal
Computing Product, Australia
(September 1997)
PC Magazine, Technical Excellence Award: Software Category (December 1997)
Popular Science Magazine, The Best of What's New: 1997 Grand Winner for
Computers & Software (December 1997)
PC Magazine Middle & Near East, 1997 Award of Excellence: Most Innovative
Software Product of the Year, United Arab Emirates (October 1997)
PC Week, Best of COMDEX Fall 1997: Best Utility Software (November 1997)
BYTE, 1997 Editors' Choice Award: Award of Excellence (December 1997)
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END-USERS
Dragon's end-users range from individuals using the products for a wide
range of personal and professional purposes to companies and government agencies
using the Company's products and technologies for a particular function or
department. Some of the companies and government agencies that use Dragon's
products or technology for significant applications include:
CORPORATE/INDUSTRIAL GOVERNMENT HEALTH CARE/PHARMACEUTICAL
Abbott Laboratories Parliament of Australia Georgetown University
Allianz AG Holding French Ministry of School of Medicine
The Boeing Company Education Kaiser Permanente
Canadian Pacific Railway Los Angeles Police Michigan Rehabilitation
Deere & Company Department Services
Peugeot S.A Shaw Air Force Base, S.C. Princess Alexandra
Seiko Epson Corporation The United States Navy Hospital
Teradyne, Inc. Victoria Board of V.A. Medical Centers,
Workman's over 10 locations in
Compensation 7 states
LEGAL BANKING/FINANCIAL SERVICES
Hourigans Kluger & Bank of America, FSB
Quinn, P.C. Citibank Privatkunden AG
Kilpatrick Stockton LLP Deutsche Bank AG
Long, Weinberg, Ansley Seafirst Bank
and Wheeler, LLP Wells Fargo, Ltd.
The following case studies describe the manner in which certain of the
Company's end-users employ its products and technologies:
- A global package delivery company is using Dragon voice recognition
technology for timely and accurate package sorting. The voice-driven
system allows that company's package handlers to sort packages by
speaking city, state and zip code data instead of using the keyboard.
- A cancer specialist uses Dragon NaturallySpeaking together with a
hand-held digital recorder to dictate patient visit notes, grant
proposals, textbook chapters and medical journal manuscripts. After
dictating into the recorder, he connects the recorder to his computer
which transcribes his dictation. This process reduces the time required
for transcription, improves first-draft accuracy and reduces the cost of
transcription services. As a result of this physician's experience, the
cancer center at which he practices plans to deploy Dragon
NaturallySpeaking to additional doctors on staff.
- An attorney in New York City uses Dragon NaturallySpeaking to document
client conversations and to generate legal documents and correspondence
associated with his law practice. He has advised Dragon that he has
significantly reduced, and in some cases eliminated, transcription costs
and document review cycles. In addition, Dragon NaturallySpeaking allows
him to create many of his own documents quickly and accurately, thereby
freeing his assistant to work on other projects and administrative
duties.
- Police officers at a division of a large urban police department
typically spent as much as 60% of their time preparing reports and other
paperwork. Using Dragon NaturallySpeaking speech recognition software,
officers now dictate their reports into their computers and their words
are immediately transcribed into typed police reports, freeing up time
for patrols and other police duties. According to this police department,
some officers using everyday speech, achieve dictation rates up to 100
words per minute with an accuracy rating of 99%.
- An internationally known Italian designer, manufacturer and distributor
of knitwear uses Dragon dictation products to manage stock and control
inventory in approximately one-third the time required
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by the manual methods. Productivity is further enhanced because of the
software's short training time and multi-user support.
- To automate receipt of inventory and shipment of production, an Italian
newspaper distributor adopted a robotic system, consisting of two mobile
industrial robots enabled with Dragon discrete speech recognition
technology which communicates with the newspaper's servers. One robot
accompanies warehouse workers and responds to their dictated commands
with very high accuracy. The second robot provides billing or materials
information to clerical personnel, and can answer inquiries such as,
"Tell me the price," or "Tell me the stock quantity."
- Dragon and a federal government agency have developed a portable
translation device called the Multilingual Interview System ("MIS"). The
MIS allows English-speaking users to conduct basic interviews and give
instructions to non-English-speakers. It employs over 7,000 common
phrases and combines voice recognition and digital voice recording of
translations with a wearable computer. The MIS has been deployed in
Bosnia to aid U.S. forces in performing a number of important tasks
requiring communication with locals, including medical care, landmine
management, force protection and refugee resettlement.
SALES, MARKETING AND DISTRIBUTION
The Company's marketing organization uses a variety of marketing programs
to promote its advanced products and technologies and to increase demand
worldwide. The Company has teams of dedicated sales professionals assigned to
each of its channel markets. The Company's marketing efforts support its direct
sales and indirect distribution channels through participation in trade shows,
targeted advertising, channel sales programs, public relations campaigns, retail
promotions, product bundles, customer surveys and profiles and product promotion
through its website.
The Company markets and sells its products worldwide indirectly through
distributors, retailers, catalogs, e-commerce, VARs and ISVs and directly
through its website and telesales organization. Over 50 major retail channel
accounts worldwide sell the Company's products. In addition, the Company
licenses its technology to OEMs. The Company's OEM agreements generally license
the OEMs to incorporate the Company's speech recognition and related
technologies into their products and applications in exchange for royalty
payments to the Company. As of December 8, 1998, the Company's indirect
distribution channel was composed of approximately 35 distributors, 729 VARs,
and 19 ISVs and OEM licensees. In the fourth quarter of 1998, the Company
started using volume license agreements to sell and market the Dragon
NaturallySpeaking family of continuous dictation products.
The following table lists the Company's principal North American and
international distributors, retail channel accounts, VARs and ISVs/OEMs:
NORTH AMERICA
DISTRIBUTORS RETAIL CHANNELS VARS ISVS/OEMS
GT Interactive America Online Compaq Services Corel
Software CompUSA Division of Compaq MetroBook Computer
Ingram Micro Fry's Electronics Computer Corporation Micron Technology
Merisel Americas OfficeMax Government Technology Syracuse Language Systems
Tech Data Staples Services
Pomeroy Computer Resources
Softmart
Software House
International
Software Spectrum
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INTERNATIONAL
DISTRIBUTORS RETAIL CHANNELS VARS ISVS/OEMS
CHS Electronics CDC Point Mysoft G DATA Software
Holding Dixon's Store Group Talk Write Limited Hexaglot Holding
HCL Infosystems Groupe FNAC Voelter EDV-Beratung Jurasoft Microcomputer
Ingram Micro Harvey Norman Voice Perfect Systems TerraTec Electronic
Innelec France Mediamarket
Marketing Results
Northamber
Tech Data
Tech Pacific
The Company's two largest distributors are Ingram Micro and Tech Data.
Ingram Micro accounted for approximately 5% of the Company's net revenue for
1997 and 24% of the Company's net revenue for the nine months ended September
30, 1998. Tech Data accounted for approximately 9% of the Company's net revenue
for 1997 and 39% of the Company's net revenue for the nine months ended
September 30, 1998. The Company's agreements with its distributors typically are
not exclusive, have no stated minimum purchase obligations and may be terminated
by either party without cause. The Company believes that in the event of
termination of its relationship with one or more of its distributors, the
Company could enter into replacement agreements with new distributors. However,
failure to replace these distributors with distributors of equal marketing
capabilities and reputation could have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company intends to penetrate the international retail market indirectly
through distributors, increase the VAR business targeted at corporate accounts
and expand its OEM business. The Company has sales professionals at each of its
European subsidiaries in Germany, France and England. Sales outside North
America accounted for 15% of the Company's net revenue in 1997 and 10% of net
revenue for the nine months ended September 30, 1998.
PRODUCTION AND FULFILLMENT
Production of the Company's products involves the purchase of microphones
and digital recorders, duplication of CD-ROMs (outsourced) and assembly of
product components, user manuals and product books. The Company seeks to
minimize production costs by outsourcing production requirements, improving
process efficiencies and realizing economies of scale. The Company subjects all
of the components of its products purchased from outside vendors to high
certification standards designed to ensure product compatibility.
The Company outsources the production, packaging, and order fulfillment of
its products, both domestically and internationally, to third parties when it is
cost effective to do so. To the extent possible, the Company limits its internal
production activities to such tasks as quality inspection and testing. The
Company currently has production arrangements with ZBR Publications Inc., Omnet
Technology Corp., The Media Farm, Inc. and Modus Media International N.V.
("Modus Media") and order fulfillment agreements with Digital River, Inc. and
Modus Media. The Company believes that its existing production capacity is
sufficient to accommodate potential increases in sales volume for the
foreseeable future.
RESEARCH AND DEVELOPMENT
The Company's success will depend on its ability to develop and introduce
on a timely basis new products and enhancements to its existing products. The
Company has invested and intends to continue to invest significant resources in
product and technology development. The Company focuses and modifies its
extensive product development efforts based on customers' needs and changes in
the marketplace. The Company's research and development organizations are
principally responsible for enhancing the Company's core speech recognition
engine, as well as the acoustic and language models and noise-handling
algorithms. The Company
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currently focuses its development efforts on commercializing its research
innovations into new products and product enhancements that are more accurate
and easier to use, as well as the development of additional speech-related
applications.
The Company's strategic long-term research has been greatly aided by a
succession of competitively-awarded federal government contracts involving
several federal agencies. As a result of this government-subsidized research,
the Company has been able to further develop its leading technology in
technically challenging areas, including high noise, limited channel
communication, automatic information retrieval and automatic speaker, language
and topic identification. The Company delivers specialized systems to various
federal government agencies and regularly participates in government-sponsored
performance evaluations. However, the Company retains commercial rights to its
government-sponsored research. In addition to government-funded research and
development, Dragon conducts speech research and development and custom
engineering for a number of major industrial customers in such areas as
industrial automation, automotive engineering and telecommunications. The
Company has successfully commercialized various elements of speech technology
developed in collaboration with the federal government and third parties.
As of December 8, 1998, the Company employed 175 individuals in its
research and development organizations, 77 of whom hold doctorates or masters
degrees in a number of diverse fields, including mathematics, physics,
electrical engineering, and linguistics. The Company believes that this team and
its expertise in speech technology provides the Company with a significant
competitive advantage. The Company's ability to attract and retain highly
qualified employees will be a major determinant of its success in maintaining
its technological leadership.
Company-funded research and development expenses were approximately $8.0
million in 1996, $9.6 million in 1997 and $10.6 million in the first nine months
of 1998.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
The Company outsources its technical support and customer service
operations and provides in-house backup capabilities. In this way, Dragon
manages service call volumes cost-effectively and minimizes fixed costs and
overhead, while maintaining a high level of customer service.
The Company's in-house technical support organization responds to support
questions arising from its website, writes and posts technical tips, publishes
answers to frequently asked questions and provides other pertinent technical
information. This organization also supplies patches and free updates that users
or VARs may need. In addition, this department provides backup support to the
Company's outsourced support providers in North America and Europe, including
handling time-sensitive support problems and providing training for new
products. This organization also provides support directly to the Company's VARs
and key corporate customers.
The Company's present support policy provides all registered users with 90
days of free telephone support via a standard toll-free number (30 days for
Dragon Point & Speak). Electronic support is provided free to registered users
for a period ending six months after the Company discontinues a product.
The Company's customer service department handles non-technical incoming
calls from both its registered users and potential customers interested in
learning more about Dragon products. This group provides information consumers
may need in deciding whether to purchase Dragon products. Customers may purchase
or return Dragon products or product upgrades through the customer service
department either via telephone or the Company's website.
COMPETITION
The emerging market for speech recognition products is relatively new,
intensely competitive and subject to rapid technological change. The Company
expects competition to persist and intensify in the future. The Company's
principal current competitors for PC applications include IBM, Lernout and
Philips. In addition, the Company faces significant potential competition for PC
applications from Microsoft. As the Company
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expands its presence in the telephony market, it will also face competition from
various companies including AT&T, GTE Internetworking, Lucent, Nuance, Philips,
SpeechWorks and Voice Control.
The Company believes that its products compete favorably on the basis of
performance, quality and ease-of-use. However, many of the Company's current and
potential competitors have significantly greater financial, technical,
marketing, public relations and distribution resources than the Company.
Increased competition from these companies or new competitors, including the
introduction of new or enhanced versions of competitive products or changes in
competitors' pricing policies, could materially adversely affect the Company's
business, results of operations and financial condition. See "Risk
Factors -- Competition."
INTELLECTUAL PROPERTY
As of December 8, 1998, the Company owned 11 United States patents and had
31 United States patent applications pending, most of which cover various
aspects of its speech recognition technology. In addition, the Company holds 25
registered trademarks in the United States and abroad, including the Dragon
logo. As of December 8, 1998, the Company also owned one UK patent and one
European patent granted by the European Patent Office and had 12 patent
applications pending at the European Patent Office, as well as a patent
application pending in each of France, Canada and the UK.
In September 1993, the Company and Kurzweil Applied Intelligence
("Kurzweil") settled pending litigation by entering into two settlement and
cross-license agreements. Pursuant to one of these agreements, each party
granted the other an irrevocable, worldwide, non-exclusive, non-transferable
license to use patents and patent applications of the other party. Kurzweil was
subsequently acquired by Lernout in 1997. As a result of this acquisition, no
license grants were made under the agreement after the date of such acquisition;
however, each party maintains its rights in the patents and applications
previously granted under the agreement.
The Company relies primarily on a combination of patent, copyright and
trademark laws to establish and protect its proprietary rights. The Company also
relies on trade secret laws, confidentiality procedures and licensing
arrangements to establish and protect its technology rights. There can be no
assurance that such measures will be adequate to protect the Company's
proprietary rights. In addition, the Company seeks to protect its proprietary
rights through the use of confidentiality agreements with employees,
consultants, advisors and others. There can be no assurance that these
agreements will provide adequate protection for the Company's proprietary rights
in the event of any unauthorized use or disclosure, that employees of the
Company, consultants, advisors or others will maintain the confidentiality of
such proprietary information, or that such proprietary information will not
otherwise become known, or be independently developed, by competitors.
Despite the Company's efforts to protect its intellectual property,
unauthorized third parties may attempt to copy aspects of the Company's
products, to violate Company patents or to obtain and use the Company's
proprietary information. A substantial portion of the Company's sales are
derived from the licensing of Company products under "shrink wrap" license
agreements that are not signed by licensees and therefore may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect the Company's intellectual property to the same extent
as do the laws of the United States. In addition, the Company does not generally
incorporate copy-protection mechanisms in its software because it does not
believe they are practical or cost-effective. Current United States laws that
prohibit software copying give the Company only limited practical protection
from software "pirates," and the laws or law enforcement practices of many other
countries provide almost no protection for its intellectual property. Policing
unauthorized use of the Company's products is difficult, expensive and
time-consuming and the Company expects that software piracy will be a persistent
problem for its desktop software products. The loss of any material trademark,
trade name, trade secret or copyright could have a material adverse effect on
the Company's business, results of operations and financial condition.
The Company does not believe that its products infringe the rights of third
parties. However, there can be no assurance that third parties will not assert
infringement claims against the Company in the future or that any such assertion
will not result in costly litigation or require the Company to obtain a license
to third party
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intellectual property. In addition, there can be no assurance that such licenses
will be available on reasonable terms or at all, which could have a material
adverse effect on the Company's business, results of operations and financial
condition.
The Company's business also includes funded research and development for
certain commercial customers and governmental agencies pursuant to which the
Company typically retains copyrights and other intellectual property rights
associated with the software developed. Although the Company's contracts with
those customers provide that it retains the rights to intellectual property
employed or developed by the Company, there can be no assurance that customers
will not assert rights in, or seek to limit the Company's use of, such
intellectual property.
EMPLOYEES
As of December 8, 1998, the Company employed 316 people including 175
employees in research and development and 88 employees in sales and marketing.
None of the Company's employees is represented by a labor union, and the Company
has never experienced a work stoppage. The Company considers its relations with
its employees to be good.
The Company's future performance depends largely upon its continuing
ability to attract and retain highly qualified scientific, technical, sales and
managerial personnel. Competition for such personnel is intense, particularly in
the fields of software engineering and research, and there can be no assurance
that the Company can attract, motivate and retain key scientific, technical,
sales and managerial employees. If the Company cannot retain or is unable to
attract such key personnel, the Company's business, results of operations and
financial condition would be materially adversely affected.
The Company believes that its dynamic, entrepreneurial and creative culture
is particularly attractive to technologists seeking new, non-traditional work
environments. The Company strives to maintain its competitive and creative
leadership by employing professionals with a variety of academic backgrounds
including mathematics, engineering, linguistics, physics and other disciplines.
More than 91 of the Company's employees hold either doctorates or masters
degrees.
FACILITIES
The Company leases approximately 81,000 square feet of office and
distribution facilities in Newton, Massachusetts under two leases that expire on
November 30, 2001. The Company has the right to purchase its Newton,
Massachusetts location under certain circumstances. The aggregate rental expense
under these leases was approximately $1,172,000 during 1998. The Company also
leases office space for its employees in California, England, France and
Germany. The aggregate rental expense for such office space was approximately
$31,000 during 1998. The Company believes that additional space may be required
as its business expands and will be available as required on acceptable terms.
LEGAL PROCEEDINGS
In February 1996, Articulate sued Apple Computer, Inc. ("Apple") for patent
infringement in Massachusetts. Apple then sued Articulate in May 1996 in
California alleging that Articulate's PowerSecretary product infringed four
Apple patents. In September 1996, Apple added Dragon, which then owned a
minority interest in Articulate and distributed PowerSecretary, as a defendant
to its suit in California. In a separate proceeding in October 1997, Apple sued
Dragon and one of its customers, MetroBook Computer Corporation ("MetroBook"),
in Virginia alleging that the Company's Dragon NaturallySpeaking product
infringed three Apple patents.
Articulate's initial suit in Massachusetts is still pending. In Apple's
California suit, the court has granted a summary judgment motion in favor of
Articulate and the Company on all claims. Apple has filed an appeal with the
U.S. Court of Appeals for the Federal Circuit. Apple's Virginia suit has been
transferred to California, and the court has granted summary judgment in favor
of the Company and MetroBook with respect to one of Apple's patents. The
remainder of the case (with respect to the final two Apple patents) is
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still in discovery. The Company believes that its Dragon PowerSecretary and
Dragon NaturallySpeaking products do not infringe any of Apple's patents, but
there can be no assurance that the Company will prevail in these matters. The
Company's patent counsel, Fish & Richardson P.C., based on information known to
it as of the date of this Prospectus, has advised the Company it has substantial
defenses in each case, but the outcome cannot be predicted.
The Company is not a party to any other material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, and their ages and
positions as of December 8, 1998 are as follows:
NAME AGE POSITION
- ---- --- --------
Janet M. Baker....................... 51 Chairman of the Board of Directors and Chief Executive
Officer
John D. Shagoury..................... 40 President and Director
Diane M. Hudson...................... 45 Chief Financial Officer, Vice President, Finance,
Treasurer and Assistant Secretary
Kim B. Edwards(1)(2)................. 51 Director
Stephen J. Luczo(1)(2)............... 40 Director
Robert Roth.......................... 47 Principal Research Scientist and Director
Paul G. Bamberg...................... 55 Vice President
Laurence S. Gillick.................. 47 Vice President, Research
Roger Matus.......................... 44 Vice President, Marketing, North America
Jeanne F. McCann..................... 47 Vice President, Development
Tamah Solomon Rosker................. 35 Vice President, Human Resources and Secretary
Steven Semenzato..................... 35 Vice President, Channel Sales, North America
Andreas E. Widmer-Schultz............ 32 Director, International Sales and Marketing
- ------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Janet M. Baker co-founded the Company and has served as Chairman of the
Board and Chief Executive Officer since December 1998. Dr. Baker served as
President and Secretary from June 1982 until December 1998 and has served as a
director since June 1982. Prior to co-founding Dragon, Dr. Baker was a research
staff member at IBM, where she was a contributor to the Continuous Speech
Research Project, from June 1974 to January 1979, and was also Vice President of
Research at the Verbex Division of Exxon Enterprises, where she worked from
January 1979 to May 1982. Dr. Baker received her B.S. and B.A. degrees from
Tufts University and her Ph.D. in Computer Science from Carnegie Mellon
University.
John D. Shagoury joined the Company in June 1998 as Chief Operating
Officer, and was promoted to President and elected Director in December 1998.
Mr. Shagoury has over 17 years of management experience in the PC software
industry. From January 1993 to June 1998 Mr. Shagoury held various senior
executive positions, most recently as President, North America, at Corporate
Software & Technology, Inc. Prior to that he held various management positions
including Vice President of Sales and Marketing for ON Technology and Director
of Sales Support and Distribution Channels at Lotus Development Corp. Mr.
Shagoury received his B.S. in Marketing and M.B.A. from Babson College.
Diane M. Hudson joined the Company in April 1995 as Vice President,
Finance, was elected Treasurer in September 1995 and became Chief Financial
Officer in April 1998 and Assistant Secretary in August 1998. From December 1988
to April 1995, Ms. Hudson was Controller and Director of Financial Planning at
MicroTouch Systems, Inc., a leading manufacturer and distributor of touch screen
systems. Ms. Hudson received her A.S. in accounting from Becker Junior College,
studied business administration at Northeastern University, and received her
M.B.A. from Simmons Graduate School of Management.
Kim B. Edwards was elected as a Director of the Company in December 1998.
From January 1994 to March 1998, Mr. Edwards served as President and Chief
Executive Officer of Iomega Corporation. From
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March 1993 to December 1993, he was President and Chief Executive Officer of
Gates Energy Products, Inc., a manufacturer of rechargeable batteries and the
successor of General Electric Battery Division. From January 1987 until March
1993, Mr. Edwards served in various other executive positions for Gates Energy
Products, Inc. Prior to that, Mr. Edwards was employed for 18 years at General
Electric Company in various sales and marketing positions. He earned his B.S. in
Mechanical Engineering from Lafayette College.
Stephen J. Luczo has served as a Director of the Company since July 1994.
Since October 1993, Mr. Luczo has held various executive positions with Seagate,
where he currently serves as President and Chief Executive Officer and as a
member of the Board of Directors. Prior to joining Seagate, Mr. Luczo was Senior
Managing Director of the Global Technology Group of Bear, Stearns & Co., an
investment banking firm, from February 1992 to October 1993. Mr. Luczo received
his A.B. from Stanford University and his M.B.A. from the Stanford University
Graduate School of Business.
Robert Roth has been employed as a Principal Research Scientist at the
Company, and has served as a Director since June 1982. He received his S.B. from
the Massachusetts Institute of Technology, and his M.S. and Ph.D. from the
University of California, Berkeley.
Paul G. Bamberg joined the Company in June 1982 as a Principal Research
Scientist and has served as Vice President since January 1994. He served as a
Director from January 1994 until December 1998. From 1967 to June 1995, Dr.
Bamberg was a faculty member of Harvard University in the physics department and
division of continuing education. He received his A.B. from Harvard College and
his D.Phil. from Oxford University, where he studied as a Rhodes Scholar.
Laurence S. Gillick joined the Company in January 1985 as a researcher and
has served as Vice President, Research, since October 1996. Dr. Gillick taught
on the mathematics faculty of Northeastern University from 1979 and then was
Visiting Assistant Professor of Applied Mathematics at the Massachusetts
Institute of Technology from September 1981 to May 1983. Dr. Gillick received
his B.A. from Swarthmore College, his M.A. in Chemistry from Columbia
University, and his Ph.D. in Mathematics from the Massachusetts Institute of
Technology.
Roger Matus joined the Company as Director of Marketing in May 1995 and was
promoted to Vice President, Marketing, North America, in July 1997. From January
1994 to April 1995 he was Director of Product Marketing at ATI Technologies,
Inc., a producer of personal computer boards, components, and multimedia
software. From February 1982 to December 1993 he held various positions,
including Director of Marketing, Personal Computer Business Unit at Digital
Equipment Corporation. Mr. Matus received his B.A. from Syracuse University,
M.B.A. from the University of Chicago, and his M.Sc. in Engineering from Boston
University.
Jeanne F. McCann joined the Company in July 1998 as Vice President,
Development. From March 1997 to July 1998 she was Vice President, Development at
Eastman Software, Inc. and held various positions, including Vice President,
Development at Wang Laboratories, Inc. from February 1979 to March 1997. Ms.
McCann received her B.A. from Simmons College and her M.B.A. from Babson
College.
Tamah Solomon Rosker joined the Company in October 1994 as Director, Human
Resources and was promoted to Vice President, Human Resources in October 1998.
From June 1994 to September 1994 she was Manager, Human Resources at PerSeptive
Biosystems, Inc. and was Director, Human Resources at Kendall Square Research
from February 1992 to June 1994. She received her B.S. from Tufts University and
her J.D. from Boston College Law School.
Steven Semenzato joined the Company as Director, North American Sales, in
February 1996 and was promoted to Vice President, Channel Sales, North America
in October 1998. From September 1992 to February 1996, Mr. Semenzato held
various positions, including North American Desktop Channel Sales Manager, from
April 1995 to February 1996, at Avid Technology, Inc. Mr. Semenzato received an
engineering degree from Staffordshire University in England.
Andreas E. Widmer-Schultz joined the Company as Director, International
Sales and Marketing in August 1996. From July 1990 to August 1996, Mr.
Widmer-Schultz held several positions at FTP Software
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Worldwide, Inc., including vice president in the sales and marketing area. Mr.
Widmer-Schultz received his B.S. in International Business from Merrimack
College, studied finance and accounting at the Benedict School in Lucerne,
Switzerland, and received his B.S. in Sales Management from Kaufmaennische
Schule Luzern in Lucerne, Switzerland.
See "Certain Transactions" and "Principal Stockholders" for certain
information concerning the Company's directors and executive officers.
ELECTION OF DIRECTORS
Following this offering, the Board of Directors will be divided into three
classes, each of whose members will serve for a staggered three-year term. Mr.
Luczo and Dr. Roth will serve in the class whose term expires in 2000; Messrs.
Edwards and Shagoury will serve in the class whose term expires in 2001; and Dr.
Janet Baker will serve in the class whose term expires in 2002. Upon the
expiration of the term of a class of directors, directors in such class will be
elected for three-year terms at the annual meeting of stockholders in the year
in which such term expires.
COMPENSATION OF DIRECTORS
The Company reimburses non-employee directors for reasonable out-of-pocket
expenses incurred in attending meetings of the Board of Directors. The Company
may, in its discretion, grant stock options and other equity awards to its
non-employee directors from time to time pursuant to its 1999 Stock Incentive
Plan. The Company has not yet determined the amount and timing of such grants or
awards.
BOARD COMMITTEES
The Board of Directors has established a Compensation Committee and an
Audit Committee. The Compensation Committee, which consists of Messrs. Edwards
and Luczo, reviews executive salaries, administers any bonus, incentive
compensation and stock option plans of the Company, and approves the salaries
and other benefits of the executive officers of the Company. In addition, the
Compensation Committee consults with the Company's management regarding pension
and other benefit plans and compensation policies and practices of the Company.
The Audit Committee, which consists of Messrs. Edwards and Luczo, reviews the
professional services provided by the Company's independent accountants, the
independence of such accountants from management of the Company, the annual
financial statements of the Company and the Company's system of internal
accounting controls. The Audit Committee also reviews such other matters with
respect to the accounting, auditing and financial reporting practices and
procedures of the Company as it may find appropriate or may be brought to its
attention.
TECHNICAL ADVISORY BOARD
The Company plans to establish a Technical Advisory Board whose membership
is expected to include experts in basic fields of science and technology which
are relevant to the Company's future products, such as linguistics, statistics,
acoustics, phonetics and mathematics. Dr. James K. Baker, a co-founder of the
Company, has agreed to serve as Chairman of the Technical Advisory Board without
compensation. The other members of the Board are expected to be appointed during
the first half of 1999. It is expected that the Technical Advisory Board will
meet with the Company's key research and development personnel at least
quarterly and will provide advice regarding future trends in technology and
basic sciences.
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EXECUTIVE COMPENSATION
The following table sets forth, for the year ended December 31, 1997, the
cash compensation paid and shares underlying options granted to (i) the
Company's Chief Executive Officer and (ii) each of the four other most highly
compensated other executive officers who received annual compensation in excess
of $100,000 (collectively, the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION(1) AWARDS
---------------------------------- -------------
OTHER ANNUAL SHARES ALL OTHER
NAME AND SALARY BONUS COMPENSATION UNDERLYING COMPENSATION
PRINCIPAL POSITION ($) ($) ($) OPTIONS(#)(6) ($)
- ------------------------------------- -------- ------- ------------ ------------- ------------
James K. Baker(2).................... $199,493 $10,000 -- 105,000 $10,098(7)
Janet M. Baker....................... 198,135 10,000 -- 123,750 10,098(7)
Chairman of the Board of Directors
and Chief Executive Officer(3)
Steven Semenzato..................... 185,722(4) -- -- 72,500 4,722(8)
Vice President, Channel Sales, North
America
Andreas E. Widmer-Schultz............ 149,968(5) -- -- 65,000 2,953(9)
Director, International Sales and
Marketing
Paul G. Bamberg...................... 140,834 1,000 -- -- 7,901(10)
Vice President
- ------------
(1) In accordance with the rules of the Securities and Exchange Commission (the
"Commission"), the compensation set forth in the table does not include
medical, group life or other benefits which are available to all salaried
employees of the Company, and certain perquisites and other benefits,
securities or property which do not exceed the lesser of $50,000 or 10% of
the person's salary and bonus shown in the table.
(2) Dr. James K. Baker served as President, Chief Executive Officer and
Chairman of the Board of Directors of the Company during the fiscal year
ended December 31, 1997 and resigned from such capacities effective
December 1, 1998. John D. Shagoury became President of the Company on
December 1, 1998.
(3) Dr. Janet M. Baker has served as Chairman of the Board of Directors and
Chief Executive Officer since December 1, 1998.
(4) Consists of $87,403 base salary and $98,319 sales commission.
(5) Consists of $116,965 base salary and $33,003 sales commission.
(6) The Company did not make any restricted stock awards, grant any stock
appreciation rights or make any long-term incentive payments during fiscal
1998 to its executive officers. Options granted to the Named Executive
Officers were granted at fair market value as determined by the Board of
Directors based on all factors available to them on the grant date.
(7) Comprised of $9,500 of 401(k) matching payments made by the Company and
$598 of disability insurance premiums paid by the Company.
(8) Comprised of $4,673 of 401(k) matching payments made by the Company and $49
of disability insurance premiums paid by the Company.
(9) Comprised of $2,875 of 401(k) matching payments made by the Company and $78
of disability insurance premiums paid by the Company.
(10) Comprised of $7,051 of 401(k) matching payments made by the Company and
$850 of disability insurance premiums paid by the Company.
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In the table above, columns required by the Regulations of the Commission
have been omitted where no information was required to be disclosed under those
columns.
STOCK OPTIONS
The following table contains information concerning the grant of options to
purchase shares of the Company's common stock to each of the Named Executive
Officers of the Company during the fiscal year ended December 31, 1997:
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
---------------------------------------------------- POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER OF TOTAL ANNUAL RATES OF
SECURITIES OPTIONS STOCK
UNDERLYING GRANTED TO APPRECIATION FOR
OPTIONS EMPLOYEES IN EXERCISE OF OPTION TERM(3)
GRANTED FISCAL BASE PRICE EXPIRATION ---------------------
NAME (#) YEAR(1) ($/SH)(2) DATE 5%($) 10%($)
- ---- ---------- ------------ ----------- ---------- --------- ---------
James K. Baker..................... 12,500 1.43% $3.50 9/30/07 $27,514 $69,726
Janet M. Baker..................... 12,500 1.43 3.50 9/30/07 27,514 69,726
Steven Semenzato................... 5,000 0.57 3.18 9/30/07 9,999 25,341
Andreas E. Widmer-Schultz.......... 10,000 1.15 3.18 9/30/07 19,999 50,681
Paul G. Bamberg.................... -- -- -- -- -- --
- ------------
(1) Based on an aggregate of 871,250 shares subject to options granted to
employees of the Company in 1997.
(2) All options were granted at or above fair market value as determined by the
Board of Directors on the date of grant.
(3) Amounts reported in these columns represent amounts that may be realized
upon exercise of options immediately prior to the expiration of their term
assuming the specified compounded rates of appreciation (5% and 10%) on the
Company's common stock over the term of the options. The potential
realizable values set forth above do not take into account applicable tax
and expense payments that may be associated with such option exercises.
Actual realizable value, if any, will be dependent on the future price of
the common stock on the actual date of exercise, which may be earlier than
the stated expiration date. The 5% and 10% assumed annualized rates of stock
price appreciation over the exercise period of the options used in the table
above are mandated by the rules of the Commission and do not represent the
Company's estimate or projection of the future price of the common stock on
any date. There is no representation either express or implied that the
stock price appreciation rates for the common stock assumed for purposes of
this table will actually be achieved.
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FISCAL YEAR-END OPTION VALUES
The following table sets forth information for each of the Named Executive
Officers with respect to the value of options outstanding as of December 31,
1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUE
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED OPTIONS AT FISCAL YEAR-END IN-THE-MONEY OPTIONS AT
ON VALUE (#) FISCAL YEAR-END($)(1)
EXERCISE REALIZED --------------------------- ---------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------- -------- ----------- ------------- ----------- -------------
James K. Baker................... -- -- 43,750 61,250 $ 79,690 $ 88,590
Janet M. Baker................... -- -- 46,250 63,750 84,250 93,150
Steven Semenzato................. -- -- 15,625 51,875 27,563 82,688
Andreas E. Widmer-Schultz........ -- -- 13,750 51,250 24,225 72,675
Paul G. Bamberg.................. -- -- -- -- -- --
- ------------
(1) There was no public trading market for the common stock as of December 31,
1997. Accordingly, as permitted by the rules of the Commission, these values
have been calculated on the basis of the fair market value of the Company's
common stock as of December 31, 1997, of $3.18 per share, as determined by
the Board of Directors, less the aggregate exercise price.
EMPLOYMENT AGREEMENTS
The Company and John D. Shagoury entered into a letter agreement dated May
14, 1998 that sets forth the terms of Mr. Shagoury's employment with the
Company. Under the agreement, Mr. Shagoury's annual base salary through July 1,
1999 is fixed at $250,000, provided, however that this amount may thereafter be
increased in accordance with normal business practice. Under the agreement, Mr.
Shagoury is also eligible for a performance bonus of up to $75,000 in calendar
1998 and up to $150,000 for calendar 1999 and thereafter, if certain performance
criteria are met. In addition, the Company granted Mr. Shagoury stock options to
purchase an aggregate of 561,000 shares of the Company's common stock, of which
330,000 shares are subject to incentive stock options and 231,000 shares are
subject to non-statutory options. The exercise price of these options is $16.00
per share. The incentive stock options will vest in four equal, annual
installments. The non-statutory stock options are exercisable at the end of
seven years from the date of the agreement, provided that, if certain
performance-based criteria are met, a percentage of such options will vest prior
to the end of the seven-year vesting period. These criteria include certain
specified revenue, after-tax profit, and market capitalization targets for the
Company. Also, Mr. Shagoury is entitled to severance pay if the Company
terminates his employment without cause on or before December 31, 2000, as
follows: $250,000 if such termination occurs before December 31, 1999 and
one-half of his base salary as of the date of termination if such termination
occurs on or after January 1, 2000 and prior to December 31, 2000. The severance
payments are subject to Mr. Shagoury's full compliance with the non-disclosure
and non-competition agreements between himself and the Company.
BENEFIT PLANS
1994 Stock Option Plan. In July 1994, the Company's Board of Directors
approved the 1994 Stock Option Plan (the "1994 Stock Option Plan"), which
provides for the grant of incentive stock options and non-qualified stock
options. An aggregate of 4,033,545 shares of common stock (less the number of
shares issuable under options granted pursuant to the Dragon Systems UK Company
Share Option Plan (the "UK Plan")) are authorized to be issued pursuant to the
1994 Stock Option Plan. As of December 8, 1998, an aggregate number of 3,692,310
shares of common stock at a weighted average exercise price of $6.29 per share
were
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outstanding under the 1994 Stock Option Plan. No additional option grants will
be made under the 1994 Stock Option Plan.
1999 Stock Incentive Plan. In December 1998, the Company's Board of
Directors approved the 1999 Stock Incentive Plan (the "Incentive Plan"). The
Incentive Plan provides for the grant of restricted stock and other stock-based
awards and stock options (collectively, "Awards") for an aggregate of 3,000,000
shares of the Company's common stock. The grant of incentive stock options under
the Incentive Plan is intended to qualify under Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code").
Officers, employees, directors, consultants and advisors of the Company and
its subsidiaries are eligible to receive Awards under the Incentive Plan;
however, incentive stock options may only be granted to employees. The maximum
number of shares with respect to which Awards may be granted to any participant
under the Incentive Plan may not exceed shares in any calendar year.
Options may be granted at an exercise price which may be less than, equal
to or greater than the fair market value of the common stock on the date of
grant. Under present law, incentive stock options and options intended to
qualify as performance-based compensation under Section 162(m) of the Code may
not be granted at an exercise price less than the fair market value of the
common stock on the date of grant (or less than 110% of the fair market value in
the case of incentive stock options granted to optionees holding more than 10%
of the voting power of the Company). The Incentive Plan permits the Board of
Directors to determine the manner of payment of the exercise price of options,
including through payment by cash, check or in connection with a "cashless
exercise" through a broker, by surrender to the Company of shares of common
stock, by delivery to the Company of a promissory note, or by an combination of
the permitted forms of payment.
The Incentive Plan is administered by the Compensation Committee of the
Board of Directors. The Compensation Committee has the authority to adopt, amend
and repeal the administrative rules, guidelines and practices relating to the
Incentive Plan and to interpret the provisions thereof. Pursuant to the terms of
the Incentive Plan, the Board of Directors may delegate authority under the
Incentive Plan to one or more committees of the Board of Directors and, subject
to certain limitations, to one or more executive officers of the Company.
Subject to any applicable limitations contained in the Incentive Plan, the Board
of Directors, the Compensation Committee or any other committee or executive
officer to whom the Board of Directors delegates authority, as the case may be,
selects the recipients of Awards and determines (i) the number of shares of
common stock covered by options and the dates upon which such options become
exercisable, (ii) the exercise price of options, (iii) the duration of options,
and (iv) the number of shares of common stock subject to any restricted stock or
other stock-based Awards and the terms and conditions of such Awards, including
the conditions for repurchase, issue price and repurchase price.
In the event of a merger, liquidation or other Acquisition Event (as
defined in the Incentive Plan), the Board of Directors is authorized to provide
for outstanding options or other stock-based awards to be assumed or substituted
for by the acquiror. If the Acquisition Event also constitutes a Change in
Control (as defined in the Incentive Plan), (i) each outstanding option shall
become exercisable for one-half of the shares subject to each such option with
the remaining half vesting in accordance with the original vesting schedule, and
(ii) restrictions on one-half of each other outstanding stock-based award shall
lapse. In addition, following an Acquisition Event, an assumed or substituted
Award will accelerate if the employment of its holder with the acquiror is
terminated prior to the first anniversary of the Acquisition Event other than
"for cause" or if the holder terminates his or her employment for "good reason,"
each as defined in the Incentive Plan.
No Award may be granted under the Incentive Plan after December 2008, but
the vesting and effectiveness of Awards previously granted may extend beyond
that date. The Board of Directors may at any time amend, suspend or terminate
the Incentive Plan, except that no Award granted after an amendment of the
Incentive Plan and designated as subject to Section 162(m) of the Code by the
Board of Directors shall become exercisable, realizable or vested (to the extent
such amendment was required to grant such Award) unless and until such amendment
is approved by the Company's stockholders.
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Dragon Systems UK Company Share Option Plan. In 1997, the Company's Board
of Directors approved the UK Plan. The UK Plan provides for the grant of stock
options in compliance with the laws of England and Wales. The maximum number of
shares of common stock issuable upon the exercise of options granted under the
UK Plan is limited to 200,000 shares.
1999 Employee Stock Purchase Plan. The Company's 1999 Employee Stock
Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors in
December 1998. The Purchase Plan authorizes the issuance of up to a total of
500,000 shares of common stock to participating employees. The Company intends
to make the Purchase Plan effective at or about the time of this offering.
All employees of the Company, including the Company's employee-directors,
who have been employed for more than six months are eligible to participate in
the Purchase Plan. Employees who would immediately after the grant own 5% or
more of the total combined voting power or value of the stock of the Company or
any subsidiary are not eligible to participate.
The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions, which may not exceed 10% of an employee's
compensation, subject to certain limitations. On the first day of a designated
payroll deduction period (the "Offering Period"), the Company will grant to each
eligible employee who has elected to participate in the Purchase Plan the right
to purchase shares of common stock. On the last day of the Offering Period, the
employee is deemed to have exercised the option, at the purchase price, to the
extent of accumulated payroll deductions. Under the terms of the Purchase Plan,
the purchase price is an amount equal to 85% of the fair market value per share
of the common stock on either the first day or the last day of the Offering
Period, whichever is lower. The Compensation Committee may, in its discretion,
choose an Offering Period of 12 months or less for each of the Offerings and
choose a different Offering Period for each Offering.
An employee who is not a participant on the last day of the Offering Period
is not entitled to exercise his purchase right, and the amount of such
employee's accumulated payroll deductions will be refunded. An employee's rights
under the Purchase Plan terminate upon voluntary withdrawal from the Purchase
Plan at any time, or when such employee ceases employment for any reason, except
that upon termination of employment because of death, the employee's beneficiary
has certain rights to elect to exercise the option to purchase the shares which
the accumulated payroll deductions in the participant's account would purchase
at the date of death.
401(k) Plan. The Company's 401(k) Profit Sharing Plan (the "401(k) Plan")
is a tax-qualified plan covering all full-time employees of the Company who have
met the minimum age and service requirements. Under the 401(k) Plan,
participants may elect to defer a portion of their eligible compensation,
subject to certain limitations. In addition, at the discretion of the Board of
Directors, the Company may make matching contributions to the 401(k) Plan for
all eligible employees. The Company currently matches 100% of each employee's
pre-tax contribution to the plan, with such matching subject to a limit of 5% of
such employee's eligible compensation. The 401(k) Plan provides that, at the
discretion of the Board of Directors, the Company may make profit sharing
contributions for all eligible employees. Profit sharing contributions and
matching contributions currently vest in increments over a two-year period,
beginning on an employee's date of employment. The Company contributed
approximately $409,000 during 1995, $398,000 during 1996 and $419,000 during
1997 to the 401(k) Plan. The Company contributed approximately $355,000 to the
Plan during the nine months ended September 30, 1998.
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CERTAIN TRANSACTIONS
The Company is a party to a Development and Marketing Agreement dated as of
October 25, 1996 with Articulate and Medifax, Inc. This Agreement was superseded
by a Technology License Agreement, dated July 7, 1998, between the Company and
Articulate pursuant to which Dragon has granted Articulate an exclusive license
to certain of its speech technology in one field of use (radiology, emergency
medicine and cardiology) and a non-exclusive license in another (the remainder
of the healthcare market). At the time it entered into the Technology License
Agreement, the Company owned 49.7% of the outstanding voting securities of
Articulate. The Company sold its minority interest in Articulate to fonix
corporation on September 2, 1998.
The Company received approximately $655,000 in 1997 and $345,000 in 1996
under a commercial development contract with Seagate, which owns approximately
38% of the Company's outstanding capital stock prior to this offering. The
Company believes that this agreement was entered into on an arm's-length basis
on terms that were no less favorable to the Company than could have been
obtained from an unaffiliated third party. Mr. Luczo, Seagate's President and
Chief Executive Officer, has been a member of the Board of Directors of the
Company since July 1994.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's common stock as of December 8, 1998 and as adjusted
to reflect the sale of the shares in this offering by (i) each person who is
known by the Company to own beneficially more than 5% of the outstanding shares
of common stock, (ii) each director and Named Executive Officer of the Company,
and (iii) all directors and executive officers of the Company as a group.
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING(1) AFTER THE OFFERING(1)(2)
------------------------- -------------------------
NAME NUMBER PERCENT NUMBER PERCENT
- ---- ------------ --------- ----------- ----------
James K. Baker(3).............................. 15,592,060 52.0%
Janet M. Baker(4).............................. 15,592,060 52.0
Seagate Technology, Inc.(5).................... 11,466,130 38.4
Paul G. Bamberg................................ 1,761,340 5.9
John D. Shagoury............................... -- *
Robert Roth(6)................................. 849,650 2.8
Kim B. Edwards................................. -- *
Stephen J. Luczo(7)............................ 11,466,130 38.4
Steven Semenzato(8)............................ 32,500 *
Andreas E. Widmer-Schultz(9)................... 30,000 *
All executive officers and directors as a group
(13 persons)(10)............................. 30,100,740 99.6
- ------------
* Less than 1% of the outstanding common stock.
(1) The number of shares of common stock deemed outstanding prior to this
offering includes: (i) 13,628,380 shares of common stock outstanding as of
December 8, 1998; and (ii) shares issuable pursuant to options held by each
person included in this table which may be exercised within 60 days after
December 8, 1998, as set forth below. The number of shares of common stock
deemed outstanding after this offering includes the shares that are
being offered for sale by the Company in this offering. Beneficial
ownership is determined in accordance with the rules of the Commission, and
includes voting and investment power with respect to shares. Unless
otherwise indicated below, to the knowledge of the Company, all persons
named in the table have sole voting and investment power with respect to
their shares of common stock, except to the extent authority is shared by
spouses under applicable law. Unless otherwise indicated, the address of
each person below owning more than 5% of the outstanding shares of common
stock is c/o Dragon Systems, Inc., 320 Nevada Street, Newton, MA 02460.
(2) The above table assumes no exercise of the over-allotment option to
purchase up to an aggregate of shares of common stock. If the
underwriters exercise their over-allotment option in full, the following
stockholders (the "Selling Stockholders") will sell such number of
additional shares of common stock pursuant to such option and, after such
sale, will beneficially own such number of shares of common stock, that is
set forth below opposite their respective names:
SHARES TO BE BENEFICIALLY
SHARES OWNED AFTER OFFERING
BEING --------------------------
NAME OFFERED NUMBER PERCENTAGE
---- ----------- ----------- -----------
(3) Includes 70,000 shares issuable pursuant to options held by Dr. James Baker
that may be exercised within 60 days after December 8, 1998. Also includes
an aggregate of 7,797,905 shares held by Dr. Janet Baker.
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(4) Includes 73,750 shares issuable pursuant to options held by Dr. Janet Baker
that may be exercised within 60 days after December 8, 1998. Also includes
an aggregate of 7,794,155 shares held by Dr. James Baker.
(5) The address of Seagate Technology, Inc. is 920 Disk Drive, Scotts Valley,
CA 95066.
(6) Includes 11,875 shares issuable pursuant to options held by Dr. Roth that
may be exercised within 60 days after December 8, 1998.
(7) Includes 11,466,130 shares held by Seagate as to which Mr. Luczo disclaims
beneficial ownership.
(8) Includes 32,500 shares issuable pursuant to options held by Mr. Semenzato
that may be exercised within 60 days after December 8, 1998.
(9) Includes 30,000 shares issuable pursuant to options held by Mr.
Widmer-Schultz that may be exercised within 60 days after December 8, 1998.
(10) Includes 411,250 shares of common stock issuable upon the exercise of stock
options that vest within 60 days after December 8, 1998. See notes (3)
through (9).
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DESCRIPTION OF CAPITAL STOCK
Effective upon the closing of this offering, the authorized capital stock
of the Company will consist of 100,000,000 shares of common stock, $.04 par
value per share, and 5,000,000 shares of preferred stock, $.04 par value per
share.
The following summary description of the Company's capital stock is not
intended to be complete and is qualified in its entirety by reference to the
provisions of applicable law and to the Company's Restated Certificate of
Incorporation and Restated By-Laws, filed as exhibits to the Registration
Statement of which this Prospectus is a part.
COMMON STOCK
As of December 8, 1998, there were 29,823,135 shares of common stock
outstanding held by 16 stockholders of record. Based upon the number of shares
outstanding as of that date, and giving effect to the issuance of the
shares of common stock offered by the Company in this offering, there will be
shares of common stock outstanding upon the closing of this offering. In
addition, as of December 8, 1998, there were outstanding stock options for the
purchase of a total of 3,692,310 shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares present
in person or by proxy at the meeting and entitled to vote in such election.
Holders of common stock are entitled to receive ratably such dividends, if any,
as may be declared by the Board of Directors out of funds legally available
therefor, subject to any preferential dividend rights of outstanding preferred
stock. Upon the liquidation, dissolution or winding up of the Company, the
holders of common stock are entitled to receive ratably the net assets of the
Company available after the payment of all debts and other liabilities of the
Company, subject to the prior rights of any outstanding preferred stock. Holders
of the common stock have no preemptive, subscription, redemption or conversion
rights, nor are they entitled to the benefit of any sinking fund. The
outstanding shares of common stock are, and the shares offered by the Company in
this offering will be, when issued and paid for, validly issued, fully paid and
nonassessable. The rights, powers, preferences and privileges of holders of
common stock are subject to, and may be adversely affected by, the rights of the
holders of shares of any series of preferred stock which the Company may
designate and issue in the future.
PREFERRED STOCK
The Board of Directors will be authorized, subject to any limitations
prescribed by law, without further stockholder approval, to issue from time to
time up to an aggregate of 5,000,000 shares of preferred stock, in one or more
series. Each such series of preferred stock shall have such number of shares,
designations, preferences, voting powers, qualifications and special or relative
rights or privileges as shall be determined by the Board of Directors, which may
include, among others, dividend rights, voting rights, redemption provisions,
liquidation preferences, conversion rights and preemptive rights. The rights of
the holders of common stock will be subject to the rights of holders of any
preferred stock issued in the future.
The stockholders of the Company have granted the Board of Directors
authority to issue the preferred stock in order to eliminate delays associated
with a stockholder vote on specific issuances. The issuance of preferred stock,
while providing desirable flexibility in connection with possible acquisitions
and other corporate purposes, could adversely affect the voting power or other
rights of the holders of common stock, and could make it more difficult for a
third party to acquire, or discourage a third party from attempting to acquire,
a majority of the outstanding voting stock of the Company.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS; ANTI-TAKEOVER EFFECTS
The Company is subject to the provisions of Section 203 of the General
Corporation Law of Delaware. Section 203 prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. A "business combination"
includes mergers, consolidations, asset sales and other transactions involving
the Company and an interested stockholder. Subject to certain exceptions, an
"interested stockholder" is a person
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who, together with affiliates and associates, owns, or within three years did
own, 15% or more of the corporation's voting stock.
The Restated Certificate of Incorporation and Restated By-Laws provide for
the division of the Board of Directors into three classes, as nearly equal in
size as possible, with staggered three-year terms. See "Management -- Election
of Directors." In addition, the Restated Certificate of Incorporation and
Restated By-Laws provide that directors may be removed only for cause by the
affirmative vote of the holders of at least 75% of the shares of capital stock
of the Company entitled to vote. The Restated Certificate of Incorporation and
Restated By-Laws provide that any vacancy on the Board of Directors, however
occurring, including a vacancy resulting from an enlargement of the Board, may
only be filled by vote of a majority of the directors then in office. The
classification of the Board of Directors and the limitations on the removal of
directors and filling of vacancies could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
acquiring, control of the Company.
The Restated Certificate of Incorporation and Restated By-Laws also provide
that, after the closing of this offering, (i) any action required or permitted
to be taken by the stockholders of the Company at an annual meeting or special
meeting of stockholders may only be taken if it is properly brought before such
meeting and may not be taken by written action in lieu of a meeting, and (ii)
special meetings of the stockholders may only be called by the Chairman of the
Board of Directors, the President of the Company, or by the Board of Directors.
The Restated By-Laws provide that, in order for any matter to be considered
"properly brought" before a meeting, a stockholder must comply with certain
requirements regarding advance notice to the Company. The foregoing provisions
could have the effect of delaying until the next stockholders' meeting
stockholder actions which are favored by the holders of a majority of the
outstanding voting securities of the Company. These provisions may also
discourage another person or entity from making a tender offer for the Company's
common stock, because such person or entity, even if it acquired a majority of
the outstanding voting securities of the Company, would be able to take action
as a stockholder (such as electing new directors or approving a merger) only at
a duly called stockholders meeting, and not by written consent.
The General Corporation Law of Delaware provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. The Restated Certificate of Incorporation
requires the affirmative vote of the holders of at least 75% of the shares of
capital stock of the Company entitled to vote to amend or repeal any of the
foregoing provisions of the Restated Certificate of Incorporation. The Restated
By-Laws may be amended or repealed by a majority vote of the Board of Directors
or the holders of a majority of the shares of the capital stock of the Company
issued and outstanding and entitled to vote, subject to certain limitations
concerning special meetings of stockholders, written actions of stockholders in
lieu of a meeting, and the election, removal and classification of members of
the Board of Directors which require the affirmative vote of the holders of at
least 75% of the shares of capital stock of the Company entitled to vote. The
stockholder vote would be in addition to any separate class vote that might in
the future be required pursuant to the terms of any series preferred stock that
might be outstanding at the time any such amendments are submitted to
stockholders.
LIMITATION OF LIABILITY AND INDEMNIFICATION
The Restated Certificate of Incorporation provides that the directors and
officers of the Company shall be indemnified by the Company to the fullest
extent authorized by Delaware law, as it now exists or may in the future be
amended, against all expenses and liabilities reasonably incurred in connection
with the service for or on behalf of the Company. In addition, the Restated
Certificate of Incorporation provides that the directors of the Company will not
be personally liable for monetary damages to the Company for breaches of their
fiduciary duty as directors, unless they violated their duty of loyalty to the
Company or its stockholders, acted in bad faith, knowingly or intentionally
violated the law, authorized illegal dividends or redemptions or derived an
improper personal benefit from their action as directors.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is Boston EquiServe
L.P.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have shares of
common stock outstanding (assuming no exercise of outstanding options). Of these
shares, the shares ( shares if the over-allotment option is
exercised in full) to be sold in this offering will be freely tradable without
restriction or further registration under the Securities Act of 1933, as amended
(the "Securities Act"), except that any shares purchased by affiliates of the
Company, as that term is defined in Rule 144 ("Rule 144") under the Securities
Act ("Affiliates"), may generally only be sold in compliance with the
limitations of Rule 144 described below.
SALES OF RESTRICTED SHARES
The remaining 29,823,135 shares of common stock outstanding upon completion
of this offering are deemed "Restricted Shares" under Rule 144 or Rule 701 under
the Securities Act. Subject to the lock-up agreements described below (the
"Lock-up Agreements"), 133,650 of such Restricted Shares will be eligible for
sale in the public market, pursuant to Rule 701, 90 days after the date of this
Prospectus. Upon expiration of the Lock-up Agreements, 180 days after the date
of this Prospectus, an additional 1,875 shares of common stock will be eligible
for sale in the public market pursuant to Rule 144(k) under the Securities Act.
In general, under Rule 144, a person (or persons whose shares are
aggregated), including an Affiliate, who has beneficially owned Restricted
Shares for at least one year is entitled to sell, within any three-month period,
a number of such shares that does not exceed the greater of (i) one percent of
the then outstanding shares of common stock (approximately shares
immediately after this offering) or (ii) the average weekly trading volume in
the common stock in the over-the-counter market during the four calendar weeks
preceding the date on which notice of such sale is filed, provided certain
requirements concerning availability of public information, manner of sale and
notice of sale are satisfied. In addition, Affiliates must comply with the
restrictions and requirements of Rule 144, other than the one-year holding
period requirement, in order to sell shares of common stock which are not
restricted securities. Under Rule 144(k), a person who is not an Affiliate and
has not been an Affiliate for at least three months prior to the sale and who
has beneficially owned Restricted Shares for at least two years may resell such
shares without compliance with the foregoing requirements. In meeting the one-
and two-year holding periods described above, a holder of Restricted Shares can
include the holding periods of a prior owner who was not an Affiliate. The one-
and two-year holding periods described above do not begin to run until the full
purchase price or other consideration is paid by the person acquiring the
Restricted Shares from the issuer or an Affiliate. Rule 701 provides that
currently outstanding shares of common stock acquired under the Company's
employee compensation plans may be resold beginning 90 days after the date of
this Prospectus (i) by persons, other than Affiliates, subject only to the
manner of sale provisions of Rule 144, and (ii) by Affiliates under Rule 144,
and by Affiliates under Rule 144 without compliance with its one-year minimum
holding period, subject to certain limitations.
STOCK OPTIONS
At December 8, 1998, approximately 1,306,740 shares of common stock were
issuable pursuant to vested options or pursuant to other rights granted under
the Company's 1994 Stock Option Plan of which approximately 308,835 shares are
not subject to Lock-up Agreements with the Underwriters and will be eligible for
sale in the public market in accordance with Rule 701 under the Securities Act
beginning 90 days after the date of this Prospectus.
The Company intends to file one or more registration statements on Form S-8
under the Securities Act following the date of this Prospectus, to register up
to 3,692,310 shares of common stock subject to outstanding stock options or
other rights granted pursuant to the Company's 1994 Stock Option Plan as of
December 8, 1998, including the 1,306,740 shares of common stock subject to
options vested as of December 8, 1998, and 2,385,570 shares of common stock
issuable pursuant to the Company's 1994 Stock Option Plan. Such registration
statements are expected to become effective upon filing. At such time,
approximately 1,306,740 shares of common stock issuable upon the exercise of
options granted as of December 8, 1998 and covered by these registration
statements will be vested and eligible for sale in the public market upon the
exercise of underlying options to the extent not previously sold pursuant to
Rule 701.
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LOCK-UP AGREEMENTS
Subject to certain exceptions, the Company and the executive officers,
directors, Selling Stockholders and other securityholders of the Company have
agreed that, without the prior written consent of Morgan Stanley & Co.
Incorporated, they will not, during the period ending 180 days after the date of
this Prospectus, (a) offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend, or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities convertible
into or exercisable or exchangeable for common stock (regardless of whether such
shares or any such securities are then owned by such person or are thereafter
acquired), or (b) enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership of
the common stock, regardless of whether any such transactions described in
clauses (a) or (b) of this paragraph are to be settled by delivery of such
common stock or such other securities, in cash or otherwise. In addition, for a
period of 180 days from the date of this Prospectus, except as required by law,
the Company has agreed that its Board of Directors will not consent to any offer
for sale, sale or other disposition, or any transaction which is designed or
could be expected, to result in, the disposition by any person, directly or
indirectly, of any shares of common stock without the prior written consent of
Morgan Stanley & Co. Incorporated. See "Underwriters."
REGISTRATION RIGHTS
The Company and Seagate are parties to an Amended and Restated Registration
Rights Agreement dated September 4, 1997. Under the terms of this agreement,
Seagate is entitled to certain demand registration rights regarding the
registration of its shares under the Securities Act after the closing of this
offering, subject to certain limitations and restrictions. Under the terms of
the agreement, the Company is not required to effect any additional
registrations upon demand after it has effected two such registrations and such
registrations have been declared or ordered effective and, further, is not
required to effect a registration within six months after the closing of this
offering. In addition, under the terms of the Agreement, the Company is not
required to effect more than one such registration upon demand in any six-month
period. The agreement also grants Seagate piggyback registration rights, subject
to conditions, with respect to the registration of its shares under the
Securities Act. In the event that the Company proposes to register any shares of
common stock under the Securities Act, either for its own account or for the
account of other security holders, the agreement provides that Seagate pursuant
to its piggyback registration rights is entitled to receive notice thereof, and
has the right to include its shares in that registration, subject to certain
limitations. Under the terms of the Agreement, the Company is not required to
effect more than one such piggyback registration in any six-month period.
Further, the agreement provides that Seagate may require the Company to file up
to an aggregate of three registration statements under the Securities Act on
Form S-3 with respect to its shares, subject to certain limitations. The Company
is not required to effect such a registration on Form S-3 within one year of the
closing of this offering or for a period 60 days prior to or six months
following the effective date of certain registration statements regarding the
Company's securities. Further, under the terms of the Agreement, the Company is
not required to effect more than one such registration on Form S-3 in any six
month period. The various registration rights provided under the agreement are
subject to conditions and limitations, including the right of the underwriters
of an offering to limit the number of shares of common stock held by security
holders with registration rights to be included in such registration. Other than
registrations on Form S-3 requested to be filed by Seagate, the Company is
generally required to bear all of the expenses of all registrations, except
underwriting discounts, commissions, and stock transfer taxes. Seagate shall
bear all of the expenses of any demand registration on Form S-3 requested to be
filed by Seagate. Registration of any of the shares of common stock held by
securityholders with registration rights would result in such shares becoming
freely tradable without restriction under the Securities Act upon effectiveness
of such registration.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock of the Company, and no predictions can be made as to the effect, if any,
that market sales of shares of common stock from time to time, or the
availability of shares for future sale, may have on the market price for the
common stock. Sales of substantial amounts of common stock, or the perception
that such sales could occur, could adversely effect prevailing market prices for
the common stock and could impair the Company's future ability to obtain capital
through an offering of equity securities.
55
58
UNDERWRITERS
Under the terms and subject to the conditions contained in an underwriting
agreement dated the date of this Prospectus (the "underwriting agreement"), the
underwriters named below, for whom Morgan Stanley & Co. Incorporated, Hambrecht
& Quist LLC and SG Cowen Securities Corporation are acting as representatives,
have severally agreed to purchase, and the Company has agreed to sell to them,
severally, the respective number of shares of common stock set forth opposite
the names of such underwriters below:
NUMBER OF
NAME SHARES
- ---- ----------------
Morgan Stanley & Co. Incorporated...........................
Hambrecht & Quist LLC.......................................
SG Cowen Securities Corporation.............................
--------
Total..................................................
========
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from the Company and subject to prior sale. The
underwriting agreement provides that the obligations of the several underwriters
to pay for and accept delivery of the shares of common stock offered hereby are
subject to the approval of certain legal matters by their counsel and to certain
other conditions. The underwriters are obligated to take and pay for all the
shares of common stock offered hereby (other than those covered by the
over-allotment option described below) if any such shares are taken.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the cover
page hereof and part to certain dealers at a price that represents a concession
not in excess of $ a share under the public offering price. Any underwriter
may allow, and such dealers may reallow, a concession not in excess of $ a
share to other underwriters or to certain dealers. After the initial offering of
the shares of common stock, the offering price and other selling terms may from
time to time be varied by the representatives.
The Selling Stockholders have granted the underwriters an option,
exercisable for 30 days from the date of this Prospectus, to purchase up to an
aggregate of additional shares of common stock at the public offering
price set forth on the cover page hereof, less underwriting discounts and
commissions. The underwriters may exercise such option solely for the purpose of
covering over-allotments, if any, made in connection with the offering of the
shares of common stock offered hereby. To the extent such option is exercised,
each underwriter will become obligated, subject to certain conditions, to
purchase approximately the same percentage of such additional shares of common
stock as the number set forth next to such underwriter's name in the preceding
table bears to the total number of shares of common stock set forth next to the
names of all underwriters in the preceding table. If the underwriters' option is
exercised in full, the total price to the public would be $ , the total
underwriters' discounts and commissions would be $ , and total proceeds
to the Company would be $ .
At the request of the Company, the underwriters have reserved up to
shares of the common stock offered hereby for sale at the initial
public offering price to certain employees, consultants, business associates and
other persons associated with the Company. The number of shares of common stock
available for sale to the general public will be reduced to the extent such
persons purchase such reserved shares. Any
56
59
reserved shares not so purchased will be offered by the underwriters to the
general public on the same basis as the other shares offered hereby.
The underwriters have informed the Company that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares of
common stock offered by them.
The common stock has been approved for quotation, subject to official
notice of issuance, on the Nasdaq National Market under the symbol "DRGN."
Subject to certain limited exceptions, the Company and the executive
officers, directors, the Selling Stockholders and certain other securityholders
of the Company have agreed that, without the prior written consent of Morgan
Stanley & Co. Incorporated, they will not, during the period ending 180 days
after the date of this Prospectus, (a) offer, pledge, sell, contract to sell,
sell any option or contract to purchase, purchase any option or contract to
sell, grant any option, right or warrant to purchase, lend, or otherwise
transfer or dispose of, directly or indirectly, any shares of common stock or
any securities convertible into or exercisable or exchangeable for common stock
(regardless of whether such shares or any such securities are then owned by such
person or are thereafter acquired), or (b) enter into any swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the common stock, regardless of whether any such
transactions described in clauses (a) or (b) of this paragraph are to be settled
by delivery of such common stock or such other securities, in cash or otherwise.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering, if the syndicate repurchases previously
distributed common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the common stock above independent market
levels. The underwriters are not required to engage in these activities, and may
end any of these activities at any time.
From time to time, certain of the underwriters have provided, and may
continue to provide, investment banking services to the Company.
The Company, the Selling Stockholders and the underwriters have agreed to
indemnify each other against certain liabilities, including liabilities under
the Securities Act.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock. The initial public offering price will be determined by negotiations
between the Company and the representatives of the underwriters. Among the
factors to be considered in determining the initial public offering price will
be the future prospects of the Company and its industry in general, net sales,
earnings and certain other financial and operating information of the Company in
recent periods, and the price-earnings ratios, certain other ratios, and market
prices of securities and certain financial and operating information of
companies engaged in activities similar to those of the Company. The estimated
initial public offering price range set forth on the cover page of this
preliminary prospectus is subject to change as a result of market conditions and
other factors.
57
60
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for the Company by Hale and Dorr LLP, Boston, Massachusetts. Certain legal
matters in connection with this offering will be passed upon for the
underwriters by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts.
EXPERTS
The Consolidated Financial Statements and Financial Statement Schedule of
the Company as of December 31, 1996 and December 31, 1997 and for the three
years in the period ended December 31, 1997 included in this Prospectus and
elsewhere included in the Registration Statement have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their reports with
respect thereto, and are included herein in reliance upon the authority of said
firm as experts in giving said reports.
The statements in the Prospectus in the first two paragraphs under the
caption "Business -- Intellectual Property" and the first two paragraphs under
the caption "Business -- Legal Proceedings" have been reviewed and approved by
Fish & Richardson P.C., patent counsel of the Company, as experts on patent
matters, and are included herein in reliance upon that review and approval and
the authority of such counsel as experts in patent law.
ADDITIONAL INFORMATION
The Company has filed with the Commission, a Registration Statement on Form
S-1 (together with all amendments, exhibits and schedules thereto, the
"Registration Statement") under the Securities Act with respect to the common
stock offered hereby. This Prospectus, which constitutes part of the
Registration Statement, does not contain all of the information set forth in the
Registration Statement, certain parts of which are omitted in accordance with
the rules and regulations of the Commission. For further information with
respect to the Company and the common stock offered hereby, reference is made to
the Registration Statement. Statements contained in this Prospectus as to the
contents of any contract or other document filed as an exhibit to the
Registration Statement are not necessarily complete, and in each instance
reference is made to the copy of such document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. The Registration Statement may be inspected without charge at
the principal office of the Commission in Washington, D.C. and copies of all or
any part of which may be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Room
1024, Washington, D.C. 20549, and at the Commission's regional offices located
at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511 and 7 World Trade Center, Suite 1300, New York, New York 10048.
Copies of such material can also be obtained at prescribed rates by mail from
the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549. In addition, the Commission maintains a website
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission.
58
61
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public
Accountants......................... F-2
Consolidated Balance Sheets........... F-3
Consolidated Statements of
Operations.......................... F-4
Consolidated Statements of
Stockholders' Equity................ F-5
PAGE
----
Consolidated Statements of Cash
Flows............................... F-6
Notes to Consolidated Financial
Statements.......................... F-7
F-1
62
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Dragon Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Dragon
Systems, Inc. and subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Dragon
Systems, Inc. and subsidiaries as of December 31, 1996 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
December 1, 1998 (except for the matter
discussed in Note 6, as to which the date is
December 17, 1998)
F-2
63
DRAGON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30,
1996 1997 1998
------- ------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,616 $ 4,894 $ 6,598
Investments, available for sale........................... 3,296 7,427 5,840
Accounts receivable, net of allowance for bad debt of
$381, $813 and $1,024................................... 998 2,501 9,351
Unbilled revenues......................................... 1,301 968 1,658
Inventories............................................... 481 2,162 5,561
Refundable income taxes................................... 1,406 570 588
Prepaid expenses and other current assets................. 444 482 909
Deferred tax assets....................................... 215 2,809 5,547
------- ------- -------
Total current assets.................................... 11,757 21,813 36,052
------- ------- -------
Property and equipment, net................................. 1,165 1,373 1,976
Other assets................................................ 191 -- 250
------- ------- -------
Total assets............................................ $13,113 $23,186 $38,278
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 713 $ 2,615 $ 6,562
Accrued expenses.......................................... 2,438 2,745 6,311
Income taxes payable...................................... 35 453 1,421
Deferred revenue.......................................... -- 24 328
Net liabilities of a discontinued operation............... 2,635 2,495 --
------- ------- -------
Total current liabilities............................... 5,821 8,332 14,622
------- ------- -------
Commitments and contingencies (Note 8)
Stockholders' equity:
Convertible preferred stock, $.04 par value; 5,000,000
shares authorized; 2,847,349; 3,207,598 and 3,238,951
shares issued and outstanding (preference in
liquidation: $64,779)................................... 114 128 130
Common stock, $.04 par value; 45,000,000 shares
authorized; 11,966,120; 13,483,120 and 13,628,380 shares
issued and outstanding (preference in liquidation:
$18,480)................................................ 479 539 545
Additional paid-in capital................................ 18,135 30,975 31,028
Retained deficit.......................................... (11,422) (16,718) (8,045)
Accumulated other comprehensive income.................... (14) (70) (2)
------- ------- -------
Total stockholders' equity.............................. 7,292 14,854 23,656
------- ------- -------
Total liabilities and stockholders' equity.............. $13,113 $23,186 $38,278
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
64
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- --------------------------
1995 1996 1997 1997 1998
------- ------- ------- ----------- -----------
(UNAUDITED)
Net revenue:
Software licenses.................................... $12,171 $11,479 $19,506 $10,222 $44,766
Development contracts................................ 4,716 5,559 7,315 5,206 4,810
------- ------- ------- ------- -------
Total net revenue.................................. 16,887 17,038 26,821 15,428 49,576
------- ------- ------- ------- -------
Cost of revenue:
Cost of software licenses............................ 3,365 3,465 5,394 2,806 12,162
Cost of development contracts........................ 3,315 3,582 4,993 3,660 2,595
------- ------- ------- ------- -------
Total cost of revenue.............................. 6,680 7,047 10,387 6,466 14,757
------- ------- ------- ------- -------
Gross profit....................................... 10,207 9,991 16,434 8,962 34,819
------- ------- ------- ------- -------
Operating expenses:
Research and development............................. 6,688 7,983 9,577 7,096 10,607
Selling and marketing................................ 4,825 5,403 9,350 5,734 16,025
General and administrative........................... 2,192 1,940 2,485 1,769 2,907
------- ------- ------- ------- -------
Total operating expenses........................... 13,705 15,326 21,412 14,599 29,539
------- ------- ------- ------- -------
Operating income (loss)................................ (3,498) (5,335) (4,978) (5,637) 5,280
Interest income...................................... 760 520 511 369 452
------- ------- ------- ------- -------
Income (loss) from continuing operations before
income taxes..................................... (2,738) (4,815) (4,467) (5,268) 5,732
Provision for (benefit from) income taxes.............. (646) (564) (2,190) (2,583) 1,699
------- ------- ------- ------- -------
Income (loss) from continuing operations........... (2,092) (4,251) (2,277) (2,685) 4,033
------- ------- ------- ------- -------
Gain (loss) on discontinued operations:
Loss from operations............................... (3,070) (1,706) (3,019) (2,306) (2,142)
Gain on sale, net of taxes of $1,420............... -- -- -- -- 6,782
------- ------- ------- ------- -------
Gain (loss) on discontinued operations............. (3,070) (1,706) (3,019) (2,306) 4,640
------- ------- ------- ------- -------
Net income (loss).................................. $(5,162) $(5,957) $(5,296) $(4,991) $ 8,673
======= ======= ======= ======= =======
Earnings per share:
Income (loss) from continuing operations:
Basic.............................................. $ (.18) $ (.36) $ (.18) $ (.22) $ .30
Diluted............................................ $ (.18) $ (.36) $ (.18) $ (.22) $ .13
Gain (loss) from discontinued operations:
Basic.............................................. $ (.26) $ (.14) $ (.24) $ (.19) $ .34
Diluted............................................ $ (.26) $ (.14) $ (.24) $ (.19) $ .15
Net income (loss):
Basic.............................................. $ (.43) $ (.50) $ (.43) $ (.41) $ .64
Diluted............................................ $ (.43) $ (.50) $ (.43) $ (.41) $ .27
Weighted average shares outstanding:
Basic.............................................. 11,897 11,922 12,460 12,116 13,622
Diluted............................................ 11,897 11,922 12,460 12,116 31,844
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
65
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ACCUMULATED
----------------- ------------------ ADDITIONAL OTHER TOTAL
NUMBER OF PAR NUMBER OF PAR PAID-IN RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES VALUE SHARES VALUE CAPITAL DEFICIT INCOME EQUITY
--------- ----- ---------- ----- ---------- -------- ------------- -------------
Balance, December 31,
1994..................... 2,830,962 $113 11,897,225 $476 $18,115 $ (303) $ -- $18,401
Net loss................. (5,162) (5,162)
Foreign currency
translation
adjustment............. (9) (9)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income.....
Balance, December 31,
1995..................... 2,830,962 113 11,897,225 476 18,115 (5,465) (9) 13,230
Exercise of stock options
and units.............. 16,387 1 68,895 3 20 24
Net loss................. (5,957) (5,957)
Foreign currency
translation
adjustment............. (5) (5)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income.....
Balance, December 31,
1996..................... 2,847,349 114 11,966,120 479 18,135 (11,422) (14) 7,292
Exercise of stock options
and units.............. 510 -- 5,010 -- 4 4
Issuance of convertible
preferred stock and
common stock........... 359,739 14 1,511,990 60 11,926 12,000
Issuance of subsidiary
stock.................. 910 910
Net loss................. (5,296) (5,296)
Foreign currency
translation
adjustment............. (56) (56)
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income.....
Balance, December 31,
1997..................... 3,207,598 128 13,483,120 539 30,975 (16,718) (70) 14,854
Exercise of stock options
and units.............. 31,353 2 145,260 6 53 61
Net income............... 8,673 8,673
Unrealized gain on
investments available
for sale............... 50 50
Foreign currency
translation
adjustment............. 18 18
--------- ---- ---------- ---- ------- -------- ---- -------
Comprehensive income.....
Balance, September 30, 1998
(unaudited).............. 3,238,951 $130 13,628,380 $545 $31,028 $(8,045) $ (2) $23,656
========= ==== ========== ==== ======= ======== ==== =======
COMPREHENSIVE
INCOME
-------------
Balance, December 31,
1994..................... $ --
Net loss................. (5,162)
Foreign currency
translation
adjustment............. (9)
-------
Comprehensive income..... (5,171)
Balance, December 31,
1995.....................
Exercise of stock options
and units..............
Net loss................. (5,957)
Foreign currency
translation
adjustment............. (5)
-------
Comprehensive income..... (5,962)
Balance, December 31,
1996.....................
Exercise of stock options
and units..............
Issuance of convertible
preferred stock and
common stock...........
Issuance of subsidiary
stock..................
Net loss................. (5,296)
Foreign currency
translation
adjustment............. (56)
-------
Comprehensive income..... (5,352)
Balance, December 31,
1997.....................
Exercise of stock options
and units..............
Net income............... 8,673
Unrealized gain on
investments available
for sale............... 50
Foreign currency
translation
adjustment............. 18
-------
Comprehensive income..... 8,741
Balance, September 30, 1998
(unaudited)..............
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
66
DRAGON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------------
1995 1996 1997 1997 1998
-------- ------- -------- ----------- -----------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................... $ (5,162) $(5,957) $ (5,296) $(4,991) $ 8,673
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization...................... 1,788 1,919 970 739 776
Gain on sale of discontinued operations............ -- -- -- (6,782)
Deferred income taxes.............................. -- -- (2,594) (1,399) (2,738)
Changes in operating assets and liabilities:
Accounts receivable.............................. (358) 1,119 (1,503) (325) (6,850)
Unbilled receivables............................. 525 (563) 333 453 (690)
Inventories...................................... (59) (58) (1,681) (1,957) (3,399)
Refundable income taxes.......................... (201) (697) 836 (941) (18)
Prepaid expenses and other current assets........ 26 (143) (38) (34) (427)
Accounts payable................................. (85) 285 1,902 1,897 3,947
Accrued expenses................................. 204 742 307 137 3,566
Deferred revenues................................ (203) (52) 24 877 304
Income taxes payable............................. 56 347 418 (403) (453)
Discontinued operations.......................... 1,129 1,506 (140) 393 1,912
-------- ------- -------- ------- -------
Net cash used in operating activities............ (2,340) (1,552) (6,462) (5,554) (2,179)
-------- ------- -------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets............................ (677) (660) (1,003) (602) (1,379)
Purchases of investments............................. (1,963) (3,296) (8,418) (3,539) (2,383)
Maturities and sales of investments.................. -- 1,963 4,287 3,296 5,586
Cash from sale of discontinued operations............ -- -- -- 2,230
Additions to capitalized software costs.............. (962) (538) -- -- --
Other assets......................................... 261 60 17 (12) (250)
-------- ------- -------- ------- -------
Net cash provided by (used in) investing
activities..................................... (3,341) (2,471) (5,117) (857) 3,804
-------- ------- -------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible preferred stock
and common stock................................... -- 24 12,004 11,988 61
Proceeds from issuance of subsidiary preferred
stock.............................................. -- -- 910 800 --
-------- ------- -------- ------- -------
Total cash provided by financing activities...... -- 24 12,914 12,788 61
-------- ------- -------- ------- -------
Foreign exchange impact on cash and cash
equivalents........................................ (10) (4) (57) (14) 18
-------- ------- -------- ------- -------
Net increase (decrease) in cash and cash
equivalents........................................ (5,691) (4,003) 1,278 6,363 1,704
Cash and cash equivalents, beginning of period....... 13,310 7,619 3,616 3,616 4,894
-------- ------- -------- ------- -------
Cash and cash equivalents, end of period............. $ 7,619 $ 3,616 $ 4,894 $ 9,979 $ 6,598
======== ======= ======== ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for (refunds received from) income
taxes............................................ $ (444) $ (68) $ (872) $ (65) $ 2,177
======== ======= ======== ======= =======
Cash paid for interest............................. $ -- $ -- $ -- $ -- $ --
======== ======= ======== ======= =======
SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING
ACTIVITIES:
fonix stock received from sale of discontinued
operations....................................... $ -- $ -- $ -- $ -- $ 1,566
======== ======= ======== ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
67
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. THE COMPANY
The Company is a leading developer and provider of advanced speech
recognition products and related speech technologies that humanize the way
people communicate with computers and other electronic devices. The Company's
products and technologies enable electronic devices to understand speech.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
Through September 2, 1998, the Company owned approximately 38% of the
outstanding voting shares of Articulate Systems, Inc. ("Articulate"). The
financial statements of Articulate have been reflected in the consolidated
financial statements of the Company as discontinued operations (see Note 3).
(b) Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of income and expenses during the reporting
periods. Operating results in the future could vary from the amounts derived
from management's estimates and assumptions.
(c) Foreign Currency
Assets and liabilities of the Company's foreign operations are translated
into U.S. dollars at the exchange rate in effect as of the balance sheet date,
and revenue and expenses are translated at average exchange rates during the
period. The resultant translation adjustment is reflected as a separate
component of accumulated other comprehensive income. Net gains and losses
resulting from foreign exchange transactions are reflected in the consolidated
statements of operations and were not material in all periods presented.
(d) Revenue Recognition
The Company sells its products predominantly through major distributors to
retail channel accounts and VARs and directly to OEMs and ISVs. The Company
recognizes revenue and the related receivable from software license revenue to
distributors at the time the products are shipped out of distribution into the
retail accounts and VARs. The Company recognizes revenue from product sold
directly to end users at the time of shipment. An allowance for estimated future
returns is recorded at the time revenue is recognized. Revenue from royalty fees
is recognized upon the shipment of units by the OEM.
Revenue received under development contracts and government funded
research, is recognized using the percentage-of-completion method. Losses, if
any, are provided for at the time that management determines that development
costs will exceed related fees. Payments received under development contracts
prior to completion of the related work and attainment of milestones are
recorded as deferred revenue. Unbilled revenue represents revenue recognized in
excess of amounts billed.
The Company has historically provided customers with free technical support
services for a ninety-day period, which it is not contractually obligated to
provide. A provision is made at the time of sale for the cost of such free
services. Accrued product support expenses are included in accrued expenses in
the accompanying financial statements.
(e) Research and Development and Software Development Costs
Software development costs for new software and for enhancements to
existing software are charged to operations as incurred until the establishment
of technological feasibility. Software development costs
F-7
68
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
incurred subsequent to the establishment of technological feasibility and prior
to general release of the product are capitalized and amortized to cost of
software licenses on a straight-line basis over the estimated useful life of the
related products, generally from one to two years.
For the year ended December 31, 1997 and for the nine months ended
September 30, 1998, no software development costs were capitalized as the
amounts expended subsequent to reaching technological feasibility were
immaterial. In 1995 and 1996, approximately $962 and $538, respectively, of
software development costs were capitalized. Amortization expense for the years
ended 1995, 1996 and 1997 and for the nine month periods ended September 30,
1997 and 1998 were $1,068, $1,007, $174, $174 and $0, respectively. Net
capitalized software costs are included in other assets in the accompanying
balance sheet.
(f) Income Taxes
The Company utilizes the liability method of accounting for income taxes,
as set forth in Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been recognized in the Company's financial statements or tax returns.
In estimating future tax consequences, SFAS No. 109 generally considers all
expected future events other than enactments of changes in the tax law or rates.
Deferred tax assets are recognized, net of any valuation allowance, for
deductible temporary differences and operating loss and credit carryforwards, if
any. Deferred tax expense represents the change in the deferred tax asset or
liability balances.
(g) Net Income (Loss) per Share
All earnings per share information presented has been calculated in
accordance with SFAS No. 128, "Earnings Per Share." Under SFAS 128, basic net
income (loss) per common share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted income (loss) per common share is computed
using the weighted average number of common shares and common stock equivalent
shares outstanding during the periods in accordance with the treasury stock
method.
A reconciliation between basic and diluted earnings per share is as
follows:
NINE-MONTHS ENDED
SEPTEMBER 30,
-------------------------
1995 1996 1997 1997 1998
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
Net income (loss)............... $ (5,162) $ (5,957) $ (5,296) $ (4,991) $ 8,673
Basic EPS:
Basic common shares........... 11,897,225 11,922,261 12,460,192 12,116,276 13,622,493
----------- ----------- ----------- ----------- -----------
Basic EPS..................... $ (.43) $ (.50) $ (.43) $ (.41) $ .64
Diluted EPS:
Basic common shares........... 11,897,225 11,922,261 12,460,192 12,116,276 13,622,493
Plus: convertible preferred
stock...................... -- -- -- -- 16,187,396
Plus: impact of stock
options.................... -- -- -- -- 2,034,507
----------- ----------- ----------- ----------- -----------
Diluted common shares......... 11,897,225 11,922,261 12,460,192 12,116,276 31,844,396
----------- ----------- ----------- ----------- -----------
Diluted EPS................... $ (.43) $ (.50) $ (.43) $ (.41) $ .27
----------- ----------- ----------- ----------- -----------
F-8
69
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
For the years ended 1995, 1996, 1997 and for the nine months ended
September 30, 1997, convertible preferred stock which is convertible into
14,154,810; 14,184,585; 14,823,265 and 14,414,640 weighted average shares of
common stock, respectively, was outstanding but not included in the calculation
of dilutive net income (loss) per share because their effect would be
anti-dilutive. In addition, options to purchase 1,673,125; 2,125,875; 2,883,385;
2,881,445 and 713,500 shares of common stock were outstanding in the years ended
1995, 1996, 1997 and in the nine months ended September 30, 1997 and 1998,
respectively, but were not included in the calculation of dilutive net income
(loss) per share because their effect would be anti-dilutive.
(h) Financial Instruments
The Company considers all highly liquid investments that are readily
convertible to cash and that have original maturity dates of three months or
less to be cash equivalents. Cash equivalents consist primarily of money market
funds. In accordance with the SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," investments in securities are classified as
trading, available-for-sale or held-to-maturity. The Company's investments are
classified as available-for-sale and are carried at fair market value on the
accompanying balance sheets. The investments available-for-sale are as follows:
DECEMBER 31, SEPTEMBER 30,
--------------------------------- ---------------
1996 1997 1998
--------------- --------------- ---------------
COST MARKET COST MARKET COST MARKET
------ ------ ------ ------ ------ ------
(UNAUDITED)
U.S. government and government agency
securities........................... $3,296 $3,296 $6,891 $6,891 $4,224 $4,224
Corporate securities................... -- -- 536 536 -- --
fonix Class A common stock............. -- -- -- -- 1,566 1,616
------ ------ ------ ------ ------ ------
Total investments...................... $3,296 $3,296 $7,427 $7,427 $5,790 $5,840
====== ====== ====== ====== ====== ======
Investments in U.S. government and government agency and corporate
securities mature within one year.
(i) Fair Value and Concentration of Credit Risks
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires that disclosure be made of estimates of the fair value of financial
instruments. The Company's financial instruments consist primarily of cash and
cash equivalents, letters of credit, accounts receivable and accounts payable.
The carrying amount of these instruments approximates fair value due to their
short-term nature.
The Company sells its products primarily to distributors, resellers,
government agencies, and large corporate customers. The Company performs ongoing
evaluations of customers' financial condition and, generally, does not require
collateral. In addition, the Company maintains reserves for potential credit
losses, and such losses, in the aggregate, have not exceeded management's
expectations.
(j) Major Customers
The Company's sales to the United States government under contracts were
approximately 22%, 25% and 27%, of net revenue for the years ended December 31,
1995, 1996 and 1997 and 30% and 7.5% of net revenue for the nine months ended
September 30, 1997 and 1998, respectively. At December 31, 1996 and 1997 and at
September 30, 1998, total amounts due from the United States government were
approximately $1,199, $943 and $2,270, respectively (including unbilled amounts
of approximately $832, $916 and $1,656, respectively).
F-9
70
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company's sales to its two largest distributors were approximately 39%
and 24%, respectively, of net revenue for the nine months ended September 30,
1998. At September 30, 1998, total amounts included in accounts receivable from
the two distributors were approximately $5,537 and $1,970, net of allowances.
For the years ended December 31, 1996 and 1997, no customer accounted for 10% or
more of net revenues. For the year ended December 31, 1995, revenue from a
customer was 10% of net revenue.
(k) Inventories
Inventories primarily include finished goods and are stated at the lower of
cost or market, cost being determined on the first-in, first-out method.
DECEMBER 31,
-------------- SEPTEMBER 30,
1996 1997 1998
---- ------ -------------
(UNAUDITED)
Component parts....................................... $326 $ 756 $2,221
Finished goods........................................ 155 1,406 3,340
---- ------ ------
$481 $2,162 $5,561
==== ====== ======
(l) Property and Equipment
Property and equipment is recorded at cost. The Company provides for
depreciation and amortization on the straight-line method. Charges are made to
operating expenses in amounts that are sufficient to amortize the cost of the
assets over their estimated useful lives. Property and equipment are summarized
as follows:
DECEMBER 31,
---------------- SEPTEMBER 30, DEPRECIABLE
1996 1997 1998 LIFE IN YEARS
------ ------ ------------- ---------------------
(UNAUDITED)
Furniture and fixtures............... $ 588 $ 580 $ 686 3-5
Office and computer equipment........ 3,626 4,262 5,496 3-5
Leasehold improvements and other..... 309 613 652 3-10 or term of lease
------ ------ ------
4,523 5,455 6,834
Less: accumulated depreciation and
amortization....................... 3,358 4,082 4,858
------ ------ ------
$1,165 $1,373 $1,976
====== ====== ======
(m) Accrued Expenses
Accrued expenses consist of the following:
DECEMBER 31,
---------------- SEPTEMBER 30,
1996 1997 1998
------ ------ -------------
(UNAUDITED)
Compensation................................................ $ 733 $ 840 $3,330
Marketing costs............................................. 44 356 995
Other....................................................... 1,661 1,549 1,986
------ ------ ------
$2,438 $2,745 $6,311
====== ====== ======
F-10
71
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(n) Recent Accounting Pronouncements
In March, 1998 the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP") "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 is effective for the
year ended December 31, 1999. SOP 98-1 provides guidance for the costs of
computer software developed or obtained for internal use. The Company does not
expect adoption of SOP 98-1 to have a material impact on its consolidated
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities." The statement is
effective for the year ended December 31, 2001. SFAS 133 establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. The Company does not expect adoption of
this statement to have a material impact on its consolidated financial position
or results of operations.
(o) Stock-Based Compensation
Effective January 1, 1996, the Company adopted the provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." The Company has elected to
continue to account for stock options at intrinsic value under Accounting
Principles Board Opinion (APB) No. 25 with disclosure of the effects of fair
value accounting on the net income and earnings per share on a pro forma basis
(see Note 6).
(p) Unaudited Third Quarter Information
The unaudited financial statements as of and for the nine month periods
ended September 30, 1997 and 1998 reflect, in the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
fairly present the financial position, results of operations and cash flows as
of and for the periods presented. The results for the interim periods presented
are not necessarily indicative of results to be expected for the full year.
3. DISCONTINUED OPERATIONS
Effective September 2, 1998, the Company sold its interest in Articulate to
fonix corporation ("fonix"). The Company owned approximately 38% of the voting
interest in Articulate at the time of the sale. The results of Articulate are
reflected in the Company's consolidated financial statements as discontinued
operations for all periods presented. As consideration for the sale, the Company
received $2,230 of cash, $4,035 of demand notes from fonix, 1,260,988 shares of
unregistered Class A common stock of fonix and 779,093 shares of unregistered
Class B common stock of fonix. In November 1998, the Company called the demand
notes but payment of the notes has not been made by fonix. Due to the
significant uncertainty regarding collectibility of these notes, the Company has
fully reserved the value of the notes as part of the gain on sale. To the extent
that the notes are collected in the future, the Company would recognize a gain.
See also Note 8 for discussion of the Company's agreement with fonix related to
certain outstanding litigation.
F-11
72
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following is a summary of the results of discontinued operations for
the three years ended December 31, 1995, 1996 and 1997 and for the nine months
ended September 30, 1997 and 1998:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1995 1996 1997 1997 1998
------- ------- ------- ----------- -----------
(UNAUDITED)
Net sales................................. $ 1,704 $ 1,829 $ 770 $ 368 $ 329
Loss before income taxes.................. (3,070) (1,706) (3,019) (2,306) (2,142)
Loss from discontinued operations......... (3,070) (1,706) (3,019) (2,306) (2,142)
4. INCOME TAXES
The provision for income taxes consists of the following:
1995 1996 1997
----- ----- -------
Current provision:
Federal................................................... $(596) $(599) $ 341
State..................................................... (105) -- 35
Foreign................................................... 55 35 28
----- ----- -------
Total current............................................. $(646) $(564) $ 404
----- ----- -------
Deferred provision:
Federal................................................... $ -- $ -- $(2,205)
State..................................................... -- -- (389)
Foreign................................................... -- -- --
----- ----- -------
Total deferred............................................ $ -- $ -- $(2,594)
----- ----- -------
Total tax provision......................................... $(646) $(564) $(2,190)
===== ===== =======
Reconciliations of the U.S. federal statutory rate to the Company's
effective tax rate are as follows:
1995 1996 1997
----- ----- ----
U.S. federal statutory rate................................. 34.0% 34.0% 34.0%
State income taxes, net of federal income tax effect........ 6.0 6.0 6.0
Change in valuation allowance............................... (16.4) (27.8) --
Tax credits generated....................................... -- -- 7.6
Other, net.................................................. -- (.5) 1.4
----- ----- ----
Effective tax rate.......................................... 23.6% 11.7% 49.0%
===== ===== ====
F-12
73
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The temporary differences and carryforwards that created the deferred tax
assets and liabilities as of December 31, 1996 and 1997 are as follows:
1996 1997
------- -------
Deferred tax assets:
Net operating loss and credit carryforward................ $ 1,342 $ 755
Deferred revenues......................................... -- 2,813
Non deductible reserves and accruals...................... 835 1,186
Capitalized software...................................... (70) --
Other..................................................... 92 39
------- -------
Total deferred tax assets......................... 2,199 4,793
Valuation allowance....................................... (1,984) (1,984)
------- -------
Net deferred taxes.......................................... $ 215 $ 2,809
------- -------
The net tax benefits have been reduced by a valuation allowance as they do
not satisfy the recognition criteria set forth in SFAS 109. Of the valuation
allowance at December 31, 1997, approximately $84 will be reduced directly to
equity when realized related to stock option benefits.
As of December 31, 1997, the Company had available, subject to review and
possible adjustment, net operating loss carryforwards of approximately $2,139
for state income taxes, which expire through the year 2010. In addition the
Company had credit carryforwards of approximately $160 and $467 for federal and
state income taxes, respectively. No net operating loss carryforwards are
available for federal income taxes. The Internal Revenue Code contains
provisions that may limit the net operating loss carryforwards available to be
used in any given year, in the event of significant changes in ownership
interest.
5. STOCKHOLDERS' EQUITY
Convertible Preferred Stock
At September 30, 1998, the Company had issued and outstanding a total of
3,238,951 shares of Convertible Preferred Stock, convertible into a total of
16,194,755 shares of common stock. All shares of Convertible Preferred Stock are
required to be converted into common stock upon the closing of an initial public
offering of the Company's common stock yielding aggregate gross proceeds to the
Company of at least $10,000.
In the event of any liquidation, dissolution or winding up of the Company,
the holders of Convertible Preferred Stock shall be entitled to receive $20 per
share plus any declared and unpaid dividends. After such payment to the holders
of Convertible Preferred Stock, the remaining assets available for distribution
shall first be distributed to the holders of the common stock at a rate of $1.36
per share plus all declared and unpaid dividends and the remaining assets, if
any, shall be distributed pro rata among the holders of common stock and the
holders of Convertible Preferred Stock (on an as converted basis). The holders
of Convertible Preferred Stock are entitled to the number of votes equal to the
number of shares of common stock into which the shares of Convertible Preferred
Stock could be converted.
Convertible Preferred Stock is entitled to receive a noncumulative, annual
dividend of $1.60 per share, when and if declared by the Board of Directors. No
cash dividends may be paid on common stock during any year unless the annual
dividend on Convertible Preferred Stock has been paid or declared during such
year.
During 1997, the Company recorded $910 of additional paid in capital
resulting from Articulate's issuance of preferred stock.
F-13
74
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Common Stock
At December 31, 1997 and September 30, 1998, the Company has 19,623,560 and
20,228,300 shares of its common stock reserved for issuance upon conversion of
Preferred Stock and the exercise of all stock options available under the
Company's stock option plans.
On December 1, 1998, the Company effected a five for one stock split of its
common stock in the form of a stock dividend of four shares for each share then
outstanding. In addition, the Company increased the number of Common Stock
authorized to 45,000,000 shares. The accompanying consolidated financial
statements and notes thereto, have been retroactively adjusted to reflect the
stock split.
6. EMPLOYEE BENEFIT PLANS
Stock Option Plans
In June 1984, the Company adopted the 1984 Stock Option Plan (the "1984
Plan") and upon its expiration in 1994, the Company adopted the 1994 Stock
Option Plan (the "1994 Plan"). Each plan provides for the granting of incentive
stock options and nonqualified stock options to employees, consultants and
directors of the Company. In June 1997, the Company adopted the 1997 Dragon
Systems UK Company Share Option Plan (the "1997 Plan"), which provides for the
granting of options for UK employees. At September 30, 1998, the total number of
shares available under all of the Company's stock option plans is 4,033,545.
Under the plans, the Board of Directors determines the term of each option,
option price, number of shares for which options are granted and the vesting
period, which ranges from three to four years. The exercise price per share for
incentive stock options and nonqualified options granted may not be less than
100% and 90%, respectively, of the fair market value per share of the underlying
common stock on the date granted. The term of the options granted cannot exceed
ten years. No options have been granted under the 1984 Plan since its expiration
in 1994.
The activity under the Company's stock option for plans is as follows:
OUTSTANDING OPTIONS
---------------------------
WEIGHTED
RESERVED AVERAGE
SHARES NUMBER EXERCISE PRICE
--------- --------- --------------
Outstanding, December 31, 1995.......................... 3,299,910 1,229,250 $1.36
Granted............................................... -- 832,500 1.40
Exercised............................................. -- --
Terminated............................................ -- (229,000) 1.36
--------- --------- -----
Outstanding, December 31, 1996.......................... 3,299,910 1,832,750 1.38
Granted............................................... -- 871,250 3.03
Exercised............................................. (2,865) (2,865) 1.35
Terminated............................................ -- (106,185) 1.55
--------- --------- -----
Outstanding, December 31, 1997.......................... 3,297,045 2,594,950 1.91
Increase in plan size................................. 750,000 --
Granted............................................... -- 755,000 15.24
Exercised............................................. (13,500) (13,500) .20
Terminated............................................ -- (40,250) 2.87
--------- --------- -----
Outstanding, September 30, 1998 (unaudited)............. 4,033,545 3,296,200 $5.00
========= ========= =====
The above table reflects options exercised for common stock. In addition,
at December 31, 1995 the Company had 6,625 options which allowed the holder to
acquire units. Each unit consisted of approximately
F-14
75
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
six shares of common stock and seven shares of preferred stock, at an exercise
price of $10. The number of shares issued relating to the units was 16,387
preferred shares and 68,895 common shares in 1996; 510 preferred shares and
2,145 shares in 1997; and 31,353 preferred shares and 131,760 common shares in
1998. At September 30, 1998, all units had been exercised.
As of September 30, 1998, the status of the Company's outstanding and
exercisable options was as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------- ----------- ----------- -------- ----------- --------
$ 1.36 - $ 1.50 1,763,950 7.46 $ 1.38 1,112,340 $ 1.37
$ 2.30 - $ 2.55 25,000 8.50 $ 2.35 6,250 $ 2.35
$ 3.18 - $ 3.50 752,250 9.00 $ 3.19 187,210 $ 3.19
$ 7.20 - $ 7.20 41,500 9.50 $ 7.20 -- $ --
$10.00 - $10.00 35,000 9.58 $10.00 -- $ --
$16.00 - $16.00 678,500 9.76 $16.00 -- $ --
- --------------- --------- ---- ------ --------- ------
$ 1.36 - $16.00 3,296,200 8.34 $ 5.00 1,305,800 $ 1.63
Had compensation costs for the stock option plan been determined using the
fair value method, the Company's net loss would have been increased to the
following pro forma amounts:
1995 1996 1997
------- ------- -------
Net loss --
As reported........................................... $(5,162) $(5,957) $(5,296)
Pro forma............................................. (5,193) (6,081) (5,524)
Consistent with SFAS 123, pro forma net loss has not been calculated for
options granted prior to January 1, 1995. Pro forma compensation may not be
representative of that to be expected in future years.
The weighted average fair value of options granted was $.40, $.45, and $.90
for options granted during 1995, 1996 and 1997, respectively. The values were
estimated on the date of grant using the minimum value method and the following
weighted average assumptions for grants:
1995 1996 1997
------- ------- -------
Risk free interest rate................................. 6.07% 6.58% 6.09%
Expected life........................................... 6 years 6 years 6 years
Volatility factor....................................... 0% 0% 0%
Expected dividend yield................................. 0% 0% 0%
F-15
76
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1999 Plans
Employee Stock Purchase Plan
The Company's 1999 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in December 1998. The Purchase Plan authorizes
the issuance of up to a total of 500,000 shares of common stock to participating
employees.
All employees of the Company, including the Company's employee-directors,
who have been employed for more than six months are eligible to participate in
the Purchase Plan. Employees who would immediately after the grant own 5% or
more of the total combined voting power or value of the stock of the Company or
any subsidiary are not eligible to participate.
The Purchase Plan permits eligible employees to purchase common stock
through payroll deductions, which may not exceed 10% of an employee's
compensation, subject to certain limitations. On the first day of a designated
payroll deduction period (the "Offering Period"), the Company will grant to each
eligible employee who has elected to participate in the Purchase Plan an option
to purchase shares of common stock. On the last day of the Offering Period, the
employee is deemed to have exercised the option, at the option exercise price,
to the extent of accumulated payroll deductions. Under the terms of the Purchase
Plan, the option price is an amount equal to 85% of the fair market value per
share of the common stock on either the first day or the last day of the
Offering Period, whichever is lower. The Compensation Committee may, in its
discretion, choose an Offering Period of 12 months or less for each of the
Offerings and choose a different Offering Period for each Offering.
1999 Stock Incentive Plan
In December 1998, the Company approved the 1999 Stock Incentive Plan
(Incentive Plan). The plan provides for the granting of an aggregate of
3,000,000 shares issuable pursuant to incentive stock options, non qualified
stock options, restricted stock awards and other stock based awards. As of
December 17, 1998, no awards were granted under the Incentive Plan.
Other Compensation Plans
The Company has a Profit Sharing and Bonus Plan, which provides for the
distribution of a percentage of pretax profits to Company employees. The Company
also has a 401(k) plan for its employees. Eligible employees may make voluntary
contributions to the 401(k) plan through a salary reduction contract up to the
statutory limit or 12% of their annual compensation. The Company matches
employees' voluntary contributions to the plan, up to certain prescribed limits.
These Company contributions vest over a two year period commencing upon
enrollment in the Plan. The total charge to expense under these plans was $575,
$789, $762, $472 and $2,291 in fiscal 1995, 1996, 1997 and for the nine months
ended September 30, 1997 and 1998, respectively.
7. REPORTABLE SEGMENTS
The Company's reportable segments include its software licensing segment
and development contract segment. The software licensing segment produces voice
recognition software products for sale to end users through distributors, OEMs
and resellers. The development contract segment provides contractual software
development services to commercial and government entities.
Each reportable segment is a strategic business unit that offers different
products and services to end users. Each segment is separately managed because
its end users are very different, thus requiring different technology and
marketing strategies.
F-16
77
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Measurement of Reportable Segments
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates the
performance of each reportable segment based on the segment's contribution
towards selling, marketing, general and administrative costs. Intersegment sales
or transfers are immaterial as each segment has different products and services.
Financial Information
The following table reflects certain financial information relating to each
reportable segment:
NINE MONTHS ENDED
SEPTEMBER 30,
SEGMENT DATA: 1995 1996 1997 1998
------- ------- ------- -----------------
(UNAUDITED)
Net revenue from external customers:
Software licensing............................ $12,171 $11,479 $19,506 $44,766
Development contracts......................... 4,716 5,559 7,315 4,810
------- ------- ------- -------
Total net revenue............................. $16,887 $17,038 $26,821 $49,576
Contribution towards selling, marketing, general
and administrative:
Software licensing............................ $ 2,118 $ 31 $ 4,535 $21,997
Development contracts......................... 1,401 1,977 2,322 2,215
------- ------- ------- -------
Total contribution............................ $ 3,519 $ 2,008 $ 6,857 $24,212
Segment assets are not included in the determination of segment assets
reviewed by the chief operating decision maker.
NINE MONTHS ENDED
SEPTEMBER 30,
GEOGRAPHIC DATA: 1995 1996 1997 1998
------- ------- ------- -----------------
(UNAUDITED)
Net revenue from external customers:
United States................................. $12,433 $12,148 $22,750 $44,596
Rest of world................................. 4,454 4,890 4,071 4,980
------- ------- ------- -------
Total net revenue............................. $16,887 $17,038 $26,821 $49,576
Total assets:
United States................................. $15,674 $12,752 $22,816 $37,944
Rest of world................................. 549 361 370 334
------- ------- ------- -------
Total assets.................................. $16,223 $13,113 $23,186 $38,278
F-17
78
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments
The Company has operating lease commitments for certain facilities and
equipment. The Company's minimum lease payments as of December 31, 1997 are as
follows:
1998........................................................ $1,133
1999........................................................ 1,136
2000........................................................ 1,120
2001........................................................ 1,122
------
Total minimum lease payments................................ $4,511
======
Total rental expense for years ended 1995, 1996, and 1997 and for the nine
months ended September 30, 1997 and 1998 was $574, $731, $1,053, $786 and $851,
respectively.
(b) Contingencies
In February 1996, Articulate sued Apple Computer, Inc. ("Apple") for patent
infringement in Massachusetts. Apple then sued Articulate in May 1996 in
California alleging that Articulate's PowerSecretary product infringed four
Apple patents. In September 1996, Apple added Dragon, which then owned a
minority interest in Articulate and distributed PowerSecretary, as a defendant
to its suit in California. In a separate proceeding in October 1997, Apple sued
Dragon and one of its customers, MetroBook, in Virginia alleging that the
Company's Dragon NaturallySpeaking product infringed three Apple patents.
Articulate's initial suit in Massachusetts is still pending. In Apple's
California suit, the court has granted a summary judgment motion in favor of
Articulate and the Company on all claims. Apple has filed an appeal with the
U.S. Court of Appeals for the Federal Circuit. Apple's Virginia suit has been
transferred to California, and the court has granted summary judgment in favor
of the Company and MetroBook with respect to one of Apple's patents. The
remainder of the case (with respect to the final two Apple patents) is still in
discovery. The Company believes that its Dragon PowerSecretary and Dragon
NaturallySpeaking products do not infringe any of Apple's patents, but there can
be no assurance that the Company will prevail in these matters. The Company
believes it has substantial defenses in each case, but the outcome cannot be
predicted.
In connection with the Articulate sale to fonix, the Company has agreed to
jointly defend the pending lawsuit in Massachusetts against the Company and
Articulate. This agreement commits the Company to pay one half of the legal cost
incurred to defend the lawsuit and one half of any settlement.
9. PATENT SETTLEMENT
In September 1993, the Company and Kurzweil Applied Intelligence
("Kurzweil") settled pending litigation by entering into two settlement and
cross-license agreements. Pursuant to one of these agreements, each party
granted the other an irrevocable, worldwide, non-exclusive, non-transferable
license to use patents and patent applications of the other party. Kurzweil was
subsequently acquired by Lernout in 1997. As a result of this acquisition, no
license grants were made under the agreement after the date of such acquisition;
however, each party maintains its rights in the patents and applications
previously granted under the agreement.
F-18
79
DRAGON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In consideration for the license, the Company recorded software license
revenue in the amounts of $798, $902, $1,019, $765 and $863 during the years
ended December 31, 1995, 1996 and 1997, and for the nine months ended September
30, 1997 and 1998, respectively. In addition, Kurzweil is required to pay $1,301
and $1,470 during the years ended December 31, 1999 and 2000.
Kurzweil has the option to continue its license by continuing to make such
payments to the Company through June 1, 2006, at which time its license would be
fully paid. If Kurzweil were to elect to renew its license each year, the
settlement agreement provides that the Company would receive approximately
$13,539 from 1999 through 2006.
10. RELATED PARTY
Approximately $345 and $655 of net revenue for the years ended 1996 and
1997, respectively, represent amounts earned under a commercial development
contract with the holder of 39% of the Company's outstanding common stock as of
December 31, 1997. Management believes that the contract represents fair value
to the Company and was negotiated on an arm's-length basis.
F-19
80
[Description for Inside Back Cover]
Text: Dragon Systems
The National Speech Company [TM]
Graphic: Picture of a sample of awards won
by Dragon Systems products.
Text: Internationally recognized as a leader
in speech technology.
81
DRAGON SYSTEMS LOGO
82
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than the
underwriting discount, payable by the Registrant in connection with the sale of
common stock being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fees and the Nasdaq National Market listing
fee.
SEC registration fee........................................ $27,800.00
NASD filing fee............................................. 10,500.00
Nasdaq National Market listing fee..........................
Printing and engraving expenses.............................
Legal fees and expenses.....................................
Accounting fees and expenses................................
Blue Sky fees and expenses (including legal fees)...........
Transfer agent and registrar fees and expenses..............
Miscellaneous...............................................
Total..................................................
The Company will bear all expenses shown above.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Registrant's Amended and Restated Certificate of Incorporation (the
"Restated Certificate") provides that, except to the extent prohibited by the
Delaware General Corporation Law (the "DGCL"), the Registrant's directors shall
not be personally liable to the Registrant or its stockholders for monetary
damages for any breach of fiduciary duty as directors of the Registrant. Under
the DGCL, the directors have a fiduciary duty to the Registrant which is not
eliminated by this provision of the Restated Certificate and, in appropriate
circumstances, equitable remedies such as injunctive or other forms of
nonmonetary relief will remain available. In addition, each director will
continue to be subject to liability under the DGCL for breach of the director's
duty of loyalty to the Registrant, for acts or omissions which are found by a
court of competent jurisdiction to be not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are prohibited by the DGCL. This provision
also does not affect the directors' responsibilities under any other laws, such
as the federal securities laws or state or federal environmental laws. The
Registrant has obtained liability insurance for its officers and directors.
Section 145 of the DGCL empowers a corporation to indemnify its directors
and officers and to purchase insurance with respect to liability arising out of
their capacity or status as directors and officers, provided that this provision
shall not eliminate or limit the liability of a director: (i) for any breach of
the director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) arising under Section 174 of the DGCL including
for an unlawful payment of dividend or unlawful stock purchase or redemption, or
(iv) for any transaction from which the director derived an improper personal
benefit. The DGCL provides further that the indemnification permitted thereunder
shall not be deemed exclusive of any other rights to which the directors and
officers may be entitled under the corporation's by-laws, any agreement, a vote
of stockholders or otherwise. The Restated Certificate eliminates the personal
liability of directors to the fullest extent permitted by the DGCL and, together
with the Registrant's Amended and Restated By-Laws (the "Restated By-Laws"),
provides that the Registrant shall fully indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding (whether civil, criminal, administrative or
investigative) by reason of the fact that such person is or was a director or
officer of the
II-1
83
Registrant, or is or was serving at the request of the Registrant as a director
or officer of another corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise, against expenses (including attorney's fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by such person in connection with such action, suit or proceeding. Reference is
made to the Registrant's Form of Amended and Restated Certificate of
Incorporation and Form of Amended and Restated By-Laws filed as Exhibits 3.2 and
3.4 hereto, respectively.
The Underwriting Agreement provides that the Underwriters are obligated,
under certain circumstances, to indemnify directors, officers and controlling
persons of the Company against certain liabilities, including liabilities under
the Securities Act of 1933, as amended (the "Act"). Reference is made to the
form of Underwriting Agreement to be filed as Exhibit 1.1 hereto.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent as to which indemnification will be
required or permitted under the Restated Certificate. The Registrant is not
aware of any threatened litigation or proceeding that may result in a claim for
such indemnification.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In the three years preceding the filing of this registration statement, the
Company has issued the following securities that were not registered under the
Securities Act as summarized below. The share information provided below
reflects a 5-for-1 split of the common stock effected on December 1, 1998:
(a) Issuances of Capital Stock. On September 4, 1997 the Company sold to
Seagate Technology, Inc. (i) an aggregate of 1,511,990 shares of the Company's
common stock for $4,805,104 and (ii) an aggregate of 359,739 shares of the
Company's preferred stock for $7,194,780 (convertible into 1,798,695 shares of
common stock).
(b) Certain Grants and Exercises of Stock Options. The Company's 1994 Stock
Option Plan was adopted by the Board of Directors and approved by the
stockholders of the Company on July 6, 1994. The Company's 1999 Stock Incentive
Plan was approved by the Board of Directors in December 1999, subject to
stockholder approval. As of December 8, 1998, options to purchase 16,455 shares
of common stock had been exercised for a consideration of approximately $51,000
under the Company's 1994 Stock Option Plan and options to purchase 3,628,933
shares of common stock were outstanding under the Company's 1994 Stock Option
Plan. As of December 8, 1998, no options under the Company's UK Plan and options
to purchase 63,377 shares of common stock were outstanding under the UK Plan. No
options to purchase shares of common stock are outstanding under the 1999 Stock
Incentive Plan.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options to purchase common stock, Rule 701 of the
Securities Act. All of the foregoing securities are deemed restricted securities
for the purposes of the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
EXHIBIT
NO. DESCRIPTION
- -------- -----------
1.1* -- Form of Underwriting Agreement
3.1** -- Restated Certificate of Incorporation of the Registrant, as
amended
3.2** -- Form of Amended and Restated Certificate of Incorporation of
the Registrant, to be filed prior to the closing of this
offering
3.3** -- Amended and Restated By-Laws of the Registrant
3.4** -- Form of Amended and Restated By-Laws of the Registrant, to
be effective upon the closing of this offering
II-2
84
EXHIBIT
NO. DESCRIPTION
- -------- -----------
4.1* -- Specimen common stock certificate
4.2** -- See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the
Restated Certificate of Incorporation and Amended and
Restated By-Laws of the Registrant defining the rights of
holders of common stock of the Registrant
5.1* -- Opinion of Hale and Dorr LLP
10.1** -- 1994 Stock Option Plan
10.2** -- Dragon Systems UK Company Share Option Plan
10.3** -- 1999 Employee Stock Purchase Plan
10.4** -- 1999 Stock Incentive Plan
10.5 -- 401(k) Plan
10.6** -- Lease dated February 1, 1991 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.7** -- Lease dated September 15, 1994 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.8+ -- Corel Reciprocal License Agreement dated effective January
25, 1998 between and among Corel Corporation, Corel
Corporation Limited, and the Registrant
10.9+ -- Dragon Reciprocal License Agreement dated effective January
25, 1998 between and among the Registrant and Corel
Corporation and Corel Corporation Limited
10.10+ -- Technology License Agreement dated effective July 7, 1998
between Articulate Systems, Inc. and the Registrant
10.11+ -- Development and License Agreement dated effective June 28,
1996 between Seagate Technology, Inc. and the Registrant
10.12+ -- Distribution Agreement dated effective December 15, 1997
between Ingram Micro Inc. and the Registrant, as amended
10.13+ -- Distribution Agreement dated effective April 30, 1998
between Ingram European Coordination Center N.V./S.A. and
the Registrant
10.14+ -- Distributor Agreement executed January 7, 1998 between
Merisel Americas, Inc. and the Registrant
10.15+ -- Authorized Distributor Agreement dated March 18, 1998
between MultiMicro, Inc. and the Registrant
10.16+ -- Software Distribution Agreement dated June 16, 1997 between
Tech Data Product Management, Inc. and the Registrant, as
amended
10.17+ -- Outsourcing Agreement dated January 19, 1998 between Modus
Media International N.V. and the Registrant
10.18+ -- Reseller Agreement dated May 15, 1998 between Sony
Electronics Inc. and the Registrant
10.19** -- Employment Agreement with John D. Shagoury
10.20 -- Agreement dated as of December 24, 1998 between the
Registrant and Fleet Bank N.A.
19 -- Subsidiaries of the Registrant
23.1 -- Consent of Arthur Andersen LLP
23.2 -- Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.3** -- Consent of Fish & Richardson P.C.
24.1 -- Powers of Attorney (see page II-5)
27.1** -- Financial Data Schedule
- -------------------------
* To be filed by amendment.
** Previously filed.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.
II-3
85
(b) Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable, and therefore have been
omitted.
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the Underwriter
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriter to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the registrant pursuant to the Delaware General
Corporation Law, the Restated Certificate of the registrant, the Underwriting
Agreement, or otherwise, the registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act, and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered hereunder, the registrant
will, unless in the opinion of counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
The undersigned registrant hereby undertakes that:
(1) For purpose of determining any liability under the Act, the information
omitted from the form of prospectus filed as part of this Registration
Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4),
or 497(h) under the Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be
deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
II-4
86
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Newton, Massachusetts, on this 7th
day of January, 1999.
DRAGON SYSTEMS, INC.
By: /s/ JANET M. BAKER
---------------------------------------
Janet M. Baker
Chairman of the Board and Chief
Executive Officer
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers, directors and authorized representatives of
Dragon Systems, Inc. hereby severally constitute and appoint Dr. Janet M. Baker,
Mr. John D. Shagoury, and Ms. Diane M. Hudson, and each of them singly, our true
and lawful attorneys with full power to them, and each of them singly, with full
powers of substitution and resubstitution, to sign for us and in our names in
the capacities indicated below, the Registration Statement on Form S-1 filed
herewith and any and all pre-effective and post-effective amendments to said
Registration Statement, and any subsequent Registration Statement for the same
offering which may be filed under Rule 462(b), and generally to do all such
things in our names and on our behalf in our capacities as officers and
directors to enable Dragon Systems, Inc. to comply with the provisions of the
Securities Act of 1933, as amended, and all requirements of the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our said attorneys, or any of them, or their substitute or
substitutes, to said Registration Statement and any and all amendments thereto
or to any subsequent Registration Statement for the same offering which may be
filed under Rule 462(b).
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
* Chairman of the Board of Directors and January 7, 1999
- ------------------------------------------ Chief Executive Officer (Principal
Janet M. Baker Executive Officer)
* President and Director January 7, 1999
- ------------------------------------------
John D. Shagoury
* Chief Financial Officer, Vice President, January 7, 1999
- ------------------------------------------ Finance, Treasurer, and Assistant
Diane M. Hudson Secretary (Principal Financial Officer
and Principal Accounting Officer)
* Principal Research Scientist and January 7, 1999
- ------------------------------------------ Director
Robert Roth
* Director January 7, 1999
- ------------------------------------------
Kim B. Edwards
* Director January 7, 1999
- ------------------------------------------
Stephen J. Luczo
*By: /s/ JANET M. BAKER
-------------------------
Janet M. Baker
Attorney-in-Fact
II-5
87
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of Dragon Systems, Inc. and subsidiaries
included in this Registration Statement and have issued our report thereon dated
December 1, 1998 (except for the matter discussed in Note 6, as to which the
date is December 17, 1998). Our audits were made for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
schedule listed in the accompanying index is the responsibility of the company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic consolidated financial statements and, in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic consolidated financial statements taken
as a whole.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
December 1, 1998
S-1
88
DRAGON SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT ADDITIONS BALANCE AT
BEGINNING OF CHARGED TO END OF
PERIOD EXPENSE DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
Allowance for doubtful accounts:
For the nine months ended
September 30, 1998....................... $ 813 $ 394 $ (183) $1,024
For the years ended December 31,
1997..................................... 381 533 (101) 813
1996..................................... 410 60 (89) 381
1995..................................... 211 252 (53) 410
Reserve for returns, allowances and other:
For the nine months ended
September 30, 1998....................... 5,500 360 (1,360) 4,500
For the years ended December 31,
1997..................................... 360 5,140 -- 5,500
1996..................................... 240 120 -- 360
1995..................................... -- 240 -- 240
S-2
89
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- -------- -----------
1.1* -- Form of Underwriting Agreement
3.1** -- Restated Certificate of Incorporation of the Registrant, as
amended
3.2** -- Form of Amended and Restated Certificate of Incorporation of
the Registrant, to be filed prior to the closing of this
offering
3.3** -- Amended and Restated By-Laws of the Registrant
3.4** -- Form of Amended and Restated By-Laws of the Registrant, to
be effective upon the closing of this offering
4.1* -- Specimen common stock certificate
4.2** -- See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the
Restated Certificate of Incorporation and Amended and
Restated By-Laws of the Registrant defining the rights of
holders of common stock of the Registrant
5.1* -- Opinion of Hale and Dorr LLP
10.1** -- 1994 Stock Option Plan
10.2** -- Dragon Systems UK Company Share Option Plan
10.3** -- 1999 Employee Stock Purchase Plan
10.4** -- 1999 Stock Incentive Plan
10.5 -- 401(k) Plan
10.6** -- Lease dated February 1, 1991 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.7** -- Lease dated September 15, 1994 between Joseph Biotti, Jr.,
Trustee of One Nevada Realty Trust and the Registrant, as
amended
10.8+ -- Corel Reciprocal License Agreement dated effective January
25, 1998 between and among Corel Corporation, Corel
Corporation Limited, and the Registrant
10.9+ -- Dragon Reciprocal License Agreement dated effective January
25, 1998 between and among the Registrant and Corel
Corporation and Corel Corporation Limited
10.10+ -- Technology License Agreement dated effective July 7, 1998
between Articulate Systems, Inc. and the Registrant
10.11+ -- Development and License Agreement dated effective June 28,
1996 between Seagate Technology, Inc. and the Registrant
10.12+ -- Distribution Agreement dated effective December 15, 1997
between Ingram Micro Inc. and the Registrant, as amended
10.13+ -- Distribution Agreement dated effective April 30, 1998
between Ingram European Coordination Center N.V./S.A. and
the Registrant
10.14+ -- Distributor Agreement executed January 7, 1998 between
Merisel Americas, Inc. and the Registrant
10.15+ -- Authorized Distributor Agreement dated March 18, 1998
between MultiMicro, Inc. and the Registrant
10.16+ -- Software Distribution Agreement dated June 16, 1997 between
Tech Data Product Management, Inc. and the Registrant, as
amended
10.17+ -- Outsourcing Agreement dated January 19, 1998 between Modus
Media International N.V. and the Registrant
10.18+ -- Reseller Agreement dated May 15, 1998 between Sony
Electronics Inc. and the Registrant
10.19** -- Employment Agreement with John D. Shagoury
10.20 -- Agreement dated as of December 24, 1998 between the
Registrant and Fleet Bank N.A.
19 -- Subsidiaries of the Registrant
23.1 -- Consent of Arthur Andersen LLP
23.2 -- Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.3** -- Consent of Fish & Richardson P.C.
90
EXHIBIT
NO. DESCRIPTION
- -------- -----------
24.1 -- Powers of Attorney (see page II-5)
27.1** -- Financial Data Schedule
- -------------------------
* To be filed by amendment.
** Previously filed.
+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.