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Rating Action:

MOODY'S DOWNGRADES RATING TO Ca ON DICTAPHONE'S GTD SENIOR SUBORDINATED NOTES; OUTLOOK IS NEGATIVE

27 Nov 2000
MOODY'S DOWNGRADES RATING TO Ca ON DICTAPHONE'S GTD SENIOR SUBORDINATED NOTES; OUTLOOK IS NEGATIVE

Approximately $158 Million of Debt Securities Affected.

New York, November 27, 2000 -- Moody's Investors Service lowered the rating to Ca from B3 on Dictaphone Corporation's outstanding $158 million 11-3/4% guaranteed senior subordinated notes, due 2005, including $16 million of notes held by an affiliate of Lernout & Hauspie. Dictaphone's senior implied rating was lowered to Caa1 from B1 and its senior unsecured issuer rating was lowered to Caa2 from B1. The ratings outlook is negative.

The ratings downgrades are based upon uncertainties surrounding the finances of Dictaphone's parent, Lernout & Hauspie, following Lernout & Hauspie's announcement of plans to restate its FY1998, FY1999 and FY2000H1 financial statements; Dictaphone's revelation in its FY2000Q3 and revised FY2000Q2 10-Q filings with the U.S. Securities and Exchange Commission that in June, 2000 it delivered a limited guaranty, heretofore undisclosed, covering advances made to Lernout & Hauspie by Lernout & Hauspie's lenders under a $430 million revolving credit facility arranged in conjunction with the Dictaphone acquisition; allegations of default by the lenders pertaining to the revolving credit facility and a $20 million line of credit extended to Dictaphone by one of the lenders, Deutsche Bank; and a deterioration in Dictaphone's business over FY2000Q1-Q3, during which time revenues, on a pro forma basis reflecting the prospective disposition of the company's electronics manufacturing services unit, declined from $230 million to $170 million, or by 26.1%. The prospect of events of default being formally declared by the lenders with regard to the bank facility and the associated Dictaphone guaranty has arisen with regard to Lernout & Hauspie's pending restatement of its financial statements. Lernout & Hauspie's acknowledgement of its accounting problems, as well as its announcement that it is the subject of a U.S. SEC investigation, come in the wake of a series of articles in The Wall Street Journal citing discrepencies and raising questions pertaining to the company's licensing of its voice recognition software to customers in Belgium, Korea and Singapore.

The ratings additionally take into consideration Dictaphone's reliance on Lernout & Hauspie for near-term liquidity. Dictaphone recorded less than $2 million of cash and cash equivalents and about $78 million of accounts receivable on its September 30, 2000 balance sheet. The company and Lernout & Hauspie are currently in discussion with their lenders regarding alleged defaults under the revolving credit facility as well as the $20 million line of credit extended to Dictaphone for working capital purposes by Deutsche Bank, which itself carries a guaranty from Lernout & Hauspie. Assertions that an event of default may exist, with regard to the revolving credit facility, and that an event of default already exists under the line of credit, have been triggered by the concerns raised by the recent events. As of November 8, there was a $14.8 million balance outstanding under the line of credit for which an event of default has formally been declared by Deutsche Bank against Lernout & Hauspie as guarantor. Dictaphone does not anticipate that Deutsche Bank will permit any further draws under the line of credit, and Deutsche Bank has indicated that the company may have to pay down the line to $12.6 million as a condition to any waivers of events of default that the bank has claimed exist. Dictaphone may be close to a sale of its electronics manufacturing services unit in Melbourne, Florida, as evidenced by its classification of $35.3 million assets for disposal on a line among the current assets identified on the company's September 30, 2000 balance sheet. However, this operation has been subject to prospective divestiture over the past two years, with an actual sale being continually deferred.

Lernout & Hauspie, which advanced $223 million to Dictaphone upon closing the acquisition in May and an additional $54 million in FY2000Q3, reported nearly $200 million of cash, cash equivalents and marketable securities on its June 30, 2000 balance sheet, as well as $237 million of accounts receivable, a sharp increase from $104 million receivables recorded at December 31, 1999. However, Lernout & Hauspie's actual resources are speculative, pending the completion of the accounting restatement by the company's auditors, KPMG International, and an evaluation of an assortment of transactions with related parties which form the basis for a portion of the company's receivables. Additionally, the company has stated that its cash flow from operations for FY2000Q3 will be negative. Lernout & Hauspie's liquidity has been impaired by a suspension from trading of its common stock on NASDAQ November 9, after having plummeted to a price of $6-7/32 per share. The company has borrowed $200 million under the short-term portion of its credit facility, which is due on March 31, 2001, and an additional $30 million under a $230 million five year declining balance facility. Notwithstanding whether any defaults are declared under the revolving credit facility, Lernout & Hauspie, and Dictaphone under the guaranty, will be liable for the $200 million that becomes due unless the March 31 date is extended. Along with Dictaphone, Lernout & Hauspie is engaged in discussions with the lenders regarding the restructuring of the loans and guarantees.

The ratings are supported by Lernout & Hauspie's leading position in voice recognition software and the importance of Dictaphone's vertical markets to Lernout & Hauspie's strategy of achieving greater penetration into North American sales channels, particularly within the health care sector where Dictaphone has carved out a significant market share for its products. The new strategic direction of the merged company will result in the integration of Lernout & Hauspie's technologies into Dictaphone's integrated voice and data management systems, resulting in greater software content combined with an increased level of customization. Nevertheless, voice recognition software, for all its advances and potential, remains in its nascent stages of development, and the growth trajectories for Lernout & Hauspie's targeted markets remain highly uncertain.

The ratings are additionally buttressed by the recent managerial and board changes that have been implemented at Lernout & Hauspie, including the replacement of the company's chief executive and chief financial officers, which could be welcomed by the company's lenders and contribute positively to the current discussions regarding debt restructuring and/or prospective waivers on the existing covenants.

Lernout & Hauspie, a world leader in automatic speech recognition, text-to-speech, digital speech compression, text-to-text language translation and linguistics components technologies customized for corporate solutions, maintains its world headquarters in the Flanders region of Belgium and its North American headquarters in Burlington, Massachusetts.

Dictaphone Corporation, headquartered in Stratford, Connecticut, is engaged in the design, manufacture, marketing and service of dictation and voice management and communications recording systems in selected vertical markets.

New York
Robert N. McCreary
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

New York
Howard Sitzer
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

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