Gaston Bastiaens was flush with anticipation. It was mid-July, and the chief executive of Lernout & Hauspie Speech Products was lunching in style near the company's headquarters in Ieper, Belgium. Between sips of red wine he described how L&H, with its lock on some of the best speech-recognition software, was powerfully positioned as the Web migrated into phones and cars, where people will talk to machines and machines will talk back. With his purchase of two U.S. rivals, the 53-year-old Belgian suddenly had a software company with $1 billion in annual sales, one poised to follow SAP and Nokia Corp. into Europe's tech elite. ''This market is going to explode,'' he said (see BW Online, Video Views, "Talking Tech").
For Bastiaens, that may well have been the last sunny moment of the summer. Within days, newspaper reports alleged that the company inflated its fast-growing South Korean revenues. Bastiaens denied the reports and ordered KPMG to conduct a special audit. Still, L&H investors, battered over the years by revelations of tangled finances, dumped the company's stock. From a high of 72 1/2 in March, it plummeted to 34 on Aug. 24. The next day, Bastiaens stepped down. John H. Duerden, the former CEO of Dictaphone, one of Bastiaens' U.S. acquisitions, replaced him. But worried investors drove L&H shares down further even as Duerden pledged to provide ''greater clarity and precision.''
Where have we heard those words before? ''Clarity and precision'' are becoming Europe's New Economy refrain, one that resounds from the remains of the software burnout Baan Co. to the Amsterdam bourse, site of the disastrous initial public offering of Internet service provider World Online. L&H too has struggled to grow from a small-country company into a global heavyweight. It not only has issued sheaves of windy press releases but has also engaged unsettled investors on numerous fronts, from insider stock trades far above market price to the surprising burst of Asian sales. Such behavior spooks investors, draining funds from Europe's high-tech hopefuls.
SHAKEUP. L&H's latest stumble could hardly have come at a worse time. Bastiaens had assembled a speech technology powerhouse, one rivaled only by IBM. And L&H's base in Europe has positioned it for a bonanza in the mobile Internet, where the Old World leads America. Now, though, the company must weather a management shakeup. And even if L&H proves that its lofty Korean sales are genuine, the company must come to terms with its history. For years, L&H has alternated zanily between soaring vision and unsettling surprises. That's why it has long been a favorite of short-sellers.
Hype has been part of the company since its birth in 1987. Even as founders Jo Lernout and Pol Hauspie were passing the hat among neighboring farmers in the Flemish lowlands, they were planning to create a portfolio of companies. And for this they needed a high-flying stock.
But L&H was plagued by a disconnect between its vision and technology. Speech programs in their infancy were too primitive and computers too weak for L&H's technology to take off. While L&H wowed investors with techno-mirages of humans chatting with computers, it made money with low-tech offerings. Its speech programs went into talking toys and tinny translation machines that provided good earnings. The company listed on Nasdaq in 1995.
Initially, Bastiaens, an engineer who led the failed Newton project at Apple Computer Inc., flourished at L&H despite frequent run-ins with analysts. Bastiaens bought technological leaders, including Kurzweil Technologies Inc., a speech-recognition company in Wellesley Hills, Mass., and Mendez Translation Group of Brussels. In 1997, a year after he came on board, Bastiaens landed the big one: William H. Gates III. Microsoft invested $45 million in L&H, ending up with an 8% stake. Intel Corp. jumped in in 1999 with $30 million. The early Microsoft investment gave L&H much needed credibility and revenues--Microsoft uses L&H software. ''Speech recognition is one of the key technologies of the future,'' Gates said at a press conference in Brussels--just before anarchists lobbed a cream pie at him.
L&H's vision grew ever more grandiose. The company wouldn't just be a commercial success; it would also create a technological cluster. The Flanders Language Valley Fund, a venture-capital fund, went public in 1997 with offices right next to L&H's headquarters. But it turned out the fund was supporting some of L&H's own customers. Chastened, Lernout and Hauspie severed their ties. ''It was a mistake because people thought we were buying our revenues,'' Lernout admits.
Bastiaens' conflicts with financial analysts escalated this year. In February, Lehman Brothers Inc.'s Brian Skiba issued a bombshell report. It claimed that L&H's growth in the U.S. and Europe was much lower than investors had assumed, and that the company was not coming clean. Bastiaens denied it, but in a conference call, he refused to give a geographic breakdown of sales.
Still, investors applauded the acquisitions of Stratford (Conn.)-based Dictaphone and Dragon of Newton, Mass. Soon after the $650 million Dictaphone deal, Royal Philips Electronics paid $1.2 billion for medical-transcription company Medqvist. ''Philips is validating our strategy,'' said Bastiaens.
PUZZLING. But the Dictaphone purchase meant more than half of L&H's business was in the U.S., which obliged the company to file detailed accounts with the Securities & Exchange Commission. Analysts learned that sales in Korea had soared from a mere $97,000 in 1998 to $58.9 million in this year's first quarter, some 52% of the total. Suspecting an attempt to pump up results, investors began dumping the stock. At the end of July, Bastiaens bought 620,000 shares from founder Lernout at a 12.5% premium, while letting Lernout keep his voting rights. The move only puzzled analysts, who suspected a ploy to prop up the stock ahead of bad news. ''Why buy just two weeks before reporting second-quarter results, and why at a premium?'' asks Patrick Michielsen of Fortis Bank in Brussels. Says Bastiaens: ''I wanted to show confidence in the company.'' L&H reported a first-half net loss of $15.6 million on sales of $365.6 million. But if one-time charges for the Dictaphone acquisition are excluded, it earned 23 cents a share.
Then, on Aug. 8, the Wall Street Journal claimed discrepancies in the all-important Korean sales. Bastiaens and other top officials saw a conspiracy to bring them down. ''This was no accident,'' one says in private. In particular, they questioned the role of New York-based Rocker Partners. Rocker General Partner Marc Cohodes admits shorting the stock but not feeding dirt to reporters. ''Instead of saying, 'It's the shorts,' this company should answer the questions about its related-party dealings and how Korea accounts for two to three times more than its U.S. business,'' says Cohodes.
After the Korea scandal broke, Bastiaens rushed to restore confidence. He contacted several of the Korean customers interviewed for the Journal story, and they publicly said they were misquoted. A trip to Korea was arranged for two financial analysts, both of whom were impressed with the company's business there. ''I met customers and saw L&H products really being used,'' says Kurt Janssens of KBC Securities in Brussels. BUSINESS WEEK also contacted LG Electronics and Hung Chang, both quoted in the Journal article, who confirmed that they are L&H customers but refused to reveal the extent of their contracts. Most important, Bastiaens asked for the KPMG special audit. ''He wouldn't be so stupid as to ask for an audit if he had something to hide,'' says Pierre-Paul Verelst, an analyst at Brussels brokers Vermeulen Raemdonck. Yet if the Korean allegations prove true, investor reaction will be devastating.
By this time, founders Lernout and Hauspie thought Bastiaens had become a liability. His replacement is Duerden, a British-born U.S. citizen who had worked at Xerox Corp. and Reebok International Ltd. before running Dictaphone. Bastiaens remains on the board and is a 2% shareholder. Meanwhile, Duerden is flying to Seattle to personally reinforce ties with Microsoft, a key shareholder and customer. For important meetings, face-to-face is still better than the phone--especially when the company's credibility is on the line.