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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
| | TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-27038
SCANSOFT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3156479
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
9 CENTENNIAL DRIVE
PEABODY, MA 01960
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(978) 977-2000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes | X | No | |
63,220,542 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of October 31, 2002.
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SCANSOFT, INC.
FORM 10-Q
INDEX
PAGE
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets at September 30, 2002 and December 31, 2001.................................. 3
b) Consolidated Statements of Operations for the three and nine months ended
September 30, 2002 and September 30, 2001............................................................... 4
c) Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and September 30, 2001............................................................... 5
d) Notes to Consolidated Financial Statements............................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................................. 27
Item 4. Controls and Procedures..................................................................................... 27
PART II: OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................................................ 27
Signatures.............................................................................................................. 28
Certifications.......................................................................................................... 29
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 14,382 $ 14,324
Accounts receivable, less allowances of $7,650 and $6,273, respectively 17,106 14,266
Inventory ............................................................. 1,562 507
Prepaid expenses and other current assets ............................. 2,853 1,614
--------- ---------
Total current assets ............................................. 35,903 30,711
Goodwill ................................................................... 63,308 65,231
Other intangible assets, net ............................................... 36,035 43,301
Property and equipment, net ................................................ 2,933 2,150
Other assets ............................................................... 1,091 677
--------- ---------
TOTAL ASSETS ............................................................... $ 139,270 142,070
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................................... 5,541 5,320
Accrued expenses ...................................................... 11,695 14,471
Deferred revenue ...................................................... 955 1,375
Note payable .......................................................... 227 227
Other current liabilities ............................................. 1,720 --
--------- ---------
Total current liabilities ........................................ 20,138 21,393
Deferred revenue .......................................................... 278 2,534
Long-term note payable, net of current portion ............................ 3,101 3,273
Other liabilities ......................................................... 819 336
--------- ---------
Total liabilities ................................................ 24,336 27,536
--------- ---------
Commitments and contingencies (Notes 10, 11 and 12)
Stockholders' equity:
Preferred stock, $0.001 par value;
40,000,000 shares authorized; 3,562,238 shares issued and
outstanding (liquidation preference $4,631) ........................ 4,631 4,631
Common stock, $0.001 par value; 140,000,000 shares
authorized; 65,334,366 and 62,754,211 shares issued and
63,216,988 and 62,098,211 shares outstanding, respectively ......... 65 63
Additional paid-in capital ............................................ 269,822 264,893
Treasury stock, at cost; 2,117,378 and 656,000 shares, respectively ... (8,031) (1,031)
Deferred compensation ................................................. (199) (276)
Accumulated other comprehensive income (loss) ......................... 12 (487)
Accumulated deficit ................................................... (151,366) (153,259)
--------- ---------
Total stockholders' equity ....................................... 114,934 114,534
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................. $ 139,270 $ 142,070
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
3
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net revenue .................................. $ 28,235 $ 16,765 $ 78,184 $ 44,130
Costs and expenses:
Cost of revenue ................... 4,199 3,498 12,937 9,215
Research and development .......... 7,257 3,582 21,310 10,016
Selling, general and administrative 11,412 6,544 32,051 18,944
Amortization of intangible assets . 2,212 6,833 8,940 20,500
Restructuring and other charges ... -- -- 1,041 --
-------- -------- -------- --------
Total costs and expenses ..................... 25,080 20,457 76,279 58,675
-------- -------- -------- --------
Income (loss) from operations ................ 3,155 (3,692) 1,905 (14,545)
Other income (expense), net .................. (168) 13 (178) (126)
-------- -------- -------- --------
Income (loss) before income taxes ............ 2,987 (3,679) 1,727 (14,671)
Provision for (benefit from) income taxes .... 162 (465) (166) (162)
-------- -------- -------- --------
Net income (loss) ............................ $ 2,825 $ (3,214) $ 1,893 $(14,509)
======== ======== ======== ========
Net income (loss) per share: basic ........... $ 0.04 $ (0.06) $ 0.03 $ (0.30)
======== ======== ======== ========
Net income (loss) per share: diluted ......... $ 0.04 $ (0.06) $ 0.03 $ (0.30)
======== ======== ======== ========
Weighted average common shares: basic ........ 67,865 50,875 67,116 48,638
======== ======== ======== ========
Weighted average common shares: diluted ...... 74,787 50,875 72,451 48,638
======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS
ENDED
SEPTEMBER 30,
----------------------
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................................................... $ 1,893 $(14,509)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation and amortization .............................................. 1,535 1,395
Allowances for returns and bad debts ....................................... 1,246 (1,460)
Amortization of intangible assets .......................................... 8,940 20,500
Non-cash portion of restructuring and other charges ........................ 113 --
Gain on disposal or sale of property and equipment ......................... (30) (89)
Deferred compensation ...................................................... 77 --
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ..................................................... (4,234) (147)
Inventory ............................................................... (1,003) 335
Prepaid expenses and other assets ....................................... (1,189) 613
Other assets ............................................................ (273) --
Accounts payable ........................................................ (292) (799)
Accrued expenses ........................................................ 2,162 (1,117)
Deferred revenue ........................................................ (2,682) 1,371
-------- --------
Net cash provided by operating activities ....................................... 6,263 6,093
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment ............................ (2,090) (563)
Proceeds from sale of property and equipment ............................... 42 344
Payments of acquisition-related liabilities ................................ (2,360) --
Cash paid for acquisition .................................................. (500) --
Other ...................................................................... -- 62
-------- --------
Net cash used in investing activities ........................................... (4,908) (157)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term borrowings .......................................... -- (3,400)
Payments of capital lease obligation ....................................... (238) --
Purchase of treasury stock ................................................. (7,000) (521)
Payments of notes payable related to acquisition ........................... (586) --
Payments under deferred payment agreement .................................. (1,824) --
Proceeds from private placement of common stock, net of issuance costs ..... 5,690 --
Proceeds from the issuance of common stock upon exercise of options ........ 2,545 4,995
-------- --------
Net cash provided by (used in) financing activities ............................. (1,413) 1,074
-------- --------
Effects of exchange rate changes on cash and cash equivalents ................... 116 (312)
-------- --------
Net increase in cash and cash equivalents ....................................... 58 6,698
Cash and cash equivalents at beginning of period ................................ 14,324 2,571
-------- --------
Cash and cash equivalents at end of period ...................................... $ 14,382 $ 9,269
======== ========
Supplemental disclosure of noncash investing activities:
Shares issued in connection with the purchase of assets (Note 5) ................ $ 600 $ --
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
5
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of ScanSoft,
Inc. (the "Company", "we" or "ScanSoft") have been prepared in accordance with
accounting principles generally accepted in the United States of America. In the
opinion of management, these interim consolidated financial statements reflect
all adjustments, consisting of normal recurring adjustments, necessary for a
fair presentation of the financial position at September 30, 2002 and 2001 and
the results of operations and cash flows for the three and nine months ended
September 30, 2002 and 2001. Although the Company believes that the disclosures
in these financial statements are adequate to make the information presented not
misleading, certain information normally included in the footnotes prepared in
accordance with generally accepted accounting principles has been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. The accompanying financial statements should be read in conjunction
with the audited financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 filed
with the Securities and Exchange Commission on April 1, 2002.
The results for the three and nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002, or any future period.
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
disclosure of contingent assets and liabilities on the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The most significant estimates and assumptions included in the financial
statements are revenue recognition, including estimating valuation allowances
(specifically sales returns and other allowances), the recoverability of
intangible assets, including goodwill, and valuation allowances for deferred tax
assets. Actual amounts could differ significantly from these estimates.
Certain prior year financial statement amounts have been reclassified to
conform with the current year presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
144). The objectives of SFAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121), and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 supersedes SFAS 121; however, it retains
the fundamental provisions of SFAS 121 for (1) the recognition and measurement
of the impairment of long-lived assets to be held and used and (2) the
measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes
the accounting and reporting provisions of Accounting Principles Board No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" (APB 30), for segments of a business to be disposed of.
However, SFAS 144 retains the requirement of APB 30 that entities report
discontinued operations separately from continuing operations and extends that
reporting requirement to "a component of an entity" that either has been
disposed of or is classified as "held for sale." SFAS 144 also amends the
guidance of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to eliminate the exception to consolidation for a temporarily
controlled subsidiary. SFAS 144 is effective for financial statements issued for
fiscal years beginning after December 15, 2001, including interim periods, and,
generally, its provisions are to be applied prospectively. The Company adopted
the provisions of SFAS 144 in 2002 and its adoption had no impact on its
financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF"), a committee of
the FASB, reached a consensus on EITF Issue 01-9, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products" (EITF
01-9). EITF 01-9 presumes that consideration from a vendor to a customer or
reseller of the vendor's products is a reduction of the selling prices of the
vendor's products and, therefore, should be characterized as a reduction of
revenue when recognized in the vendor's income statement and could lead to
negative revenue under certain circumstances. Revenue reduction is required
unless consideration relates to a separate identifiable benefit and the
benefit's fair value can be established, in which case such amounts may be
recorded as operating expenses. The Company implemented EITF 01-9 on January 1,
2002. The implementation resulted in a $0.05 million and $0.3 million reduction
to net revenue and a corresponding reduction to selling, general and
administrative expenses for the three and nine months ended September 30, 2002,
respectively. Additionally, it resulted in the reclassification of $0.3 million
and $0.8 million from selling, general and administrative expenses to net
revenue for the three and nine months ended September 30, 2001, respectively.
6
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" (SFAS No. 146). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" (EITF 94-3). SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. The Company does not expect the adoption
of SFAS 146 will have a material impact on its financial position or results of
operations.
3. BALANCE SHEET COMPONENTS
The following table summarizes key balance sheet components (in thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
------- -------
Inventory:
Raw materials ................. $ -- $ 107
Finished goods ................ 1,562 400
------- -------
$ 1,562 $ 507
======= =======
Other accrued expenses:
Accrued compensation .......... $ 2,483 $ 2,775
Accrued sales and marketing ... 1,566 1,160
Accrued restructuring ......... 732 634
Accrued royalties ............. 491 750
Accrued professional fees ..... 525 571
Accrued acquisition liabilities 1,800 6,065
Accrued income taxes and other 4,098 2,516
------- -------
$11,695 $14,471
======= =======
During the nine months ended September 30, 2002, the Company entered into
settlement agreements related to certain contractual liabilities assumed in
connection with the acquisition of the majority of the speech and language
technology operations of Lernout & Hauspie (L&H acquisition), which occurred on
December 12, 2001. Upon settlement of these liabilities, $1.9 million of the
assumed liabilities recorded at the date of acquisition were reversed with a
corresponding reduction recorded to the carrying value of goodwill.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 142 (SFAS 142), "Goodwill and Other
Intangible Assets." SFAS 142 addresses financial accounting and reporting for
acquired goodwill and other intangible assets, including how goodwill and other
intangible assets should be accounted for after they have been initially
recognized. SFAS 142 provides that goodwill and intangible assets that have
indefinite useful lives not be amortized but rather be tested at least annually
for impairment; intangible assets with finite useful lives will continue to be
amortized over their useful lives.
The Company adopted SFAS 142 on January 1, 2002 and discontinued the
amortization of goodwill (including acquired workforce) of approximately $65.2
million. Upon adoption, the Company reclassified $31,000 of previously
amortizable acquired workforce to goodwill. The Company had previously been
recording amortization expense on goodwill and acquired workforce of $10.4
million annually or $2.6 million per quarter.
Under SFAS 142, the Company was required to complete a transitional
impairment test on all goodwill effective as of January 1, 2002 on a reporting
unit basis. A reporting unit is defined as an operating segment or one level
below an operating segment referred to as a component. A component of an
operating segment is a reporting unit if the component constitutes a business
and discrete financial information is prepared and regularly reviewed by
management. The Company determined that it operates in one reporting unit and,
therefore, has completed the transitional goodwill impairment test on an
enterprise-wide basis.
SFAS 142 provides for a two-step impairment test to identify potential
goodwill impairment. The first step of the goodwill impairment test compares the
fair value of a reporting unit with its carrying value, including goodwill. If
the fair value of a reporting unit exceeds its carrying value, goodwill of the
reporting unit is considered not impaired, thus the second step of the
impairment test, which determines the amount of goodwill impairment, is
unnecessary.
7
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The fair value of the reporting unit was determined using the Company's
market capitalization as of January 1, 2002. As the fair value of the reporting
unit as of January 1, 2002 was in excess of the carrying amount of the net
assets, the Company concluded that its goodwill was not impaired, and no
impairment charge was recorded. The Company will complete additional goodwill
impairment analyses at least annually or more frequently when events and
circumstances occur indicating that the recorded goodwill might be impaired. The
Company will perform its annual assessment during the fourth quarter of 2002.
Intangible assets are amortized on a straight-line basis over their
estimated useful lives of three to twelve years. As required, upon adoption of
SFAS 142, the Company reassessed the useful lives of its intangible assets and
has determined that no adjustments were required.
The following summary reflects the consolidated results of operations as if
SFAS 142 had been adopted at the beginning of the periods presented (in
thousands, except net income (loss) per share amounts):
THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- --------- --------- ----------
Net income (loss):
Reported net income (loss) ................. $ 2,825 $ (3,214) $ 1,893 $ (14,509)
Effect of goodwill amortization ............ -- 2,597 -- 7,790
--------- --------- --------- ----------
Adjusted net income (loss) ................. $ 2,825 $ (617) $ 1,893 $ (6,719)
========= ========= ========= ==========
Basic net income (loss) per share:
Reported basic net income (loss) per share . $ 0.04 $ (0.06) $ 0.03 $ (0.30)
Effect of goodwill amortization ............ -- .05 -- .16
--------- --------- --------- ----------
Adjusted basic net income (loss) per share . $ 0.04 $ (0.01) $ 0.03 $ (0.14)
========= ========= ========= ==========
Diluted net income (loss) per share:
Reported diluted net income (loss) per share $ 0.04 $ (0.06) $ 0.03 $ (0.30)
Effect of goodwill amortization ............ -- .05 -- .16
--------- --------- --------- ----------
Adjusted diluted net income (loss) per share $ 0.04 $ (0.01) $ 0.03 $ (0.14)
========= ========= ========= ==========
Other intangible assets consist of the following (in thousands):
SEPTEMBER 30, 2002 GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------- ------------
Core technology $ 48,130 $17,343 $30,787
Developed technology 16,340 16,340 --
Trademarks and patents 7,461 2,573 4,888
Non-competition agreement 4,048 4,048 --
Acquired favorable lease 553 553 --
OEM relationships 1,100 740 360
Other 200 200 --
-------- ------ ----
$ 77,832 $41,797 $36,035
======== ======= =======
DECEMBER 31, 2001 GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------
Core technology $ 46,456 $ 11,771 $34,685
Developed technology 16,340 14,714 1,626
Trademarks and patents 7,461 1,784 5,677
Non-competition agreement 4,048 3,646 402
Acquired favorable lease 553 355 198
OEM relationships 1,100 524 576
Assembled workforce 374 270 104
Other 200 167 33
-------- -------- -------
$ 76,532 $ 33,231 $43,301
======== ======== =======
8
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Aggregate amortization expense was $2.2 million and $8.9 million for the
three and nine months ended September 30, 2002, respectively. Estimated
amortization expense for each of the five succeeding fiscal years as of
September 30, 2002 is as follows (in thousands):
YEAR ENDING AMOUNT
----------- ------
Remainder of 2002 $2,212
2003 8,847
2004 7,977
2005 3,576
2006 2,327
2007 2,284
Thereafter 8,812
--------
Total $ 36,035
========
5. ACQUISITION
On February 22, 2002, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and intellectual
property from L&H Holdings USA, Inc. The transaction was completed on March 21,
2002. Pursuant to the Purchase Agreement, the Company acquired patents and core
technology associated with the Audiomining assets of the speech and language
technology assets of L&H and paid $1.5 million in total consideration to L&H as
follows: $0.5 million in cash, 121,359 shares of the Company's common stock
valued at $0.6 million (based on the average of the closing share price of the
Company's stock 5 days before and after the date the transaction was completed)
and a 9% promissory note in the principal amount of $0.4 million (the "Note"),
with principal and interest to be repaid in full on July 31, 2002. The Company
incurred $0.2 million of acquisition related costs. The purchase price including
acquisition costs of $1.7 million was allocated to core technology.
On July 31, 2002, the Company repaid all amounts due under the Note, which
included principal and interest of $414,000.
6. RESTRUCTURING AND OTHER CHARGES
In January 2002, the Company announced, and in March 2002 completed, a
restructuring plan to consolidate facilities, worldwide sales organizations,
research and development teams and other personnel following the December 12,
2001 L&H acquisition. As a result, the Company exited facilities in both North
America and Europe, eliminating 21 employee positions, including 12 in research
and development and nine in selling, general and administrative functions. In
the first quarter of 2002, the Company recorded a restructuring charge in the
amount of $0.6 million for severance payments to these employees, and a
restructuring charge of $0.4 million for certain termination fees to be incurred
as a result of exiting the facilities, including the write-off of previously
recorded assembled workforce of $0.1 million.
During the nine months ended September 30, 2002, the Company paid a total
of $0.7 million in severance payments, of which $0.6 million related to the
March 2002 restructuring and $0.1 million related to severance paid to the
former Caere President and CEO, pursuant to a 2000 restructuring.
At September 30, 2002, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.7 million. This balance is
comprised of $0.2 million of lease exit costs resulting from the 2002
restructuring and $0.5 million of severance to the former Caere President and
CEO. The severance due to the former Caere President and CEO will be paid
through March 2005.
The following table sets forth activity under the 2002 and 2000
restructuring actions (in thousands):
RESTRUCTURING AND OTHER CHARGES RESERVE
EMPLOYEE LEASE
RELATED EXIT COSTS TOTAL
------- ---------- -----
Balance at December 31, 2001 ............................... $ 634 $ -- $ 634
Restructuring and other charges for March 2002 restructuring 576 465 1,041
Non cash write-offs ........................................ -- (113) (113)
Cash payments .............................................. (722) (108) (830)
------- ------- -------
Balance at September 30, 2002 .............................. $ 488 $ 244 $ 732
======= ======= =======
9
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. DEFERRED PAYMENT AGREEMENT
In connection with the Caere acquisition in the first quarter of 2000 and
pursuant to a concurrent non-competition and consulting agreement, the Company
agreed to pay in cash to the former Caere President and CEO, a current member of
the Board of Directors of the Company, on the second anniversary of the merger,
March 13, 2002, the difference between $13.50 and the closing price per share of
ScanSoft common stock at that time, multiplied by 486,548. On March 5, 2002, the
Company negotiated a deferred payment agreement with the former Caere President
and CEO to terminate this agreement. Under the terms of the deferred payment
agreement, the Company paid $1.0 million in cash on March 5, 2002 and agreed to
make future cash payments totaling $3.3 million, with such amounts payable in
equal quarterly installments of approximately $0.4 million over the following
two years. During the nine months ended September 30, 2002, the Company paid two
quarterly installments under this agreement totaling $0.8 million.
The total consideration of this agreement was accounted for in the original
Caere purchase price and had no effect on the results of operations. The
remaining liability at September 30, 2002 is $2.4 million, of which $1.6 million
is included in other current liabilities and $0.8 million is included in other
long-term liabilities.
8. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed using the weighted average
number of common shares outstanding during the period. Basic net income per
share for the three and nine months ended September 30, 2002 includes the
assumed conversion of the Series B Preferred Stock, which participates in
dividends with common stock when and if declared as well as the weighted average
impact of vested restricted stock shares. Diluted net income (loss) per share is
computed based on (i) the weighted average number of common shares outstanding,
(ii) the assumed conversion of the Series B Preferred Stock, and (iii) the
effect, when dilutive, of outstanding stock options, warrants, and unvested
shares of restricted stock using the treasury stock method.
The following is a reconciliation of the shares used in the computation of
basic and diluted net income (loss) per share (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Basic net income (loss) per share:
Weighted average number of common shares
outstanding..................................... 64,303 50,875 63,554 48,638
Assumed conversion of Series B Preferred Stock .. 3,562 -- 3,562 --
------ ------ ------ ------
Weighted average common shares: basic ............... 67,865 50,875 67,116 48,638
Effect of dilutive common equivalent shares:
Stock options .................................. 6,362 -- 4,772 --
Warrants ....................................... 463 -- 468 --
Unvested restricted stock ...................... 97 -- 95 --
------ ------ ------ ------
Weighted average common shares: diluted ............. 74,787 50,875 72,451 48,638
====== ====== ====== ======
For the three and nine months ended September 30, 2002, stock options to
purchase 3,383,559 and 1,655,604 shares, respectively, of common stock were
outstanding but were excluded from the calculation of diluted net income per
share because the options' exercise prices were greater than the average market
price of the Company's common stock during the periods.
For the three and nine months ended September 30, 2001, diluted net loss per
share excludes 5,300,741 and 4,611,135 common share equivalents, respectively.
These potential common shares were excluded from the calculation of diluted net
loss per share as their inclusion would have been antidilutive for all periods
presented.
9. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), net of taxes, was approximately $3.0
million and $2.4 million for the three and nine months ended September 30, 2002,
respectively, and was approximately ($3.3) million and ($14.8) million for the
three and nine months ended September 30, 2001, respectively. Total
comprehensive income (losses) consisted of net income or losses and foreign
currency translation adjustments for the respective periods.
10
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. COMMITMENTS AND CONTINGENCIES
In December 2001, the Company was sued for patent infringement initiated by
the Massachusetts Institute of Technology and Electronics For Imaging, Inc. The
Company was one of more than 200 defendants named in this suit. Damages are
sought in an unspecified amount. The Company filed an Answer and Counterclaim on
July 1, 2002. The Company cannot predict the outcome of the claim, nor can it
make any estimate of the amount of damages, if any, for which it will be held
responsible in the event of a negative conclusion of the claim. The Company
believes this claim has no merit, and it intends to defend the action
vigorously.
As a normal incidence of the nature of the Company's business, various
claims, charges and litigation have been asserted or commenced against the
Company arising from or related to employee relations and other business
matters. Management does not believe these claims will have a material effect on
the financial position or results of operations of the Company.
11. EQUITY TRANSACTIONS
On April 12, 2002, the Company completed a private placement of 1.0 million
shares of common stock at a purchase price of $6.00 per share with SF Capital
Partners Ltd., resulting in proceeds, net of issuance costs, of $5.7 million.
In September of 2002, the Company repurchased 1,461,378 shares of common
stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech Products N.V.
(collectively, L&H) at $4.79 per share for a total consideration of $7.0
million. The price per share was based on the greater of $4.79 or the twenty day
trading average beginning August 14, 2002, which was $4.67. These shares
represented a portion of the common shares that were issued to L&H in
connection with the December 12, 2001 acquisition of certain of L&H's speech and
language technology operations and the March 21, 2002 acquisition of the
AudioMining assets of L&H Holdings USA, Inc., a wholly-owned subsidiary of L&H.
The Company agreed to issue 150,000 shares of its common stock to L&H if it does
not complete an underwritten public offering of the shares held by L&H by
December 15, 2002. The Company further agreed to issue an additional 150,000
shares of its common stock to L&H if it does not complete an underwritten public
offering by February 15, 2003. The Company also will be required to issue an
additional 100,000 shares of its common stock to L&H if, by February 15, 2003,
it fails to file a registration statement to register the shares remaining
unsold. Additionally, if the consummation of the offering does not occur by
January 1, 2003, the outstanding principal and interest under the $3.5 million
promissory note that was issued in connection with the acquisition of L&H
operations would become immediately due and payable. The value ascribed to the
potential right to acquire additional shares of the Company's common stock was
valued at $0.3 million using a probability-weighted, Black-Scholes valuation
model and recorded as a credit to additional paid-in capital, with a
corresponding reduction in additional paid-in capital because the Company has an
accumulated deficit. Accordingly, the right had no net effect on the Company's
financial position or results of operations.
12. SUBSEQUENT EVENTS
On October 7, 2002, the Company signed a definitive agreement with Royal
Philips Electronics (Philips) to acquire its Speech Processing Telephony and
Voice Control business units and related intellectual property. Under the
agreement, the Company will pay Philips $3.0 million in cash, issue a $4.9
million note due December 31, 2003 bearing 5.0% interest per annum and issue a
$27.5 million three-year, zero-interest debenture, convertible at any time into
shares of the Company's common stock at $6.00 per share. The Company expects to
close the transaction in the first quarter of 2003.
On October 21, 2002, the Company filed with the Securities and Exchange
Commission two registration statements. The first registration statement was
filed in connection with a proposed underwritten public offering of 7.0 million
shares of the Company's common stock, of which 6.0 million shares are being
offered by Lernout & Hauspie Speech Products N.V. and L&H Holdings USA, Inc. and
1.0 million shares are being offered by the Company. The second registration
statement provides for the registration of 9.0 million shares of the Company's
common stock on behalf of three large institutional investors. These shares will
not be included in the proposed underwritten public offering and are being
registered pursuant to registration rights agreements previously entered into by
the Company.
On October 31, 2002, the Company entered into a two year Loan and Security
Agreement (the "Loan Agreement") with Silicon Valley Bank (the "Bank") that
consisted of a $10,000,000 revolving loan (the "Credit Facility"). Borrowings
under the Credit Facility will bear interest at the Bank's prime rate plus
0.375% or 0.75%, which is determined by the Company's fixed charge coverage
ratio, as defined in the Loan Agreement. The maximum aggregate amount of
borrowings outstanding at any one time will be limited to the lesser of
$10,000,000 or a borrowing base. The borrowing base will be equal to either 80%
or 70% of eligible accounts receivable, as defined in the Loan Agreement, which
is determined by the
11
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Company's fixed charge coverage ratio. Pursuant to the Loan Agreement, the
Company will be required to maintain certain financial and non-financial
covenants, the most restrictive of which is a quarterly minimum fixed charge
coverage ratio of 1.25 to 1.00. Borrowings under the Loan Agreement are
collateralized by substantially all of the Company's personal property,
predominantly its accounts receivable, but not its intellectual property.
12
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and
related notes thereto, located in Item 1 of this quarterly report.
FORWARD-LOOKING STATEMENTS
This quarterly report contains forward-looking statements. These
forward-looking statements include predictions regarding:
- our revenue, earnings, cash flow and liquidity;
- our strategy relating to speech and language technologies;
- our expectations regarding our acquisition of certain assets from
Philips, including the expected closing date;
- the potential of future product releases;
- our product development plans and investments in research and
development;
- future acquisitions;
- international operations and localized versions of our products; and
- cost savings arising from the Company's 2002 restructuring;
- legal proceedings and litigation matters.
You can identify these and other forward-looking statements by the use of
words such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "intends," "potential," "continue" or the
negative of such terms, or other comparable terminology. Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.
Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth in this quarterly report under the heading "Risk Factors That May Affect
our Future Results of Operations." All forward-looking statements included in
this document are based on information available to us on the date hereof. We
assume no obligation to update any forward-looking statements.
OVERVIEW
We are a leading provider of software that enables the capture and
conversion of information, including documents, images and speech, into digital
applications. Our products and technologies replace manual processes with
automated solutions that help enterprises, professionals and consumers increase
productivity, reduce costs and save time. Our products are built upon core
technologies in digital capture and speech, and are sold as solutions into the
financial, legal, healthcare, government, telecommunications and automotive
industries. We focus on markets where we can exercise market leadership, where
significant barriers to entry exist and where we possess competitive advantages,
because of the strength of our technologies, products, channels and business
processes.
On December 12, 2001, we acquired substantially all of the speech and
language technologies operations of L&H. Consideration for the transaction
comprised $10 million in cash, a $3.5 million note and 7.4 million shares of our
common stock having a value of $27.8 million. The operations acquired include
text-to-speech, speech recognition and dictation, and voice control
technologies.
On October 7, 2002, we entered into a definitive agreement with Royal
Philips Electronics (Philips) to acquire the Philips Speech Processing Telephony
and Voice Control business units and related intellectual property.
Consideration for the transaction will consist of $3.0 million in cash, a $4.9
million note due December 31, 2003 bearing 5.0% interest per annum and a $27.5
million three-year, zero-interest debenture, convertible at any time into shares
of our common stock at $6.00 per share. We expect that this transaction will
close during the first quarter of 2003. The technology to be acquired includes
several speech recognition and voice control products.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table presents, as a percentage of net revenue, certain
selected financial data for the three and nine months ended September 30, 2002
and 2001:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2001 2002 2001
------ ------ ------ ------
Net revenue ............................. 100.0% 100.0% 100.0% 100.0%
Cost and expenses:
Cost of revenue .................... 14.9 20.8 16.6 20.9
Research and development ........... 25.7 21.4 27.3 22.7
Selling, general and administrative 40.4 39.0 41.0 42.9
Amortization of intangible assets .. 7.8 40.8 11.4 46.5
Restructuring and other charges .... -- -- 1.3 --
Total costs and expenses .... 88.8 122.0 97.6 133.0
------ ------ ------ ------
Income (loss) from operations ........... 11.2 (22.0) 2.4 (33.0)
------ ------ ------ ------
Other income (expense), net ............. (0.6) 0.1 (0.2) (0.3)
------ ------ ------ ------
Income (loss) before income taxes ....... 10.6 (21.9) 2.2 (33.3)
Provision for (benefit from) income taxes 0.6 (2.7) (0.2) (0.4)
------ ------ ------ ------
Net income (loss) ....................... 10.0% (19.2%) 2.4% (32.9%)
====== ====== ====== ======
GENERAL
We derive our revenue from sales of our software products to customers
through distribution partners and value-added resellers, royalty revenues from
OEM partners, license fees from sales of our products to customers and from
services, primarily maintenance associated with software license transactions.
Sales of our software products through distribution partners and
value-added resellers provide certain rights of return. As a result, we make
estimates of potential future product returns related to products sold to
distributors. Our estimates of sales returns and allowance reserves are based on
inventory levels at distributors and value-added resellers as well as historical
returns, current economic trends, and obsolescence based on new product
introductions. The judgments and estimates used in connection with establishing
the sales returns may be material in any accounting period. If actual returns
differ significantly from those estimates, such differences may have a material
impact on the results of operations for the period in which the actual returns
become known. Similarly, we must make estimates of the uncollectibility of our
accounts receivable. We specifically analyze accounts receivable and analyze
historical bad debts, customer concentrations, customer credit-worthiness,
current economic trends and changes in our customer payment terms when
evaluating the adequacy of the allowance for doubtful accounts.
Royalty revenues derived from sales to certain OEM partners are based on
estimates of additional deployments of the licenses by the customer in the most
recent reporting period. If actual additional licenses differ significantly from
estimates made based on historical experience, such differences may have a
material impact on the results of operations for the period in which the actual
licenses deployed become known.
If our experience changes dramatically due to changes in the market,
changes in our customer base, seasonality or other economic factors, our ability
to make such estimates may be impacted and therefore we may be unable to
recognize revenue until these rights lapse or until we receive royalty payments.
Historically, we have not experienced material differences between estimated and
actual revenue in any reporting period.
Cost of revenue consists primarily of material costs, third-party
royalties, fulfillment and salaries for product support personnel and related
costs associated with contracts, which are accounted for under the percentage of
completion method of accounting. Currently, most of our software products are
manufactured, packaged and shipped by GlobalWare Solutions on a worldwide basis.
We believe that, if necessary, we could transition the services provided by
GlobalWare to another third party provider with minimal disruption to our
operations.
Research and development expense consists primarily of salary and benefits
costs of engineers. We believe that the development of new products and the
enhancement of existing products are essential to our success. Accordingly, we
plan to continue to invest in research and development activities. To date, we
have not capitalized any development costs as the cost incurred after
technological feasibility but before release of product has not been
significant.
Selling expenses include salaries, commissions, advertising, direct mail,
public relations, trade shows, travel and other related sales and marketing
expenses. General and administrative expenses include personnel costs for
administration, finance, human resources,
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
information systems and general management, in addition to legal and accounting
expenses and other professional services. We attempt to control selling, general
and administrative expense; however, if revenue continues to grow, we expect
selling, general and administrative expense to increase to support our growing
operations. In addition, we may increase selling, general and administrative
expenses in advance of revenue to support expected future revenue growth in
specific product lines or geographic regions.
NET REVENUE
Net revenue for the three months ended September 30, 2002 increased by $11.5
million or 68% from the comparable period in 2001. This increase was the result
of revenues generated by our speech recognition and dictation products. Revenue
from our speech recognition and dictation products was $11.6 million and zero
for the three months ended September 30, 2002 and 2001, respectively. Revenues
of $16.6 million generated by our digital capture products for the three months
ended September 30, 2002 remained relatively consistent with the comparable
period of 2001. During August 2002, we launched an updated version of our
digital capture product, OmniPage Pro 12, across most channels. The product
launch contributed to an overall increase in revenues from our digital capture
products primarily in our VAR/retail and direct channels, offset by lower
revenues from our OEM customers as compared to 2001. Digital capture revenue
from our OEM customers was higher in the three months ended September 30, 2001,
due to a significant contract with an OEM customer.
Net revenue for the nine months ended September 30, 2002 increased by $34.1
million or 77% from the comparable period in 2001. The growth in revenue for the
nine months ended September 30, 2002 was the result of revenues generated from
our speech recognition and dictation products. Revenue from our speech
recognition and dictation products was $32.3 million and zero for the nine
months ended September 30, 2002 and 2001, respectively. The increase in revenue
was due to the L&H acquisition, which occurred in December 2001. Revenue from
our digital capture products was $45.9 million and $44.1 million for the nine
months ended September 30, 2002 and 2001, respectively. The increase in revenue
from our digital capture products from the comparable period in 2001 was due to
an increase in our digital paper management product line, and the product launch
during August 2002 of our digital capture product, as well as the recognition of
revenue, previously deferred, on a significant long-term OEM contract.
Geographic revenue classification is based on the country in which the sale
is invoiced. Geographic revenues were relatively constant in the three and nine
months ended September 2002. Revenue for the three months ended September 30,
2002 was 74% North America and 26% international versus 78% and 22%,
respectively for the comparable period in 2001. Revenue for the nine months
ended September 30, 2002 was 74% North America and 26% international, versus 79%
North America and 21% international for the comparable period in 2001.
A number of our OEM partners distribute their products throughout the world
and do not provide us with the geographical dispersion of their products. We
believe that if provided with this information, our geographical revenue
classification would indicate a higher international percentage. Based on an
estimate that factors our OEM partners' geographical revenue mix to our revenues
generated from these OEM partners, revenue for the three months ended September
30, 2002 is approximately 70% North America and 30% international, compared to
69% and 31%, respectively, for the comparable period of 2001. Revenue for the
nine months ended September 30, 2002, based on this estimate, is approximately
69% North America and 31% international, compared to 72% North America and 28%
international for the comparable period in 2001. The increase in our
international revenue percentage for the nine months ended September 30, 2002 is
driven primarily from Europe and Asia and is the result of increased sales and
marketing resources, the addition of resellers, the release of our speech
recognition and dictation products, as well as increased revenues from our
embedded text-to-speech technologies.
The breakdown of net revenue for the three months ended September 30, 2002
was 44% VAR/retail, 27% direct and 29% OEM compared to 50% VAR/retail, 18%
direct and 32% OEM for the same period in 2001. The breakdown of revenue for the
nine months ended September 30, 2002 was 43% VAR/retail, 23% direct, and 34% OEM
compared to 48% VAR/retail, 22% direct, and 30% OEM for the same period in 2001.
The increase in OEM for the nine months ended September 30, 2002 is the result
of increased contracts with our OEM partners, including the recognition of
revenue previously deferred on a significant long-term OEM contract. Direct
revenue is higher for the three months ended September 30, 2002, as a result of
a new product launch from our digital capture products that occurred during the
third quarter of 2002.
COST OF REVENUE
Cost of revenue for the three months ended September 30, 2002 was $4.2
million or 14.9% of revenue, compared to $3.5 million or 20.8% of revenue in the
comparable period of 2001. Cost of revenue for the nine months ended September
30, 2002 was $12.9 million or 16.6% of revenue, compared to $9.2 million or
20.9% for the same period in 2001. The increase in cost of revenue in
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
absolute dollars for both the three and nine months ended September 30, 2002 is
directly attributable to the increase in the volume of product sales to the
VAR/retail customers as well as increased embedded text-to-speech revenue which
bears a higher cost than our traditional software products. The decrease in cost
of revenue as a percentage of revenue for both the three and nine months ended
September 30, 2002 is due to a higher proportion of higher margin OEM and
corporate licensing revenues and lower supply chain logistics and direct
fulfillment costs as compared to the same periods in 2001.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development costs were $7.3 million or 25.7% of revenue for the
three months ended September 30, 2002, compared to $3.6 million or 21.4% of
revenue for the comparable period in 2001. Research and development costs for
the nine months ended September 30, 2002 were $21.3 million or 27.3% of revenue,
compared to $10.0 million or 22.7% for the comparable period in 2001. The
increase in research and development expenses for both the three and nine months
ended September 30, 2002 is primarily the result of increased headcount and
costs associated with the L&H acquisition. Headcount was increased by
approximately 138 employees with the L&H acquisition. Cost savings from the
restructuring actions taken in 2002 for the three and nine months ended
September 30, 2002 were $0.2 million and $0.4 million, respectively.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense for the three months ended
September 30, 2002 was $11.4 million or 40.4% of revenue, compared to $6.5
million or 39.0% of revenue for the same period in 2001. Selling, general and
administrative expense for the nine months ended September 30, 2002 was $32.1
million or 41.0% of revenue, compared to $18.9 million or 42.9% for the same
period in 2001. The increase in selling, general and administrative expense in
absolute dollars for both the three and nine months ended September 30, 2002 is
the result of increased headcount of approximately 74 employees, primarily in
sales and marketing, added facility costs, and legal expenses related to our
increased patent and trademark portfolio acquired from L&H. The decrease in
selling, general, and administrative expense as a percentage of revenue for the
nine months ended September 30, 2002 is the result of synergies associated with
the L&H acquisition, focused market spending and revenue growth.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets for the three months ended September 30,
2002 was $2.2 million compared to $6.8 million for the comparable period in
2001. Amortization of intangible assets for the nine months ended September 30,
2002 was $8.9 million compared to $20.5 million for the comparable period in
2001. The decrease in amortization expense is partially attributable to the
adoption of SFAS 142, as a result of which we ceased the amortization of
goodwill and acquired workforce of approximately $2.6 million per quarter.
Additionally, amortization expense decreased $2.6 million and $5.2 million in
the three and nine months ended September 30, 2002, respectively, due to
intangible assets that became fully amortized in the first quarter of 2002. This
reduction was offset by additional amortization of approximately $0.6 million
and $1.7 million for the three and nine months ended September 30, 2002 from the
L&H acquisition.
RESTRUCTURING AND OTHER CHARGES
In January 2002, we announced, and in March 2002 completed, a restructuring
plan to consolidate facilities, worldwide sales organizations, research and
development teams and other personnel following the December 12, 2001 L&H
acquisition. As a result, we exited facilities in both North America and Europe,
eliminating 21 employee positions, including 12 in research and development and
nine in selling, general and administrative functions. In the first quarter of
2002, we recorded a restructuring charge in the amount of $0.6 million for
severance payments to these employees and a restructuring charge of $0.4 million
for certain termination fees to be incurred as a result of exiting the
facilities, including the write-off of previously recorded assembled workforce
of $0.1 million.
During the nine months ended September 30, 2002, we paid a total of $0.7
million in severance payments, of which $0.6 million related to the March 2002
restructuring and $0.1 million related to severance paid to the former Caere
President and CEO, pursuant to a 2000 restructuring.
At September 30, 2002, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.7 million. This balance is
comprised of $0.2 million of lease exit costs resulting from the 2002
restructuring and $0.5 million of severance to the former Caere President and
CEO. The severance due to the former Caere President and CEO will be paid
through March 2005.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We anticipate that the 2002 restructuring action will provide future cost
savings of $0.4 million for the remaining three months of 2002, of which $0.3
million relates to employee-related costs and $0.1 million relates to lease exit
costs.
INCOME (LOSS) FROM OPERATIONS
As a result of the above factors, income from operations was approximately
$3.2 million in the three months ended September 30, 2002 compared to a loss of
approximately ($3.7) million in the comparable period in 2001; while income from
operations was approximately $1.9 million in the nine months ended September 30,
2002 compared with a loss of ($14.5) million in the comparable period in 2001.
OTHER INCOME (EXPENSE), NET
Other income (expense), net was ($168,000) for the three months ended
September 30, 2002, compared to $13,000 for the same period in 2001. Other
income (expense), net was ($178,000) for the nine months ended September 30,
2002 compared to ($126,000) for the same period in 2001. The change in other
income (expense), net for the three months ended September 30, 2002 from the
comparable period of 2001 is the result of higher foreign exchange currency
losses, higher interest expense and lower interest income. The change in other
income (expense), net for the nine months ended September 30, 2002 from the
comparable period of 2001 is the result of higher interest expense and lower
other income, offset by higher interest income, $113,000 of which was earned on
an IRS tax refund received in the second quarter of 2002.
INCOME (LOSS) BEFORE INCOME TAXES
Income before income taxes was approximately $3.0 million in the three
months ended September 30, 2002 compared to a loss of approximately ($3.7)
million in the comparable period in 2001; our income before income taxes was
approximately $1.7 million in the nine months ended September 30, 2002, compared
with a loss of ($14.7) million in the comparable period in 2001.
INCOME TAXES
The provision for income taxes was $162,000 for the three months ended
September 30, 2002 and consisted of foreign and state tax provisions for which
no operating loss carryforwards are available to offset the related taxable
income. The (benefit from) income taxes of ($465,000) for the three months ended
September 30, 2001 consisted of foreign and state tax provisions offset by a
state tax benefit, related to the favorable completion of a state tax audit of
Caere Corporation for 1996 and 1997.
The (benefit from) income taxes of ($166,000) for the nine months ended
September 30, 2002 consisted of foreign and state tax provisions, offset by a
federal tax benefit of ($900,000), related to a refund of taxes paid by Caere
Corporation prior to its acquisition by us. The (benefit from) income taxes of
($162,000) for the nine months ended September 30, 2001 consisted of foreign and
state tax provisions offset by the state tax benefit.
NET INCOME (LOSS)
As a result of all these factors, net income totaled approximately $2.8
million in the three months ended September 30, 2002, compared to a net loss of
approximately ($3.2) million in the comparable period in 2001; while net income
totaled approximately $1.9 million in the nine months ended September 30, 2002,
compared with a net loss of approximately ($14.5) million in the comparable
period in 2001.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, we had cash and cash equivalents of $14.4 million
and net working capital of $15.8 million as compared to $14.3 million in cash
and cash equivalents and net working capital of $9.3 million at December 31,
2001.
Net cash provided by operating activities for the nine months ended
September 30, 2002 was $6.3 million compared to $6.1 million for the same period
in 2001. Cash provided by operations in the 2002 period came primarily from
operating income, net of non-cash adjustments, and higher balances in accrued
expenses. These increases were offset primarily by higher balances in accounts
receivable, inventory, prepaid expenses and other current assets and other
assets, and lower balances in accounts payable, as well as the recognition of
revenue on a long-term contract that was classified as deferred revenue at
December 31, 2001, for which cash was collected in a prior period.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The increase in accounts receivable from December 31, 2001 is primarily the
result of the timing of the introduction of our digital capture product release
which resulted in a higher than normal level of sales in the last six weeks of
the quarter. Additionally, the increase in allowances for returns and bad debts
from December 31, 2001 is also due to the timing of our digital capture product
release, resulting in higher inventory balances at distributors, which will be
sold through to retailers in future quarters. We have not incurred any
significant losses on our accounts receivable balances.
Net cash used in investing activities during the nine months ended September
30, 2002, was $4.9 million compared to $0.2 million for the same period in 2001.
Net cash used in investing activities during the 2002 period consisted of $2.1
million in capital expenditures, which included costs to build out facilities in
both North America and Europe and $2.9 million of payments associated with
acquisitions. The comparable period in 2001 included capital expenditures of
$0.6 million, offset by $0.3 million in proceeds from the sale of property and
equipment.
Net cash used in financing activities for the nine months ended September
30, 2002 was $1.4 million compared to $1.1 million of net cash provided by
financing activities for the same period in 2001. Net cash used in financing
activities during the 2002 period consisted of proceeds of $2.5 million from the
exercise of stock options and net proceeds of $5.7 million from a private
placement of our common stock. This was offset by a $0.2 million payment on our
capital lease obligation, a $7.0 million payment to repurchase shares of our
treasury stock held by L&H, a $0.6 million payment of notes payable related to
acquisitions and a $1.8 million payment to the former Caere President and CEO in
connection with the settlement of the non-competition and consulting agreement.
Net cash provided by financing activities during the comparable period in 2001
included proceeds of $5.0 million from a private placement of our common stock,
partly offset by payments of $3.4 million to repay in full our prior line of
credit and payments of $0.5 million to repurchase shares of our stock on the
open market.
On October 7, 2002, we signed a definitive agreement with Philips to
acquire its Speech Processing Telephony and Voice Control business units, and
related intellectual property. Under the terms of the agreement, we will pay
Philips $3.0 million in cash, issue a $4.9 million note due December 31, 2003
bearing 5.0% interest per annum and issue a $27.5 million three-year,
zero-interest debenture, convertible at any time into shares of our common stock
at $6.00 per share. With respect to the cash payment, we will pay $2.0 million
at closing and an additional $1.0 million no later than December 31, 2003.
We expect to close the transaction in the first quarter of 2003. We plan to
satisfy the cash payment from our existing cash balances.
On October 31, 2002, we entered into a two year Loan and Security Agreement
(the "Loan Agreement") with Silicon Valley Bank (the "Bank") that consisted of a
$10,000,000 revolving loan (the "Credit Facility"). Borrowings under the Credit
Facility will bear interest at the Bank's prime rate plus 0.375% or 0.75%, which
is determined by our fixed charge coverage ratio, as defined in the Loan
Agreement. The maximum aggregate amount of borrowings outstanding at any one
time will be limited to the lesser of $10,000,000 or a borrowing base. The
borrowing base will be equal to either 80% or 70% of eligible accounts
receivable, as defined in the Loan Agreement, which is determined by our fixed
charge coverage ratio. Pursuant to the Loan Agreement, we will be required to
maintain certain financial and non-financial covenants, the most restrictive of
which is a quarterly minimum fixed charge coverage ratio of 1.25 to 1.00.
Borrowings under the Loan Agreement are collateralized by substantially all of
our personal property, predominantly our accounts receivable, but not our
intellectual property.
In September of 2002, we repurchased 1,461,378 shares of common stock from
L&H Holdings USA, Inc. and Lernout & Hauspie Speech Products N.V. (collectively,
L&H) at $4.79 per share for a total consideration of $7.0 million. The price per
share was based on the greater of $4.79 or the twenty day trading average
beginning August 14, 2002, which was $4.67. We also agreed to register L&H's
remaining holdings of our common stock in an underwritten public offering. If we
do not complete an underwriting public offering by January 1, 2003, the
outstanding principal and interest under the $3.5 million promissory note that
we issued in connection with the L&H acquisition will be immediately due and
payable.
Historically and through the first quarter of 2002, we have sustained
recurring losses from operations. In the quarters ended June 30 and September
30, 2002, we have attained profitability. We reported net income for the three
and nine months ended September 30, 2002, and have an accumulated deficit of
$151.4 million at September 30, 2002. We believe that operating expense levels
in combination with expected future revenues will continue to result in positive
cash flows from operations for 2002. We also believe that we have the ability to
maintain operating expenses at levels commensurate with revenues to maintain
positive cash flows from operations. Therefore, we believe that cash flows from
future operations in addition to cash on hand and cash available from our Credit
Facility will be sufficient to meet our working capital, investing, financing
and contractual obligations as they become due, including the proposed Philips
acquisition, for the foreseeable future.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following table outlines our contractual payment obligations as of
September 30, 2002:
PAYMENTS DUE BY PERIOD
----------------------------------------------------------
WITHIN WITHIN
CONTRACTUAL OBLIGATIONS (1) TOTAL 1 YEAR 2 YEARS THEREAFTER
- --------------------------- ----- ------ ------- ----------
(IN THOUSANDS)
Notes payable including interest.................. $ 3,956 $ 534 $3,422 $ --
Operating leases.................................. 7,608 1,799 3,559 2,250
Caere acquisition related costs................... 2,457 1,638 819 --
-------- ------ ------ -----
Total contractual cash obligations................ $ 14,021 $3,971 $7,800 $2,250
======== ====== ====== ======
(1) Excludes the potential impact of the proposed Philips acquisition and
potential effect of acceleration of the $3.5 million promissory note issue in
connection with the L&H acquisition.
We have not entered into any off balance sheet arrangements or transactions
with unconsolidated entities or other persons, except as otherwise disclosed.
FOREIGN OPERATIONS
We develop and sell our products throughout the world. As a result of the
Caere acquisition in March 2000, and the L&H acquisition in December 2001, we
significantly increased our presence in Europe and added operations in Asia.
With our increased international presence in a number of geographic locations
and with international revenues projected to increase in 2002, we are exposed to
changes in foreign currencies including the euro, Japanese yen and Hungarian
forint. Changes in the value of the euro or other foreign currencies relative to
the value of the U.S. dollar could adversely affect future revenues and
operating results. We do not generally hedge any of our foreign-currency
denominated transactions or expected cash flows.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" or SFAS 142. SFAS 142
requires, among other things, the discontinuance of goodwill amortization. The
standard also includes provisions for the reassessment of the useful lives of
existing recognized intangible assets and the identification of reporting units
for purposes of assessing potential future impairments of goodwill. SFAS 142
required us to complete a transitional impairment test of goodwill within six
months of the date of adoption. We have reassessed the useful lives of our
existing intangible assets, other than goodwill, and believe that the original
useful lives remain appropriate. In addition, we have determined that we operate
in one reporting unit and, therefore, have completed our transitional goodwill
impairment test on an enterprise-wide level. Based on this analysis, we have
determined that goodwill recorded was not impaired, and no impairment charge has
been recorded. We will complete additional goodwill impairment analyses at least
annually or more frequently when events and circumstances occur indicating that
the recorded goodwill might be impaired. We will perform the annual assessment
during the fourth quarter of 2002.
Significant judgments and estimates are involved in determining the useful
lives of our intangible assets, determining what reporting units exist and
assessing when events or circumstances would require an interim impairment
analysis of goodwill or other long-lived assets to be performed. Changes in
events or circumstances, including but not limited to technological advances or
competition which could result in shorter useful lives, additional reporting
units which may require alternative methods of estimating fair value, or
economic or market conditions which may affect previous assumptions and
estimates, could have a significant impact on our results of operations or
financial position through accelerated amortization expense or impairment
charges.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
144). The objectives of SFAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121), and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 supersedes SFAS 121; however, it retains
the fundamental provisions of SFAS 121 for (1) the recognition and measurement
of the impairment of long-lived assets to be held and used and (2) the
measurement of long-lived assets to be disposed of by sale. SFAS 144 supersedes
the accounting and reporting provisions of Accounting Principles Board No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" (APB 30), for segments of a business to be disposed of.
However, SFAS 144 retains the requirement of APB 30 that entities report
discontinued operations separately from continuing operations and extends that
reporting requirement to "a component of an entity" that either has
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
been disposed of or is classified as "held for sale." SFAS 144 also amends the
guidance of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to eliminate the exception to consolidation for a temporarily
controlled subsidiary. SFAS 144 is effective for financial statements issued for
fiscal years beginning after December 15, 2001, including interim periods, and,
generally, its provisions are to be applied prospectively. We adopted the
provisions of SFAS 144 in 2002 and its adoption had no impact on our results of
operations.
On January 1, 2002, we adopted EITF 01-9, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products," which
requires amounts paid to resellers to be treated as a reduction of revenue,
unless the consideration relates to an identifiable benefit, in which case such
consideration may be recorded as an operating expense. We evaluate our marketing
programs quarterly to ensure criteria are met for expense classification. The
implementation resulted in a $0.05 million and $0.3 million reduction to net
revenue and a corresponding reduction of selling, general and administrative
expenses for the three and nine months ended September 30, 2002, respectively.
Additionally, it resulted in the reclassification of $0.3 million and $0.8
million from selling, general and administrative expenses to net revenue for the
three and nine months ended September 30, 2001, respectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," or SFAS 146. This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)," or EITF 94-3. SFAS 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. We do not expect the adoption of SFAS 146
will have a material impact on our financial position or results of operations.
RISK FACTORS THAT MAY AFFECT OUR FUTURE RESULTS OF OPERATIONS
You should carefully consider the risks described below before making a
decision to invest in our common stock. The risks described below are not the
only ones facing us. Additional risks not presently known to us or that we
currently deem immaterial may also impair our business operations and financial
situation. Our business, financial condition and results of operations could be
seriously harmed by any of these risks. The trading price of our common stock
could decline due to any of these risks, and you may lose all or part of your
investment. This quarterly report contains forward-looking statements that
involve risks and uncertainties. Our actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including the risks described below.
RISKS RELATING TO OUR BUSINESS
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND SEASONALITY. IF
WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR SHARE
PRICE MAY DECREASE SIGNIFICANTLY.
Our revenue and operating results have fluctuated in the past and may not
meet the expectations of securities analysts or investors in the future. If this
occurs, the price of our stock would likely decline. Factors that may cause
fluctuations in our operating results include the following:
- slowing sales by our distribution and fulfillment partners to their
customers, which may place pressure on these partners to reduce
purchases of our products;
- volume, timing and fulfillment of customer orders;
- customers delaying their purchase decisions in anticipation of new
versions of products;
- introduction of new products by us or our competitors;
- seasonality;
- reduction in the prices of our products in response to competition or
market conditions;
- returns and allowance charges in excess of recorded amounts;
- timing of significant marketing and sales promotions;
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- increased expenditures incurred pursuing new product or market
opportunities;
- inability to adjust our operating expenses to compensate for
shortfalls in revenue against forecast;
- demand for products; and
- general economic trends as they affect retail and corporate sales.
Due to the foregoing factors, among others, our revenue and operating
results are difficult to forecast. Our expense levels are based in significant
part on our expectations of future revenue. Therefore, our failure to meet
revenue expectations would seriously harm our business, operating results,
financial condition and cash flows. Further, an unanticipated decline in revenue
for a particular quarter may disproportionately affect our profitability because
a relatively small amount of our expenses are intended to vary with our revenue
in the short term.
WE HAVE A HISTORY OF LOSSES. WE MAY INCUR LOSSES IN THE FUTURE.
Historically and through the first quarter of 2002, we have sustained
recurring losses from operations. In the quarters ended June 30 and September
30, 2002, we have attained profitability. We reported net income for the three
and nine months ended September 30, 2002, and have an accumulated deficit of
$151.4 million at September 30, 2002. We believe that operating expense levels
in combination with expected future revenues will continue to result in positive
cash flows from operations for 2002. We also believe that we have the ability to
maintain operating expenses at levels commensurate with revenues to maintain
positive cash flows from operations. Therefore, we believe that cash flows from
future operations in addition to cash on hand and cash available from our Credit
Facility will be sufficient to meet our working capital, investing, financing
and contractual obligations as they become due, including the proposed Philips
acquisition, for the foreseeable future.
OUR BUSINESS COULD BE HARMED IF WE DO NOT SUCCESSFULLY MANAGE THE INTEGRATION OF
THE BUSINESSES THAT WE ACQUIRE, INCLUDING OUR EXPECTED PURCHASE OF THE SPEECH
PROCESSING TELEPHONY AND VOICE CONTROL BUSINESS UNITS FROM PHILIPS.
As part of our business strategy, we have in the past and expect to
continue to acquire other businesses and technologies. Our recent acquisition of
the speech and language technology operations of Lernout & Hauspie Speech
Products N.V. ("L&H") required substantial integration and management efforts.
Our expected purchase of the Speech Processing Telephony and Voice Control
business units from Philips, if and when completed, will pose similar
challenges. Acquisitions involve a number of risks, including:
- difficulty in transitioning and integrating the operations and
personnel of the acquired businesses;
- potential disruption of our ongoing business and distraction of
management;
- difficulty in incorporating acquired technology and rights into our
products and technology;
- unanticipated expenses and delays in completing acquired development
projects and technology integration;
- management of geographically remote units both in the United States
and internationally;
- impairment of relationships with partners and customers;
- entering markets or types of businesses in which we have limited
experience; and potential loss of key employees of the acquired
company.
As a result of these and other risks, we may not realize anticipated
benefits from our acquisitions. Any failure to achieve these benefits or failure
to successfully integrate these acquired businesses and technologies could
seriously harm our business.
A LARGE PART OF OUR REVENUE IS DEPENDENT ON CONTINUED DEMAND FOR OUR PRODUCTS
FROM OEM PARTNERS.
Many of our technologies are licensed to partners that incorporate our
technologies into solutions that they sell to their customers. The commercial
success of these licensed products depends to a substantial degree on the
efforts of these licensees in developing and marketing products incorporating
our technologies. The integration of our technologies into their products takes
significant time, effort and investment, and products incorporating our
technologies may never be successfully implemented or marketed by our licensees.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OEM revenue represented 30% and 34% of our consolidated revenue for the
year ended December 31, 2001 and for the nine months ended September 30, 2002,
respectively. One of our partners, Xerox Corporation, accounted for 11% and 5%
of our consolidated revenue during the year ended December 31, 2001 and the nine
months ended September 30, 2002, respectively. Our partners are not required to
continue to bundle or embed our software, and they may choose the software
products of our competitors in addition to, or in place of, our products. A
significant reduction in OEM revenue would seriously harm our business, results
of operations, financial condition and our stock price.
WE RELY ON A SMALL NUMBER OF DISTRIBUTION AND FULFILLMENT PARTNERS TO DISTRIBUTE
MANY OF OUR PRODUCTS. ANY DISRUPTION IN THESE CHANNELS COULD HARM OUR RESULTS OF
OPERATIONS.
Our products are sold through, and a substantial portion of our revenue is
derived from, a variety of distribution channels, including value-added
resellers, computer superstores, consumer electronic stores, mail order houses,
office superstores and eCommerce Web sites. We rely on a small number of
distribution partners, including 1450, Digital River, Ingram Micro and Tech
Data. In particular, during the year ended December 31, 2001, one distributor,
Ingram Micro, and one direct fulfillment partner, Digital River, accounted for
28% and 15% of our consolidated revenue, respectively. For the nine months ended
September 30, 2002, Ingram Micro and Digital River accounted for 26% and 12% of
our consolidated revenue, respectively. Additionally, our distributors in the
retail channel are experiencing competition both among themselves and from the
shift to electronic commerce. Also, if any of our major distribution and
fulfillment partners were to fail to meet their financial obligations to us,
this could require us to recognize a material amount of bad debts. Any
disruption in these distribution and fulfillment partner relationships for which
we are unable to compensate could negatively affect our results of operations.
SPEECH TECHNOLOGIES MAY NOT ACHIEVE WIDESPREAD ACCEPTANCE BY BUSINESSES, WHICH
COULD LIMIT OUR ABILITY TO GROW OUR SPEECH BUSINESS.
The market for speech technologies is relatively new and rapidly evolving.
Our ability to increase revenue in the future depends in large measure on
acceptance by both our customers and the end users of speech technologies in
general and our products in particular. The continued development of the market
for our current and future speech solutions will also depend on the following
factors:
- widespread deployment and acceptance of speech technologies;
- consumer demand for speech-enabled applications;
- development by third-party vendors of applications using speech
technologies; and
- continuous improvement in speech technology.
Sales of our speech products would be harmed if the market for speech
software does not continue to develop or develops more slowly than we expect,
and, consequently, our business could be harmed.
WE HAVE GROWN, AND MAY CONTINUE TO GROW, THROUGH ACQUISITIONS, WHICH MAY RESULT
IN SIGNIFICANT INTANGIBLE ASSETS, DILUTION OF OUR EXISTING STOCKHOLDERS, USE OF
CASH AND OTHER RISKS.
We have made several significant acquisitions over the last two years, have
recently announced the purchase of certain businesses and intellectual property
from Philips and may acquire additional complementary assets, technologies or
businesses in the future. Our past acquisitions have given rise to, and future
acquisitions may result in, substantial levels of intangible assets that will be
amortized or subject to impairment analyses in future years, and our future
results will be adversely affected if we do not achieve benefits from these
acquisitions commensurate with amortization and potential impairment charges.
For example, our acquisition of Caere Corporation included a substantial
write-off of acquired in process research and development costs, and this also
may occur as a result of other acquisitions.
In connection with the Caere and the L&H acquisitions, we issued 19.0
million and 7.4 million shares of our common stock, respectively. We may
continue to issue equity securities for future acquisitions and working capital
purposes that could dilute our existing stockholders. In connection with the L&H
acquisition, we issued a promissory note for $3.5 million. Under the terms of
the Philips acquisition, we will pay Philips $3.0 million in cash, issue a $4.9
million note due December 31, 2003 bearing 5.0% interest per annum and issue a
$27.5 million three-year zero-interest debenture, convertible at any time into
shares of our common stock at $6.00 per share. Future acquisitions may also
require us to expend significant funds or incur debt. If we expend funds or
incur additional debt, our ability to obtain financing for working capital or
other purposes could decrease.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OUR REVENUE HAS BEEN DEPENDENT ON DEMAND FOR A FEW PRODUCT AREAS.
Historically, a substantial portion of our revenue has been generated by a
few product areas. For the year ended December 31, 2001, our document and PDF
conversion products represented approximately 65% of our revenue, and our
digital paper management products represented approximately 16% of our revenue.
For the nine months ended September 30, 2002, our document and PDF conversion
products represented 38% of our revenue, our speech recognition and dictation
products represented 26% of our revenue, and our digital paper management
products represented 11% of our revenue. A reduction in revenue contribution
from any of these product areas could seriously harm our business, results of
operations, financial condition, cash flows and stock price.
THE PROTECTION OF OUR PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY IS KEY TO
OUR SUCCESS.
We rely heavily on our proprietary technology, trade secrets and other
intellectual property. Unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary.
Policing unauthorized use of our products is difficult and we may not be able to
protect our technology from unauthorized use. Additionally, our competitors may
independently develop technologies that are substantially the same or superior
to ours. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as the laws of the United States. Although
the source code for our proprietary software is protected both as a trade secret
and as a copyrighted work, litigation may be necessary to enforce our
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Litigation, regardless of the outcome, can
be very expensive and can divert management efforts.
SOME OF OUR PRODUCTS INCORPORATE TECHNOLOGY WE LICENSE FROM OTHERS. IF WE CANNOT
MAINTAIN THESE LICENSES, OUR BUSINESS COULD BE SERIOUSLY HARMED.
Some of the technology included in, or operating in conjunction with, our
products is licensed by us from others. Certain of these license agreements are
for limited terms. If for any reason these license agreements terminate, we may
be required to seek alternative vendors and may be unable to obtain similar
technology on favorable terms or at all. Even if we are able to do so, we may
need to revise some of our products to make them compatible with the alternative
technology we acquire. In addition, if we are unable to obtain alternative
license agreements, we may be required to modify some features of our products,
which could adversely affect sales of our products.
THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE THAT WE ARE INFRINGING
THEIR INTELLECTUAL PROPERTY. WE COULD BE EXPOSED TO SIGNIFICANT LITIGATION OR
LICENSING EXPENSES OR BE PREVENTED FROM SELLING OUR PRODUCTS IF SUCH CLAIMS ARE
SUCCESSFUL.
Like other technology companies, from time to time, we are subject to
claims that we or our customers may be infringing or contributing to the
infringement of the intellectual property rights of others. We may be unaware of
intellectual property rights of others that may cover some of our technologies
and products. If it appears necessary or desirable, we may seek licenses for
these intellectual property rights. However, we may not be able to obtain
licenses from any or all claimants, the terms of any offered licenses may not be
acceptable to us, and we may not be able to resolve disputes without litigation.
Any litigation regarding intellectual property could be costly and time
consuming and could divert the attention of our management and key personnel
from our business operations. In the event of a claim of intellectual property
infringement, we may be required to enter into costly royalty or license
agreements. Third parties claiming intellectual property infringement may be
able to obtain injunctive or other equitable relief that could effectively block
our ability to develop and sell our products.
In December 2001, we were sued for patent infringement initiated by the
Massachusetts Institute of Technology and Electronics For Imaging, Inc. We were
one of more than 200 defendants named in this suit. Damages are sought in an
unspecified amount. We filed an Answer and Counterclaim on July 1, 2002. We
cannot predict the outcome of the claim, nor can we make any estimate of the
amount of damages, if any, for which we will be held responsible in the event of
a negative conclusion of the claim. We believe this claim has no merit, and we
intend to defend the action vigorously.
On August 16, 2001, we were sued by Horst Froessl for patent infringement.
Damages are sought in an unspecified amount. We filed an Answer and Counterclaim
on September 19, 2001. We believe this claim has no merit, and we intend to
defend the action vigorously.
We believe that the final outcome of the current litigation matters
described above will not have a significant adverse effect on our financial
position and results of operations and we believe that we will not be required
to expend a significant amount of resources defending such claims. However,
should we not prevail in these litigation matters, our operating results,
financial position and cash flows could be adversely impacted. If any third
parties are successful in intellectual property infringement claims against us,
we maybe subject to significant damages and our operating results and financial
position could be harmed.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE AND RAPIDLY CHANGING. WE
MAY BE UNABLE TO COMPETE SUCCESSFULLY AGAINST NEW ENTRANTS AND ESTABLISHED
COMPANIES WITH GREATER RESOURCES.
There are a number of companies that develop or may develop products that
compete in our targeted markets; however, there is no one company that competes
with us in all of our products areas. The individual markets in which we compete
are highly competitive, and are rapidly changing. Within digital capture, we
compete directly with ABBYY, I.R.I.S. and NewSoft. Within speech, we compete
with AT&T, IBM, Nuance Communications, Philips Electronics and SpeechWorks
International. Vendors such as Adobe and Microsoft offer solutions that can be
considered alternatives to some of our solutions. In addition, a number of
smaller companies produce technologies or products that are in some markets
competitive with our solutions. Current and potential competitors have
established, or may establish, cooperative relationships among themselves or
with third parties to increase the ability of their technologies to address the
needs of our prospective customers.
The competition in these markets could adversely affect our operating
results by reducing the volume of the products we sell or the prices we can
charge. Some of our current or potential competitors have significantly greater
financial, technical and marketing resources than we do. These competitors may
be able to respond more rapidly than we can to new or emerging technologies or
changes in customer requirements. They may also devote greater resources to the
development, promotion and sale of their products than we do. The price and
performance of our products and technologies may not be superior relative to the
products of our competitors. As a result, we may lose competitive position that
could result in lower prices, fewer customer orders, reduced revenue, reduced
gross margins and loss of market share. Our products and technologies may not
achieve market acceptance or sell at favorable prices, which could hurt our
revenue, results of operations and the price of our common stock.
Some of our customers, such as Microsoft, have developed or acquired
products or technologies that compete with our products and technologies. These
customers may give higher priority to the sale of these competitive products or
technologies. To the extent they do so, market acceptance and penetration of our
products, and therefore our revenue, may be adversely affected.
Our success will depend substantially upon our ability to enhance our
products and technologies and to develop and introduce, on a timely and
cost-effective basis, new products and features that meet changing customer
requirements and incorporate technological advancements. If we are unable to
develop new products and enhance functionalities or technologies to adapt to
these changes, or are unable to realize synergies among our acquired products
and technologies, our business will suffer.
OUR SOFTWARE PRODUCTS MAY HAVE BUGS, WHICH COULD RESULT IN DELAYED OR LOST
REVENUE, EXPENSIVE CORRECTION, LIABILITY TO OUR CLIENTS AND CLAIMS AGAINST US.
Complex software products such as ours may contain errors, defects or bugs.
Defects in the solutions or products that we develop and sell to our customers
could require expensive corrections and result in delayed or lost revenue,
adverse client reaction and negative publicity about us or our products and
services. Customers who are not satisfied with any of our products could bring
claims against us for damages, which, even if unsuccessful, would likely be
time-consuming to defend, and could result in costly litigation and payment of
damages. Such claims could harm our financial results and competitive position.
OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS.
Since we sell our products worldwide, our business is subject to risks
associated with doing business internationally. We anticipate that revenue from
international operations will represent an increasing portion of our total
revenue. Reported international revenue for the year ended December 31, 2001 and
the nine months ended September 30, 2002, represented 21% and 26% of our
consolidated revenue for those periods, respectively. A number of our OEM
partners distribute their products throughout the world and do not provide us
with the geographical dispersion of their products. However, based on an
estimate that factors our OEM partners' geographical revenue mix to our revenue
generated from these OEM partners, international revenue would have represented
approximately 28% and 31% of our consolidated revenue for the year ended
December 31, 2001 and the nine months ended September 30, 2002, respectively.
In addition, some of our products are developed and manufactured outside
the United States. A significant portion of the development and manufacturing of
our speech products are completed in Belgium, and a significant portion of our
digital capture research and development is conducted in Hungary. In addition,
if and when we close the Philips acquisition, we will add an additional research
and development location in Germany. Our future results could be harmed by a
variety of factors associated with international sales and operations,
including:
- changes in a specific country's or region's political or economic
conditions;
- trade protection measures and import or export licensing requirements
imposed by the United States or by other countries;
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- negative consequences from changes in applicable tax laws;
- difficulties in staffing and managing operations in multiple locations
in many countries;
- difficulties in collecting trade accounts receivable in other
countries; and
- less effective protection of intellectual property.
WE ARE EXPOSED TO FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES.
Because we have international subsidiaries and distributors that operate
and sell our products outside the United States, we are exposed to the risk of
changes in foreign currency exchange rates or declining economic conditions in
these countries. We generally do not engage in hedging transactions to manage
our exposure to currency fluctuations. Our exposure to currency rate
fluctuations could affect our results of operations and cash flows.
IF WE ARE UNABLE TO ATTRACT AND RETAIN TECHNICAL AND OPERATIONAL PERSONNEL, OUR
BUSINESS COULD BE HARMED.
If any of our key employees were to leave us, we could face substantial
difficulty in hiring qualified successors and could experience a loss in
productivity while any successor obtains the necessary training and experience.
Our employment relationships are generally at-will and we have had key employees
leave us in the past. We cannot assure you that one or more key employees will
not leave us in the future. We intend to continue to hire additional highly
qualified personnel, including software engineers and operational personnel, but
we may not be able to attract, assimilate or retain qualified personnel in the
future. Any failure to attract, integrate, motivate and retain these employees
could harm our business.
FUTURE SALES OF OUR COMMON STOCK BY ANY OF OUR STOCKHOLDERS COULD CAUSE OUR
STOCK PRICE TO DECREASE.
If our stockholders sell substantial amounts of our common stock in the
public market, or if public investors believe that these stockholders are likely
to sell substantial amounts of our common stock in the near future, the market
price of our common stock could decrease.
THE STOCKHOLDINGS OF OUR TWO LARGEST STOCKHOLDERS MAY ENABLE THEM TO INFLUENCE
MATTERS REQUIRING STOCKHOLDER APPROVAL.
As of October 15, 2002, Xerox beneficially owned approximately 23.7% of
our outstanding common stock, including warrants exercisable for up to 525,732
shares of our common stock and 3,562,238 shares of our outstanding Series B
Preferred Stock, each of which is convertible into one share of our common
stock. The number of shares of common stock issuable upon exercise of the Xerox
warrant may increase in accordance with a formula defined in the warrant
agreement. The State of Wisconsin Investment Board (SWIB) is our second largest
stockholder, owning approximately 18.6% of our common stock as of October 15,
2002. Because of their large holdings of our capital stock relative to other
stockholders, Xerox and SWIB, acting individually or together, could have a
strong influence over matters requiring approval by our stockholders.
THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE SUBJECT TO
WIDE FLUCTUATIONS.
Our stock price historically has been and may continue to be volatile.
Various factors contribute to the volatility of our stock price, including, for
example, quarterly variations in our financial results, new product
introductions by us or our competitors and general economic and market
conditions. While we cannot predict the individual effect that these factors may
have on the market price of our common stock, these factors, either individually
or in the aggregate, could result in significant volatility in our stock price
during any given period of time. Moreover, companies that have experienced
volatility in the market price of their stock often are subject to securities
class action litigation. If we were the subject of such litigation, it could
result in substantial costs and divert management's attention and resources.
WE HAVE IMPLEMENTED ANTI-TAKEOVER PROVISIONS, WHICH COULD DISCOURAGE OR PREVENT
A TAKEOVER, EVEN IF AN ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS.
Provisions of our amended and restated certificate of incorporation,
bylaws and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. These
provisions include:
- a classified board of directors;
- a "poison pill", resulting in significant dilution to the holdings of
a hostile acquiror;
25
- authorized "blank check" preferred stock;
- prohibiting cumulative voting in the election of directors;
- limiting the ability of stockholders to call special meetings of
stockholders;
- requiring all stockholder actions to be taken at meetings of our
stockholders; and
- establishing advance notice requirements for nominations of directors
and for stockholder proposals.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop our products in the United States, Belgium and Hungary. We sell
our products globally, primarily through an indirect reseller channel. As a
result, our financial results are affected by factors such as changes in foreign
currency exchange rates and weak economic conditions in foreign markets.
We collect a portion of our revenue and pay a portion of our operating
expenses in foreign currencies. As a result, changes in currency exchange rates
from time to time may affect our operating results. Currently, we do not engage
in hedging transactions to reduce our exposure to changes in currency exchange
rates, although we may do so in the future.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their
evaluation as of a date within 90 days of the filing date of this quarterly
report on Form 10-Q, the Company's principal executive officer and principal
financial officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act) are effective to ensure that information required to be disclosed
by the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms.
(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed on the Exhibit Index hereto are filed or incorporated
by reference (as stated therein) as part of this report on Form 10-Q.
(b) Reports on Form 8-K
On September 13, 2002, ScanSoft filed an amendment to Form 8-K, filed on
December 27, 2001, to report under Item 2 the acquisition of certain assets of
the speech and language technology operations of L&H as an acquisition of a
business, and to include under Item 7 audited and pro forma financial
information with respect to such acquired business, as required by Rule 3-05 and
Article 11 of Regulation S-X, respectively.
On October 8, 2002, ScanSoft filed a report on Form 8-K reporting under
Item 5 that ScanSoft entered into a definitive agreement to acquire Philips
Speech Processing Business Units and related intellectual property.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Peabody, State of
Massachusetts, on November 14, 2002.
SCANSOFT, INC.
By: /s/ GERALD C. KENT, JR
-------------------------------
Gerald C. Kent, Jr.
Vice President, Chief Accounting Officer
and Controller
28
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Paul A. Ricci, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ScanSoft, Inc.
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
By: /s/ PAUL A. RICCI
------------------------
Paul A. Ricci
Chief Executive Officer and
Chairman of the Board
November 14, 2002
29
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Richard S. Palmer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ScanSoft, Inc.
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
By: /s/ RICHARD S. PALMER
----------------------------
Richard S. Palmer
Senior Vice President and
Chief Financial Officer
November 14, 2002
30
EXHIBIT INDEX
Exhibits (numbered in accordance with Item 601 of Regulation S-K)
EXHIBIT NO. DESCRIPTION OF EXHIBITS
2.1(1) Agreement and Plan of Merger dated December 2, 1998, between
Visioneer, Inc., a Delaware corporation, and Registrant.
2.2(2) Agreement and Plan of Reorganization, dated January 15, 2000,
by and among ScanSoft, Inc., a Delaware corporation, Scorpion
Acquisitions Corporation, a Delaware corporation and a
wholly-owned subsidiary of ScanSoft, and Caere Corporation, a
Delaware corporation.
2.3(3) Asset Purchase Agreement, dated as of December 7, 2001, by and
among the Registrant, Lernout & Hauspie Speech Products N.V.,
L&H Holdings USA, Inc. and certain other parties.
2.4(4) Purchase Agreement, dated October 7, 2002, between Koninklijke
Philips Electronics N.V. and the Registrant.
3.1(5) Amended and Restated Certificate of Incorporation of
Registrant.
3.2(6) Bylaws of the Registrant.
4.1(7) Specimen Common Stock Certificate.
4.2(8) Preferred Shares Rights Agreement, dated as of October 23,
1996, between the Registrant and U.S. Stock Transfer
Corporation, including the Certificate of Designation of
Rights, Preferences and Privileges of Series A Participating
Preferred Stock, the form of Rights Certificate and Summary of
Rights attached thereto as Exhibits A, B and C, respectively.
4.3(1) Common Stock Purchase Warrant.
4.4(4) Lock-Up Agreement, dated September 16, 2002, by and between
Lernout & Hauspie Speech Products N.V., L&H Holdings USA and
Paul A. Ricci.
4.5(4) Lock-Up Agreement, dated September 16, 2002, by and between
Lernout & Hauspie Speech Products N.V., L&H Holdings USA and
Michael K. Tivnan.
4.6(4) Form of Lock-Up Agreement, dated September 16, 2002, by and
between Lernout & Hauspie Speech Products N.V., L&H Holdings
USA and certain of the Registrant's officers and directors.
10.1(4) Agreement for the sale and purchase of certain shares of
Registrant held by Lernout & Hauspie Speech Products N.V. and
L&H Holdings USA, dated as of September 16, 2002, by and among
Registrant, Lernout & Hauspie Speech Products N.V. and L&H
Holdings USA.
10.2 Silicon Valley Bank Loan and Security Agreement
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 (No. 333-70603) filed with the Commission on January 14,
1999.
(2) Incorporated by reference from the Registrant's Registration Statement
on Form S-4 (No. 333-96487) filed with the Commission on February 9,
2000.
31
EXHIBIT INDEX
(3) Incorporated by reference from the Registrant's Current Report on Form
8-K filed with the Commission on December 27, 2001.
(4) Incorporated by reference from the Registrant's Registration Statement
on Form S-1 (No. 333-100647) filed with the Commission on October 21,
2002.
(5) Incorporated by reference from the Registrant's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 31, 2001, filed with the
Commission on May 11, 2001.
(6) Incorporated by reference from the Registrant's Registration Statement
on Form S-1 (No. 333-98356) filed with the Commission on October 19,
1995.
(7) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement of Form 8-A (No. 0-27038) filed with the
Commission on December 6, 1995.
(8) Incorporated by reference from the Registrant's current Report on Form
8-K filed with the Commission on October 31, 1996.
32