Lernout & Hauspie goes into Chapter 11

Speech recognition software house Lernout and Hauspie (L&H) has filed for Chapter 11 bankruptcy protection after failing to persuade its five main lending banks to restructure the $451m in debt that it owed them.

The filing, which affects all its major US businesses, is also being extended to its Belgian headquarters in a move known as a ‘concordaat’.

In a prepared statement, recently appointed chief executive John Duerden said: “We have tried, without success, to reach an acceptable accommodation with our bank lenders. After an intensive analysis of L&H’s worldwide business operations and a careful assessment of its financial position, we concluded that a voluntary reorganisation filing is both prudent and necessary to preserve and rebuild our valuable customer base and technology assets.”

According to the company’s legal counsel, a significant factor in the decision was the need to restate its earnings following an investigation into L&H’s Korean operations. Earlier this month, the company suspended John Soo from his duties as head of the Korean business after revealing that he had pledged $30m as part of a scheme to assist startups to which L&H had sold its technology.

But the latest move comes at the end of a four month period of intense scrutiny and speculation that has caused L&H’s share price to tumble to below $7 on the US Nasdaq market from a high of $72.50 in March and to just over $3 on the European Easdaq. Trading in the firm’s stock was suspended on both markets on 9 November.

On current quoted figures, L&H is now valued at about $470m, more than $1bn below its book value.

Refinancing requirements
An examination of the company’s last stock market filing for the period to 30 June 2000 revealed that it needed to refinance itself to the tune of $200m by 31 March 2001, following its May acquisition of Dictaphone for about $911m. This figure included $389m in debt.

L&H had also acquired Dragon Systems in March for $587m, rounding off a four year acquisition spree that cost it $1.912bn to add 27 companies to its portfolio.

The bankruptcy petition states that it is $490m in debt, which is offset by assets of $2.372bn as outlined in the 30 June filing. But $1.704bn of these assets are acquired goodwill, which is effectively worthless in the current circumstances.

This would suggest that L&H’s financial position is worse than it has so far revealed. But getting to the bottom of the matter is difficult.

In the US, filing for Chapter 11 bankruptcy protection is a recognition that an organisation cannot meet its financial commitments, but the move protects it from creditor action while it seeks to reorganise its affairs.

The action rarely leads to companies becoming insolvent in the way this is understood in the UK, but they have to agree a long-term strategy with the courts that will enable them to continue trading and work their way out of debt.

Insiders at L&H have been bracing themselves for swingeing cuts, and it seems likely that this latest announcement will accelerate the process.

The supplier’s balance sheet shows an asset surplus of $177m, but KPMG recently announced that its audit report for both 1998 and 1999 could no longer be relied upon. This is accountant’s shorthand for saying that the figures are wrong, implying that the explanations it was given to support its audit opinion were either false or misleading.

While it is impossible to say at the moment what the resulting restatement will throw up, the period in question coincides with L&H’s purchase of Bumil, which it used as a springboard for its operations in the Far East. In 1998-99, Bumil had a revenue run rate of around $12m to $15m.

The period also coincides with its contentious acquisition of BTG, to which L&H effectively paid a premium of around $18m to help it develop products based on L&H technology.

While the company is currently focusing its attention on discrepancies in Korea, recent filings indicate that to keep its head above water, it had been trying to balance a need to sustain momentum in the Far East and kick start sluggish sales in the US and Europe.

In the first six months of this year, Korean sales ballooned to $127m from $1.2m in the same period last year, while revenues from Singapore collapsed from $35.8m to $1.4m during the same period. Sales in its domestic Belgian market fell from $25.5m to $17.7m, but increased in the US from $38.8m to $68.8m, largely as a result of acquisitions.

Cash shortfall
The full extent of L&H’s problems is unclear, however. On current estimates, it is likely to have a cash shortfall of at least $120m and is expected to miss its revised revenue estimates by about $40m.

But it is also embroiled in more than a dozen class actions in the US, related to deals in both Korea and Singapore. The vendor has been dogged by persistent claims that it engages in mysteriously complex financial transactions, and the litigants accuse it of using Belgium’s banking and tax laws to hide the identity of related parties that it used to falsely inflate its earnings.

Its filings and public statements certainly reveal a web of interconnected companies over which co-founders Pol Hauspie and Jo Lernout exercise considerable voting influence.

While class action lawsuits are not permitted in Belgium, consultant Deminor, which is said to represent more than two per cent of private investors in the company, has been trying to work out ways of keeping it afloat without resorting to legal action.

And as the story continues to unfold, the behaviour of key executives is bound to come under scrutiny. Gaston Bastieans, L&H’s former chief executive, allegedly paid Lernout a 34 per cent premium on shares he bought for $25m with borrowed money. He also masterminded all of the takeovers.

And although Duerden has been spared criticism to date, he was the chief executive of Dictaphone, one of the two companies that L&H acquired and which helped contribute to its debt mountain.

One of the questions that is likely to be raised is how much due diligence did Dictaphone undertake with L&H, which at the time was not making money and to which it passed on a considerable debt burden to boot.