The trouble with LearnHowTospeak Korean
WSJ questions L&H sales
Lernout & Hauspie (L&H) stock fell 19 per cent on Tuesday (Aug 8, 2000) following a Wall Street Journal article which questioned the veracity of sales figures claimed by the company's operation in Korea.
With Q2 sales of $68 million for Q2, Korea contributes a very high proportion of revenues (44 per cent this quarter)booked by the speech and translation software specialist.
Korean sales were just $97,000 in Q1 1999 but reached $58 million in Q1 this year. Singapore revenues, by contrasted nosedived over the same period, with $10.43 million sales booked in Q1 1999 Q1, but only $0.501 million in Q1 2000. (Q2 2000 sales were $0.9 million.)
The WSJ article looks, at first glance, like some interesting sleuthing. And the inference is clear that it thinks some jiggery-pokery is going on.
But we advise some caution.
The WSJ contacted 18 of some 30 Korean customers identified by L&H, and of the 13 that responded, three said that they were not L&H customers and another three said that their purchases were less than L&H had claimed. L&H admitted it had made some mistakes in its list, but disagreed with the responses from Korean companies. But curiously, the WSJ account of L&H's Korean customers is itself flawed, as is seen from admissions contained in its report.
For example in follow-up interviews, one interviewee said: "I lied about everything," while another changed his story to agree with L&H's version. The impression is given that the WSJ reporter in Seoul found that L&H's data was at least close to what the company was claiming, but the piece still retains the implications of inaccurate financial reporting.
L&H said in a statement that it "categorically refutes claims made... that discrepancies exist in the company's sales figures for Korea," and went on to say that it believed that its customers were either "misquoted or factually incorrect".
L&H CEO Gaston Bastiaens said the tremendous success in the Korean market resulted from strategic alliances, the development of solutions, and that he intended "to implement the business structure we have developed there throughout our operations worldwide".
In earlier press releases, L&H had noted that it had 300 staff in Koreaserving 150 corporate customers in a "very robust" speech and language market. L&H acquired the Korean company Burmil in the summer of 1999, which became L&H Korea. The supposition is therefore that Burmil knew the potential customers and that L&H had the technology - and the result was that the market took off in a country where there is a considerable need for L&H products.
L&H has had more than its fair share of short sellers and detractors. Herb Greenberg of thestreet.com (who says he has no L&H holding) has found that his questions, which seem legitimate enough, have gone unanswered from Ellen Spooren, L&H's head PR - but he may not be well-loved at L&H.
In a different camp are the short sellers who kept the stock down for a long time before it quadrupled with last year's bull market (and declined again in parallel with the market), closing on Tuesday at a post-split $29.8125 but opening up on Wednesday as bargain hunters came out to play.
L&H has made its situation somewhat confusing by deciding to carry out a fundamental re-organisation. It is setting up separate companies for its healthcare and translation divisions as soon as practicable. Doing this while consolidating the Dictaphone and Dragon acquisitions must be putting a considerable strain on management resources.
Tongues have also been set wagging by a shelf transaction and some very strange share transactions and a shelf registration.
Money, Money, Money
Q2 showed L&H sales doubling over the previous year to $155 million, more than double the year-earlier quarter. Dictaphone and Dragon - the acquisitions were completed during the quarter - contributed $31 million, so the comparable figure for a year earlier of $124 million shows an increase of 63 per cent, with 72 per cent of the increase being attributed to organic growth.
European sales were up 23 per cent to $36 million on the year-earlier quarter, while North American sales at $48 million were up 25 per cent, and the non-Korean remainder up 11 per cent. Despite the strange revenue pattern, the company increased its cash and marketable securities during the quarter by $21 million to $200 million, so it does not seem that a cash crisis is imminent.
The acquisitions had a negative effect on the income for the quarter because of what L&H calls its more conservative revenue recognition practices. L&H wrote of its own revenue recognition policy in its 10-K that: "The Company recognizes revenue from the sale of its software licenses upon satisfaction of all of the following criteria: signing of the license agreement, shipment of the products, when no contractual terms remain unsatisfied and, if applicable, when a royalty report is received from the customer."
When Dragon filed an S-1 with the SEC last year prior to attempting to float, it said: "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."
Dictaphone says, in its 10-K : "Revenue is recognized when earned. In accordance with American Institute of Certified Public Accountants Statements of Position 97-2 'Software Revenue Recognition' and related amendments, for products with a significant software element, the Company records revenue attributable to the hardware and software elements upon shipment and defers revenue attributable to undelivered elements (principally installation and training) to the periods in which the related obligations are performed. Revenue for all other products is recognized upon shipment or when service is performed."
The devil is in the detail, no doubt, but it seems that both Dragon and Dictaphone were conservative in their revenue recognition. It would be interesting to discover just what L&H had in mind as to the difference. The next quarter will show the full effect of the income from these acquisitions, although L&H has to service $430 million of Dictaphone's "obligations".
Like Microsoft, L&H would like to change its revenue stream from one-time sales to a revenue stream. Corel found that satisfied customers for WordPerfect didn't feel compelled to buy updates, and the same thought must have occurred to L&H. Microsoft is still L&H's largest customer, as well as a shareholder.
Bastiaens said in the Q2 analyst call that Microsoft would contribute "around $10 million". Bernard Vergnes, Microsoft's head man in Europe, is on the L&H board although so far L&H has been able to maintain its independence from Microsoft. It is active in the Linux and Unix markets, and has a contract to supply Symbian with products.
A Question Of Forms
L&H has met criticism in some quarters for past failures to volunteer to file 10-Qs and 10-Ks with the SEC, although it was not obliged to do this until May when the Dictaphone acquisition was completed.
Perhaps to head off criticism, L&H decided it would voluntarily file 10-Qs for Q2 of 1999 onwards, and did this at the end of June. It was these reports that disclosed for the first time the high proportion of L&H revenue coming from Korea, and resulted in fears that revenue in the US and Europe might be declining.
US critics suggested that the 30 June filing date had been chosen to correspond with the US holiday, and maybe it was - but filing just before a weekend or holiday is a common enough way to bury information that might distract, because the financial analysts would have departed to their weekend bolt holes.
L&H was one of the targets for an SEC investigation as to how it accounted for R&D in 1997/8 - the same problem that Netscape and many others have had.
The result was that L&H had to lower losses for 1997 and 1998, and reduce profits subsequently. L&H must do a better job of presentation, and stop any more big acquisitions until it has strengthened its management.
Assuming that what it says about its accounts is true (its auditors are KPMG) and there is no funny business going on, then it should be in a commanding position when the market catches up with the technology that it has available. ®