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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 MARCH 31, 2003
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-27038
SCANSOFT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3156479
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12-b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
----
65,726,533 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of April 30, 2003.
SCANSOFT, INC.
FORM 10-Q
THREE MONTHS ENDED MARCH 31, 2003
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets at March 31, 2003 and December 31, 2002........................................... 3
b) Consolidated Statements of Operations for the three months ended March 31, 2003 and March 31, 2002............ 4
c) Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and March 31, 2002............ 5
d) Notes to Consolidated Financial Statements.................................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................... 29
Item 4. Controls and Procedures ......................................................................................... 30
PART II: OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................................................. 30
Signatures................................................................................................................ 31
Certifications ........................................................................................................... 32
Exhibit Index............................................................................................................. 34
2
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2003 2002
------------- -----------
ASSETS
Current assets:
Cash and cash equivalents........................................................................ $ 20,277 $ 18,853
Accounts receivable, less allowances of $9,202 and $5,903, respectively.......................... 19,482 15,650
Receivables from related party .................................................................. 1,231 1,518
Inventory........................................................................................ 1,367 1,241
Prepaid expenses and other current assets........................................................ 4,119 3,167
------------ ------------
Total current assets.......................................................................... 46,476 40,429
Goodwill......................................................................................... 97,117 63,059
Other intangible assets, net..................................................................... 49,569 33,823
Property and equipment, net...................................................................... 3,387 2,846
Other assets..................................................................................... 1,207 3,533
------------ ------------
Total assets.................................................................................. $ 197,756 $ 143,690
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................................. $ 8,847 $ 7,085
Accrued expenses................................................................................. 11,923 9,773
Deferred revenue................................................................................. 2,782 1,790
Note payable..................................................................................... 5,458 3,273
Deferred payment for business acquisition ....................................................... 1,052 --
Deferred payment for technology license.......................................................... 9,434 --
Other current liabilities........................................................................ 1,666 1,666
------------ ------------
Total current liabilities..................................................................... 41,162 23,587
Deferred revenue................................................................................... 209 244
Long-term note payable............................................................................. 27,524 --
Other liabilities.................................................................................. 3,236 481
------------ ------------
Total liabilities............................................................................. 72,131 24,312
------------ ------------
Commitments and contingencies (Notes 5, 13 and 16)
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; 67,820,379 and 65,540,154 shares
issued and 65,703,001 and 63,422,776 shares outstanding, respectively......................... 68 66
Additional paid-in capital....................................................................... 276,007 269,858
Treasury stock, at cost (2,117,378 and 2,117,378 shares, respectively)........................... (8,031) (8,031)
Deferred compensation............................................................................ (147) (173)
Accumulated other comprehensive loss............................................................. (53) (47)
Accumulated deficit.............................................................................. (146,850) (146,926)
------------ ------------
Total stockholders' equity.................................................................... 125,625 119,378
------------ ------------
Total liabilities and stockholders' equity.................................................... $ 197,756 $ 143,690
============ ============
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
MARCH 31,
-------------------------
2003 2002
------------ --------
Revenue, third parties................................................................... $ 26,516 $ 22,416
Revenue, related party................................................................... 1,320 1,349
----------- -----------
Total revenue....................................................................... 27,836 23,765
----------- -----------
COSTS AND EXPENSES:
Cost of revenue........................................................................ 4,302 4,129
Cost of revenue from amortization of intangible assets................................. 2,057 3,542
Research and development............................................................... 7,177 6,986
Selling, general and administrative.................................................... 13,261 9,711
Amortization of other intangible assets................................................ 361 957
Restructuring and other charges, net................................................... 529 1,041
----------- ----------
Total costs and expenses............................................................ 27,687 26,366
----------- -----------
Income (loss) from operations............................................................ 149 (2,601)
Other income (expense):
Interest income........................................................................ 41 54
Interest expense....................................................................... (80) (85)
Other income (expense), net............................................................ 61 (44)
----------- -----------
Income (loss) before income taxes........................................................ 171 (2,676)
Provision for income taxes............................................................... 95 206
----------- -----------
Net income (loss)........................................................................ $ 76 $ (2,882)
=========== ===========
Net income (loss) per share: basic and diluted........................................... $ 0.00 $ (0.05)
=========== ===========
Weighted average common shares outstanding: basic........................................ 67,689 62,304
=========== ===========
Weighted average common shares outstanding: diluted...................................... 77,220 62,304
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................................................................ $ 76 $ (2,882)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation........................................................................ 415 450
Amortization of goodwill and other intangible assets................................ 2,418 4,499
Accounts receivable allowances...................................................... 171 1,060
Non-cash portion of restructuring charges........................................... -- 113
Deferred compensation............................................................... 26 26
Foreign exchange gain............................................................... (46) --
Non-cash interest expense.......................................................... 9 --
Changes in operating assets and liabilities, net of effects from business
acquisitions:
Accounts receivable.............................................................. (211) (624)
Inventory........................................................................ 238 (688)
Prepaid expenses and other current assets........................................ 359 (754)
Other assets..................................................................... (94) 121
Accounts payable................................................................. 1,309 1,593
Accrued expenses................................................................. (2,019) (175)
Other liabilities................................................................ 271 --
Deferred revenue................................................................. (63) (2,540)
---------- ------------
Net cash provided by operating activities......................................... 2,859 199
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment........................................ (605) (661)
Cash paid for acquisitions, including transaction costs net of cash received........... (4,341) (1,162)
----------- ------------
Net cash used in investing activities............................................... (4,946) (1,823)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of note payable................................................................ (3,273) (55)
Payments of capital lease obligation................................................... -- (105)
Payments under deferred payment agreement.............................................. (410) (1,000)
Proceeds from issuance of common stock, net of issuance costs.......................... 6,773 --
Proceeds from issuance of common stock under employee stock compensation plans......... 531 1,240
---------- -----------
Net cash provided by financing activities......................................... 3,621 80
---------- -----------
Effects of exchange rate changes on cash and cash equivalents............................ (110) 3
----------- -----------
Net increase (decrease) in cash and cash equivalents..................................... 1,424 (1,541)
Cash and cash equivalents at beginning of period......................................... 18,853 14,324
---------- -----------
Cash and cash equivalents at end of period............................................... $ 20,277 $ 12,783
========== ===========
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", 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 March 31, 2003 and 2002 and the
results of operations and cash flows for the three months ended March 31, 2003
and 2002. 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 as
permitted by 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, 2002 filed
with the Securities and Exchange Commission on March 28, 2003. The results for
the three months ended March 31, 2003 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2003, or any
future period.
On January 30, 2003, the Company completed the acquisition of the Philips
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property (the "Philips
acquisition"). The Telephony business unit offers speech-enabled services
including directory assistance, interactive voice response and voice portal
applications for enterprise customers, telephony vendors and carriers. The Voice
Control business unit offers a product portfolio including small footprint
speech recognition engines for embedded applications such as voice-controlled
climate, navigation and entertainment features in automotive vehicles, as well
as voice dialing for mobile phones. The results of operations of the acquired
business have been included in the financial statements of the Company as of
January 30, 2003, the date of acquisition.
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. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Foreign Currency Risk Management
In certain circumstances, the Company enters into forward exchange
contracts to hedge against foreign currency fluctuations. These contracts are
used to reduce the Company's risk associated with exchange rate movements, as
the gains or losses on these contracts are intended to offset the exchange rate
losses or gains on the underlying exposures. The Company does not engage in
foreign currency speculation. Hedges of underlying exposures are designated and
documented at the inception of the hedge and are evaluated for effectiveness
monthly. Forward exchange contracts hedging firm commitments qualify for hedge
accounting when they are designated as a hedge of the foreign currency exposure
and they are effective in minimizing such exposure. Gains and losses on forward
exchange contracts that qualify for hedge accounting are recognized as other
comprehensive income (loss), along with the associated losses and gains on the
hedged item. As the terms of the forward exchange contract and underlying
exposure are matched generally at inception, hedging effectiveness is calculated
by comparing the change in fair value of the contract to the change in fair
value of the underlying exposure. Based upon period-end exchange rates, the
Company estimates the aggregate contract value of the forward exchange contracts
to be representative of the fair value of these instruments.
On January 30, 2003, the Company entered into a forward exchange contract
to hedge the foreign currency exposure of its 5 million euro note payable to
Philips. The contract and the note payable each have a term that expires on
December 31, 2003. For the quarter ended March 31, 2003, the Company recorded a
net exchange rate gain of approximately $7,000 in other comprehensive income on
the note payable and associated forward exchange contract.
Recently Issued Accounting Pronouncements
In November 2002, the Emerging Issues Task Force ("EITF") issued EITF No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." EITF
No. 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple revenue-generating activities.
EITF No. 00-21 establishes three principles: revenue should be recognized
separately for separate units of accounting, revenue for a separate unit of
accounting should be recognized only when the arrangement consideration is
reliably measurable and the earnings process is substantially complete, and
consideration should be allocated among the separate units of accounting in an
arrangement based on their fair value. EITF No. 00-21 is effective for all
revenue arrangements entered into in fiscal periods beginning after June 15,
2003, with early adoption permitted. The Company does not expect the adoption of
EITF No. 00-21 to have a material impact on its results of operations or
financial condition.
3. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company recognizes compensation costs using the intrinsic value-based
method described in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees".
6
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table illustrates the effect on net income (loss) and basic and
diluted net income (loss) per common share as if the fair value method
prescribed in Statement of Financial Accounting Standards No. 123, "Accounting
For Stock-Based Compensation", had been applied for the Company's stock-based
compensation and recorded in the consolidated financial statements:
THREE MONTHS ENDED
MARCH 31,
------------------
(in thousands, except per share data) 2003 2002
---------- --------
Net income (loss) -- as reported................................................... $ 76 $ (2,882)
Less: Total stock-based employee compensation expense determined under the
fair value-based-method............................................................ (2,310) (1,594)
----------- ------------
Net loss -- pro forma.............................................................. $ (2,234) $ (4,476)
========== ===========
Net income (loss) per share -- as reported: basic and diluted...................... $ 0.00 $ (0.05)
Net loss per share -- pro forma: basic and diluted................................. $ (0.03) $ (0.07)
4. INVENTORY
Inventory consists of the following (in thousands):
MARCH 31, DECEMBER
--------- --------
2003 31, 2002
---- --------
Raw materials................................................................................... $ 26 $ 26
Finished goods.................................................................................. 1,341 1,215
--------- ---------
$ 1,367 $ 1,241
========= =========
5. ACQUISITION OF PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL BUSINESS
On January 30, 2003, the Company completed the acquisition of the Philips
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property. The Telephony
business unit offers speech-enabled services including directory assistance,
interactive voice response and voice portal applications for enterprise
customers, telephony vendors and carriers. The Voice Control business unit
offers a product portfolio including small footprint speech recognition engines
for embedded applications such as voice-controlled climate, navigation and
entertainment features in automotive vehicles, as well as voice dialing for
mobile phones.
The acquisition of the Philips Speech Processing Telephony and Voice Control
business enhances the Company's market share in key markets and gives the
Company additional competitive momentum in its target markets, specifically the
telephony, automotive and embedded markets. In addition, it enhances the
distribution channel adding new reference accounts for both customer
relationships and technology partners. These incremental intangible benefits
attributed to excess purchase consideration resulting in goodwill.
The results of operations of the acquired business have been included in the
financial statements of the Company since the date of acquisition.
Consideration for the acquisition, including transaction costs of $2.1
million, before determination of the purchase price adjustment to be determined
by the parties as described below totaled $39.5 million. The consideration
consisted of 3.1 million euros ($3.4 million) in cash paid at closing, subject
to adjustment in accordance with the provisions of the purchase agreement, as
amended, and a deferred payment of 1.0 million euros in cash due no later than
December 31, 2003, a 5.0 million euro note due December 31, 2003 bearing 5.0%
interest per annum and a
7
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
$27.5 million three-year, zero-interest subordinated debenture, convertible at
any time at Philips' option into shares of common stock at $6.00 per share. The
fair value of the convertible debenture was determined to be $27.5 million based
on the present value of the expected cash outflows using an incremental
borrowing rate of 12% and the value of the conversion feature based on the
Black-Scholes option pricing calculation using the following assumptions: the
fair value of the Company's common stock of $3.62 per share, the closing price
of the Company's common stock on the day the parties entered into the
acquisition agreement, volatility of 100%, risk-free interest rate of 2.16%, no
dividends and an expected term of 3 years.
The following allocation is based on the January 30, 2003 balance sheet of
the Philips Speech Processing Telephony and Voice Control business units:
Total consideration:
Cash................................................. $ 3,350
Other current liability (1.0 million euro payable) .. 1,080
Note payable......................................... 5,410
Convertible debenture................................ 27,520
Transaction costs.................................... 2,100
----------
Total purchase consideration....................... $ 39,460
==========
Preliminary allocation of the purchase consideration:
Current assets....................................... $ 3,930
Property, plant and equipment........................ 310
Identifiable intangible assets....................... 5,650
Goodwill............................................. 34,130
----------
Total assets acquired 44,020
----------
Current liabilities.................................. (4,560)
==========
$ 39,460
==========
Current assets acquired primarily relate to accounts receivable, and
current liabilities assumed primarily relate to accounts payable and assumed
contractual liabilities related to development work with customers which were
agreed to prior to the acquisition date. The Company also assumed certain
contractual liabilities, which relate to projects for the development of speech
and language databases with the European Union. The fair value of the liability
on these European Union contracts is still being determined based on the
contractual nature of assignability of these contracts. Upon final determination
of the fair value any adjustment to the liability will result in a corresponding
adjustment to goodwill.
The purchase price is subject to adjustment based on a calculation set forth
in the purchase agreement, as amended, which must be agreed upon by the parties
and which may result in an adjustment either to increase or decrease the total
purchase consideration. Upon final determination of the purchase price
adjustment, a corresponding adjustment will be recorded to goodwill.
The following are the identifiable intangible assets acquired and the
respective periods over which the assets will be amortized on a straight-line
basis:
AMOUNT AMORTIZATION
(IN THOUSANDS) PERIOD
(IN YEARS)
Patents and core technology.................................................. $ 3,990 10
Completed technology......................................................... 460 5.5
Customer relationships....................................................... 1,030 1.8
Trade names and trademarks................................................... 170 5
----------
$ 5,650 9.3
==========
The values of the patents and core technology, completed technology,
contractual customer relationships and trade names and trademarks were
determined
8
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
using the income approach. The income approach requires a projection of revenues
and expenses specifically attributed to the intangible assets. The discounted
cash flow ("DCF") method is then applied to the potential income streams after
making necessary adjustments with respect to such factors as the wasting nature
of the identifiable intangible assets and the allowance of a fair return on the
net tangible assets and other intangible assets employed. There are several
variations on the income approach, including the relief-from-royalty method, the
avoided cost method and the lost profits method. The relief-from-royalty method
was used to value the patents, core technology and trade names and trademarks.
The relief-from-royalty method is used to estimate the cost savings that accrue
to the owner of the intangible assets that would otherwise have to pay royalties
or licensee fees on revenues earned through the use of the asset. The royalty
rate used in the analysis is based on an analysis of empirical, market-derived
royalty rates for guideline intangible assets.
Typically, revenue is projected over the expected remaining useful life of
the intangible asset. The market-derived royalty rate is then applied to
estimate the royalty savings. The key assumptions used in valuing the patents
and core technology are as follows: royalty rate 5%, discount rate 16%, tax rate
40% and estimated life of 10 years. The key assumptions used in valuing the
completed product technology are as follows: royalty rate 5%, discount rate 16%,
tax rate 40% and weighted average 5.5 years. The key assumptions used in valuing
the trade names and trademarks are as follows: observed royalty rate 0.25%,
discount rate 15%, tax rate 40% and estimated life of 5 years. The key
assumptions used in valuing the contractual customer relationships are as
follows: tax rate 40% and weighted average life of 1.8 years.
Based on the preliminary purchase price allocation above, the Company
allocated $34.1 million of the purchase consideration to goodwill. All goodwill
and other intangible assets will be deductible for tax purposes.
Under the terms of the purchase agreement, as amended, Philips agreed to
reimburse the Company for the costs, up to 5 million euros, associated with
certain restructuring actions taken through December 31, 2003, primarily
headcount and facilities related charges associated with operations based in
Germany. As of March 31, 2003, the Company entered into severance agreements
with a total of 70 employees of Philips resulting in severance costs totaling
$1.3 million. Of these amounts, 34 employees and related severance costs of $1.0
million were subject to reimbursement by Philips pursuant to the purchase
agreement and as such a related receivable was recorded and remains outstanding
at March 31, 2003. The remainder was recorded as part of the purchase price
allocation in accordance with EITF 95-3, "Recognition of Liabilities in
Connection with a Purchase Business Combination." To the extent that the total
reimbursable costs exceed 5.0 million euros as of or at any time prior to
December 31, 2003, Philips will reimburse the Company for one-third of the
excess and the Company will be responsible for the remaining two-thirds of any
excess. To the extent that the total reimbursable costs are less than 5.0
million euros at December 31, 2003, Philips will pay to the Company an amount
equal to two-thirds of such difference. Any adjustment will either increase or
decrease the total purchase consideration and a corresponding adjustment will be
recorded to goodwill.
The final purchase price, adjusted for the matters described in this Note 5,
is expected to be determined no later than December 31, 2003.
PRO FORMA RESULTS (UNAUDITED)
The following table reflects unaudited pro forma results of operations of
the Company assuming that the Philips acquisition had occurred on January 1,
2003 and 2002, respectively (in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31,
------------------------
2003 2002
--------- ---------
Revenues.......................................................... $ 28,952 $ 27,187
Net loss.......................................................... $ (547) $ (5,915)
Net loss per diluted share........................................ $ (0.01) $ (0.09)
The unaudited pro forma results of operations are not necessarily indicative
of the actual results that would have occurred had the transactions actually
taken place at the beginning of these periods.
9
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. GOODWILL
As noted in Note 5, the Company completed the Philips acquisition on January
30, 2003 adding $34.1 million to goodwill.
7. OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
GROSS NET
CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT
------ ------------ ------
MARCH 31, 2003
Patents and core technology.................................................... $ 54,080 $ 22,374 $ 31,706
Completed technology........................................................... 29,314 16,354 12,960
Trademarks..................................................................... 5,671 1,895 3,776
Non-competition agreement...................................................... 4,048 4,048 --
Acquired favorable lease....................................................... 553 553 --
Customer relationships......................................................... 2,130 1,003 1,127
Other.......................................................................... 200 200 --
--------- --------- ---------
$ 95,996 $ 46,427 $ 49,569
========= ========= =========
DECEMBER 31, 2002
Patents and core technology.................................................... $ 50,090 $ 20,331 $ 29,759
Completed technology........................................................... 16,340 16,340 --
Trademarks..................................................................... 5,501 1,725 3,776
Non-competition agreement...................................................... 4,048 4,048 --
Acquired favorable lease....................................................... 553 553 --
Customer relationships......................................................... 1,100 812 288
Other.......................................................................... 200 200 --
--------- --------- ---------
$ 77,832 $ 44,009 $ 33,823
========= ========= =========
On March 31, 2003, the Company entered into an agreement that grants
an exclusive license to the Company to resell, in certain geographies worldwide,
certain productivity applications. This period of exclusivity of the license
expires after 7 years unless terminated earlier as allowed under the agreement.
Total consideration paid by the Company for the license is $13.0 million and
will be paid as follows: 1) $6.4 million on or before June 30, 2003, 2) $3.3
million on March 31, 2004 and 3) $3.3 million on March 31, 2005. Based on the
net present value of the deferred payments due in 2004 and 2005, using an
interest rate of 7.0%, the Company recorded $12.3 million as completed
technology which will be amortized to cost of goods sold based on the greater of
(a) the ratio of current gross revenue to total current and future revenues for
the product(s) or (b) the straight-line basis over the period of expected use,
seven years. The difference of $0.7 million, representing the difference between
the stated price and the net present value of the payments, will be charged to
interest expense over the payment period. As of March 31, 2003, payments due on
or before March 31, 2004, and the remaining balance due, have been classified
as deferred payment for technology license and other liabilities, long-term
respectively.
On March 31, 2003, the Company acquired certain intellectual property assets
related to multimodal speech technology, in exchange for $0.1 million in cash
and the issuance of a warrant valued at $0.1 million (Note 14). The purchase
price was recorded as completed technology and will be amortized over three
years.
10
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Aggregate amortization expense was $2.4 million and $4.5 million (of which
$2.1 million and $3.5 million was included in cost of revenue) for the
three-month period ended March 31, 2003 and 2002, respectively. Estimated
amortization expense for the remaining period of fiscal year 2003, the four
succeeding fiscal years and thereafter as of March 31, 2003 is as follows (in
thousands):
SELLING,
COST OF GENERAL AND
YEAR ENDING REVENUE ADMINISTRATIVE TOTAL
---------- -------------- ----------
2003............................................................... $ 7,577 $ 1,149 $ 8,726
2004............................................................... 9,767 1,044 10,811
2005............................................................... 5,366 550 5,916
2006............................................................... 4,286 335 4,621
2007............................................................... 4,270 293 4,563
Thereafter......................................................... 13,400 1,532 14,932
------ -------- ----------
Total.............................................................. $ 44,666 $ 4,903 $ 49,569
========== ======== ==========
8. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
MARCH 31, DECEMBER 31,
--------- ------------
2003 2002
---- ----
Compensation............................................................................... $ 1,673 $ 2,122
Sales and marketing incentives............................................................. 2,431 1,802
Restructuring.............................................................................. 922 665
Royalties.................................................................................. 280 238
Professional fees.......................................................................... 576 472
Acquisition liabilities.................................................................... 1,743 1,654
Other...................................................................................... 4,298 2,820
--------- ----------
$ 11,923 $ 9,773
========= ==========
9. 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 9 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.
In connection with the Philips acquisition (Note 5), the Company eliminated
25 ScanSoft personnel across all functional areas resulting in approximately
$0.5 million in severance related restructuring costs in the three month period
ended March 31, 2003.
At March 31, 2003, the remaining restructuring accrual from the current and
prior restructuring activities amounted to $0.9 million. This balance is
comprised of $0.2 million of lease exit costs resulting from the 2002
restructuring and $0.7 million of employee-related severance costs, of which
$0.4 million are for severance to the former Caere President and CEO. The
severance costs related to the 2003 Philips related restructuring actions will
be paid through June 30, 2003. The lease exit costs and severance due to the
former Caere President and CEO will be paid through January 2004 and March 2005,
respectively.
11
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table sets forth the 2003 and 2002 restructuring accrual
activity (in thousands):
LEASE
EMPLOYEE EXIT
RESTRUCTURING AND OTHER CHARGES ACCRUAL RELATED COSTS TOTAL
- --------------------------------------- ------- ----- -----
Balance at December 31, 2001 ........................................... $ 634 $ -- $ 634
Restructuring and other charges -- March 2002 .......................... 576 465 1,041
Non-cash write-off ..................................................... -- (113) (113)
Cash payments .......................................................... (764) (133) (897)
------- ------- -------
Balance at December 31, 2002 ........................................... $ 446 $ 219 $ 665
Restructuring charges -- January 2003 .................................. 529 -- 529
Cash payments .......................................................... (222) (50) (272)
------- ------- -------
Balance at March 31, 2003 .............................................. $ 753 $ 169 $ 922
======= ======= =======
10. 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 months ended March 31, 2003 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
shares of restricted stock. 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, the convertible debenture, 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
MARCH 31,
--------------------
2003 2002
---- ----
Basic net income (loss) per share:
Weighted average number of common shares
outstanding ........................... 64,127 62,304
Assumed conversion of Series B Preferred
Stock .................................. 3,562 --
------ ------
Weighted average common shares: basic ...... 67,689 62,304
Effect of dilutive common equivalent shares:
Stock options ......................... 5,931 --
Convertible debenture ................. 3,058 --
Warrants .............................. 458 --
Unvested restricted stock ............. 84 --
------ ------
Weighted average common shares: diluted .... 77,220 62,304
====== ======
For the three months ended March 31, 2003, shares used in computing diluted
net income per share exclude 3,834,088 common share equivalents because their
exercise prices were greater than the average market price of the Company's
common stock for that period.
For the three months ended March 31, 2002, shares used in computing diluted
net loss per share excludes 10,356,614 common share equivalents. 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.
12
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), net of taxes, was $70,000 and ($2.9)
million for the three months ended March 31, 2003 and 2002, respectively. Total
comprehensive income for the three months ended March 31, 2003, consisted of net
income of $76,000, foreign currency translation adjustments of approximately
($13,000) and approximately $7,000 related to the forward foreign exchange
hedge on the 5 million euro promissory note to Philips (Note 5).
12. DEBT
Credit Facility
On October 31, 2002, the Company entered into a two year Loan and Security
Agreement (as amended, the "Loan Agreement") with Silicon Valley Bank (the
"Bank") that consisted of a $10 million revolving loan (the "Credit Facility").
Borrowings under the Credit Facility bear interest at the Bank's prime rate plus
0.375% or 0.75%, (5.00% at March 31, 2003) 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 is limited to the
lesser of $10.0 million or a borrowing base equal to either 80% or 70% of
eligible accounts receivable, as defined in the Loan Agreement, based on the
Company's fixed charge coverage ratio. As of March 31, 2003, based upon the
calculated borrowing base, available borrowings totaled $10.0 million.
Borrowings under the Loan Agreement cannot exceed the borrowing base and must be
repaid in the event they exceed the calculated borrowing base or upon expiration
of the two-year loan term. Pursuant to the Loan Agreement, the Company is
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. As of March 31, 2003, there was no
outstanding balance under this Credit Facility and the Company was in compliance
with all debt covenants.
The Loan Agreement also contains a restrictive covenant regarding the
payment or declaring of any dividends on the Company's capital stock during the
term of the agreement (except for dividends payable solely in capital stock)
without the Bank's prior written consent.
Notes Payable
In connection with the L&H acquisition, the Company issued a $3.5 million
promissory note (the "Note") to Lernout & Hauspie Speech Products, N.V. The Note
had a stated maturity date of December 15, 2004 and bore interest at 9% per
annum. Payments of principal and interest in the amount of $133,000 were due
quarterly commencing on March 15, 2002, for a total of eleven payments. During
the year ended December 31, 2002, four quarterly payments were made in
accordance with the terms and conditions of the promissory note.
In connection with an agreement, entered into by the Company in September
2002 to repurchase 1,461,378 shares of common stock from L&H Holdings USA, Inc.
and Lernout & Hauspie Speech Products N.V. (collectively, L&H) and to register
in an underwritten offering the remaining shares held by L&H, the terms of the
Note were amended to provide for the acceleration of the maturity date of the
outstanding principal and interest to January 1, 2003 if consummation of the
underwritten public offering did not occur by January 1, 2003. The Company did
not complete the offering by January 1, 2003 and, accordingly, the debt became
immediately due and payable. To fulfill this obligation, on January 3, 2003, the
Company paid $3.3 million in full settlement of all of the outstanding principal
and accrued interest under the Note.
In connection with the Philips acquisition on January 30, 2003, the Company
issued a 5 million euro promissory note (the "Philips Note") to Philips. The
unsecured Philips Note matures on December 31, 2003 and bears interest at 5% per
annum. Payments of principal and accrued interest are due at maturity. The
Philips Note may be pre-paid by the Company at any time without penalty. In
connection with the issuance of the Philips Note, the Company entered into a
forward foreign exchange contract on January 31, 2003 to hedge the foreign
exchange exposure on the Philips Note. The amount of the forward foreign
exchange contract is equivalent to the principal amount of the Philips Note, and
the duration of the forward contract coincides with the maturity date of the
Philips Note. The foreign exchange hedge on the Philips Note resulted in a
foreign exchange gain of approximately $0.1 million, which will be recorded in
income over the term of the forward contract.
13
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Convertible Debenture
On January 30, 2003, the Company issued a $27.5 million three-year,
zero-interest convertible subordinated debenture due January 2006 (the
"Convertible Note") to Philips in connection with the Philips acquisition (Note
5). The Convertible Note is convertible into shares of the Company's common
stock at $6.00 per share at any time until maturity at Philips' option. The
conversion rate may be subject to adjustments from time to time as provided in
the Convertible Note. The Convertible Debenture contains a provision in which
all amounts unpaid at maturity will bear interest at a rate of 3% per quarter
until paid.
The Convertible Note contains restrictive covenants that place restrictions
on the declaration or payment of dividends or distributions (other than
distributions of equity securities of the Company) on, or the redemption or
purchase of, any shares of the Company's capital stock while the Convertible
Note is outstanding. This restriction terminates when one-half or more of the
principal amount of the Convertible Note is converted by Philips into common
stock. The Convertible Note contains a restrictive provision which provides
Philips the right to require the Company to redeem the Convertible Note or any
remaining portion of the principal amount, on the date a "Change in Control"
occurs. The Convertible Note provides that a "Change in Control" is deemed to
have occurred when any person or entity acquires beneficial ownership of shares
of capital stock of the Company entitling such person or entity to exercise 40%
or more of the total voting power of all shares of capital stock of the Company,
or the Company sells all or substantially all of its assets, subject to certain
exceptions. The proposed acquisition of SpeechWorks International Inc. (Note 16)
will not result in such a "Change in Control".
13. COMMITMENTS AND CONTINGENCIES
Litigation and Other Claims
Like many companies in the software industry, the Company has from time to
time been notified of claims that it may be infringing certain intellectual
property rights of others. Where appropriate these claims have been referred to
counsel, and they are in various stages of evaluation and negotiation or have
been resolved. If it appears necessary or desirable, the Company may seek
licenses for these intellectual property rights. There is no assurance that
licenses will be offered by all claimants, that the terms of any offered
licenses will be acceptable to the Company or that in all cases the dispute will
be resolved without litigation, which may be time consuming and expensive, and
may result in injunctive relief or the payment of damages by the Company.
From time to time, we receive information concerning possible infringement
by third parties of our intellectual property rights, whether developed,
purchased or licensed by us. In response to any such circumstance, we have our
counsel investigate the matter thoroughly and we take all appropriate action to
defend our rights in these matters.
On November 27, 2002, AllVoice Computing plc filed an action against the
Company in the United States District Court for the Southern District of Texas
claiming patent infringement. In the lawsuit, AllVoice alleges that the Company
is infringing United States Patent No. 5,799,273 entitled "Automated
Proofreading Using Interface Linking Recognized Words to Their Audio Data While
Text Is Being Changed" (the "'273 Patent"). The '273 Patent generally discloses
techniques for manipulating audio data associated with text generated by a
speech recognition engine. Although the Company has several products in the
speech recognition technology field, the Company believes that its products do
not infringe the '273 Patent because they do not use the claimed techniques. The
Company believes this claim has no merit, and intends to defend the action
vigorously.
On December 28, 2001, the Massachusetts Institute of Technology and
Electronics For Imaging, Inc. sued the Company in the United States District
Court for the Eastern District of Texas for patent infringement. The patent
infringement claim was filed against more than 200 defendants. In their lawsuit,
MIT and EFI allege that the Company is infringing United States Patent No.
4,500,919 entitled "Color Reproduction System" (the "'919 Patent"). MIT and EFI
allege that the '919 Patent discloses a system for adjusting the colors of a
scanned image on a television screen and outputting the modified image to a
device. The Company has several products that permit a user to adjust the color
of an image on a computer monitor. The Company has asserted that its products do
not infringe the '919 Patent because its products do not contain all elements of
the structure required by the claimed invention and because its products do not
perform all of the steps required by the claimed method. Further, the Company
believes there may be prior art that would render the '919 Patent invalid. The
'919 Patent expired on May 6, 2002. Damages are sought in an unspecified amount.
The Company filed an Answer and Counterclaim on July 1, 2002. The Company
believes this claim has no merit, and intends to defend the action vigorously.
14
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On August 16, 2001, Horst Froessl sued the Company in the United States
District Court for the Northern District of California for patent infringement.
In his lawsuit, Froessl alleges that the Company is infringing United States
Patent No. 4,553,261 entitled "Document and Data Handling and Retrieval System"
(the "'261 Patent"). Froessl alleges that the '261 Patent discloses a system for
receiving and optically scanning documents, converting selected segments of the
digitalized scan data into machine code, and storing and retrieving the
documents and the digitalized and converted segments. Although the Company has
several products in the scanning technology field, the Company has asserted that
its products do not infringe the '261 Patent because its products do not contain
all elements of the structure required by the claimed invention and because its
products do not perform all of the steps required by the claimed method.
Further, the Company believes there may be prior art that would render the '261
Patent invalid. The '261 Patent will expire on May 31, 2003. Damages are sought
in an unspecified amount. The Company filed an Answer and Counterclaim on
September 19, 2001. The Company believes this claim has no merit, and intends to
defend the action vigorously.
The Company believes that the final outcome of these matters will not have a
significant adverse effect on its financial position and results of operations,
and the Company believes it will not be required to expend a significant amount
of resources defending such claims. However, should the Company not prevail in
any such litigation, its operating results and financial position could be
adversely impacted.
Guarantees
The Company has entered into agreements to indemnify its directors and
officers to the fullest extent authorized or permitted under applicable law.
These agreements, among other things, provide for the indemnification of its
directors and officers for expenses, judgments, fines, penalties and settlement
amounts incurred by any such person in his or her capacity as a director or
officer of the company, whether or not such person is acting or serving in any
such capacity at the time any liability or expense is incurred for which
indemnification can be provided under the agreements. The Company has a Director
and Officer insurance policy in effect that reduces its exposure under these
agreements and enables it to recover a portion of any future amounts paid. While
the maximum potential amount of any future payments under these agreements is
uncertain, as a result of its insurance coverage the Company believes the
estimated fair value of these agreements is minimal.
The Company currently includes indemnification provisions in the contracts
it enters with its customers and business partners. Generally, these provisions
require the Company to defend claims arising out of its products' infringement
of third-party intellectual property rights, breach of contractual obligations
and/or unlawful or otherwise culpable conduct on its part. The indemnity
obligations imposed by these provisions generally cover damages, costs and
attorneys' fees arising out of such claims. In most, but not all, cases the
Company's total liability under such provisions is limited to either the value
of the contract or a specified, agreed upon, amount. In some cases its total
liability under such provisions is unlimited. In many, but not all, cases the
term of the indemnity provision is perpetual. Although these provisions are
included in most of its contracts with customers and business partners, as noted
above, the Company is currently defending only four parties pursuant to such
provisions. Each of these four parties is a defendant in a case filed by the
Massachusetts Institute of Technology and Electronics for Imaging, Inc. in the
United States District Court for the Eastern District of Texas in December 2001.
The case, which alleges patent infringement by certain ScanSoft products, is
more fully described above. Although the Company believes this claim has no
merit, the Company cannot predict the outcome of this case or the total
additional indemnity costs it may produce, though it may be required to
indemnify one or more defendants in addition to those it is already
indemnifying, and additional indemnification obligations may arise in other
litigations. While the maximum potential amount of future payments the Company
could be required to make under all the indemnification provisions in its
contracts with customers and business partners is unlimited, it believes that
the estimated fair value of these provisions is minimal due to the low frequency
with which these provisions have been triggered.
14. EQUITY TRANSACTIONS
Common Stock Warrants
In connection with the March 31, 2003 acquisition of the certain
intellectual property assets related to multimodal speech technology (Note 7),
the Company issued a warrant expiring October 31, 2005, for the purchase of
78,000 shares of common stock of the Company at an exercise price of $8.10 per
share. The warrant was immediately exercisable and was valued at $0.1 million
based upon the Black-Scholes option pricing model with the following
15
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
assumptions: expected volatility of 80%, a risk-free rate of 1.87%, an expected
term of 2.5 years, no dividends and a stock price of $4.57 based on the
Company's stock price at the time of issuance. The purchase price was recorded
as completed technology and will be amortized over three years.
Underwritten Public Offering
During the three months ended March 31, 2003, the Company completed an
underwritten public offering of 8,256,906 shares of the Company's common stock
at $3.80 per share. Of the total shares sold, 6,184,406 shares were sold on
behalf of Lernout & Hauspie Speech Products N.V. and L&H Holdings USA, Inc. The
Company sold 2,072,500 common shares and received gross proceeds of $7.9
million. After considering offering costs, the net proceeds amounted to
approximately $5.5 million.
15. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in a single segment. The following table presents total
revenue information by geographic area and principal product line (in
thousands):
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
North America........................................................................ $ 20,608 $ 18,625
Other foreign countries.............................................................. 7,228 5,140
----------- ----------
Total.............................................................................. $ 27,836 $ 23,765
=========== ==========
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Digital Capture....................................................................... $ 12,587 $ 16,370
Speech................................................................................ 15,249 7,395
----------- ----------
Total............................................................................... $ 27,836 $ 23,765
=========== ==========
Revenue classification above is based on the country in which the sale
originates or is invoiced. Revenue in other countries predominately relates to
sales to customers in Asia and Europe. Intercompany sales are insignificant as
products sold outside of the United States or Europe are sourced within Europe
or the United States.
A number of the Company's North American OEM customers distribute
products throughout the world but because these customers do not provide the
geographic dispersion of their product sales, the Company recorded the revenue
in the North America category. 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 33% and 30%
of our consolidated revenue for the quarters ended March 31, 2003 and March 31,
2002, respectively.
16. SUBSEQUENT EVENT
On April 23, 2003, ScanSoft announced it had signed a definitive merger
agreement to acquire SpeechWorks International, Inc. ("SpeechWorks"), a Boston,
Massachusetts-based company that provides speech recognition, text-to-speech and
speaker verification for network and embedded environments, including multimodal
devices with both an audio interface and visual display. Under the terms of the
agreement, ScanSoft will acquire SpeechWorks in a tax-free, stock-for-stock
merger with an equity value at the time of announcement of approximately $132.0
million, net of SpeechWorks' cash balance of $49.0 million as of December 31,
2002. Upon completion of the merger, holders of SpeechWorks common stock will be
entitled to receive 0.860 shares of ScanSoft common stock for each share of
SpeechWorks common stock that they then hold. The acquisition is expected to be
completed in the third quarter of 2003. The agreement may be terminated by
either the Company or SpeechWorks upon certain events occurring or not
occurring, as defined in the agreement. In certain cases, if the agreement is
terminated, the Company may be required to pay SpeechWorks up to $6.5 million.
16
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 STRATEGY RELATING TO SPEECH AND LANGUAGE TECHNOLOGIES;
- OUR EXPECTATIONS REGARDING OUR PROPOSED ACQUISITION OF SPEECHWORKS AND
OUR ACQUISITION OF CERTAIN ASSETS FROM PHILIPS;
- 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
- 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 "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
ScanSoft is a leading provider of software that allows users to incorporate
documents, images and speech into digital applications. Our products and
technologies automate manual processes and help enterprises, professionals and
consumers increase productivity, reduce costs and save time. Our products are
built upon digital capture and speech technologies, 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.
RECENT DEVELOPMENTS
On January 3, 2003, we paid $3.3 million in full settlement of all principal
and accrued interest on a promissory note issued in connection with the L&H
acquisition on December 12, 2001.
On January 30, 2003, we completed the acquisition of the Philips Speech
Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property. The Telephony
business unit offers speech-enabled services including directory assistance,
interactive voice response and voice portal applications for enterprise
customers, telephony vendors and carriers. The Voice Control business unit
offers a product portfolio including small footprint speech recognition engines
for embedded applications such as voice-controlled climate, navigation and
entertainment features in automotive vehicles, as well as voice dialing for
mobile phones. As consideration for the business, we paid 3.1 million euros
($3.4 million) in cash at closing, subject to adjustment in accordance with the
provisions of the purchase agreement, as amended, and agreed to pay an
additional 1.0 million euros in cash due no later than December 31, 2003, issued
a 5.0 million euro note due December 31, 2003 and bearing 5.0% interest per
annum and issued a $27.5 million three-year, zero-interest subordinated
debenture, convertible at any time at Philips' option into
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
shares of our common stock at $6.00 per share. The purchase price is subject to
adjustment. We anticipate that all related adjustments will be completed no
later than December 31, 2003 and all adjustments arising from contingencies that
existed at the closing and as of March 31, 2003 will be recorded as adjustments
to goodwill. In connection with the acquisition we hired 116 employees.
During the three months ended March 31, 2003, the Company completed an
underwritten public offering of 8,256,906 shares of the Company's common stock
at $3.80 per share. Of the total shares sold, 6,184,406 shares were sold on
behalf of Lernout & Hauspie Speech Products N.V., and L&H Holdings USA, Inc. The
Company sold 2,072,500 common shares and received gross proceeds of $7.9
million. After deducting offering costs, the net proceeds amounted to
approximately $5.5 million.
On April 23, 2003, ScanSoft announced it had signed a definitive merger
agreement to acquire SpeechWorks International, Inc. ("SpeechWorks"), a Boston,
Massachusetts-based company that provides speech recognition, text-to-speech and
speaker verification for network and embedded environments, including multimodal
devices with both an audio interface and visual display. Under the terms of the
agreement, ScanSoft will acquire SpeechWorks in a tax-free, stock-for-stock
merger with an equity value at the time of announcement of approximately $132.0
million, net of SpeechWorks' cash balance of $49.0 million as of December 31,
2002. Upon completion of the merger, holders of SpeechWorks common stock will be
entitled to receive 0.860 shares of ScanSoft common stock for each share of
SpeechWorks common stock that they then hold. The acquisition is expected to be
completed in the third quarter of 2003.
RESULTS OF OPERATIONS
The following table presents, as a percentage of total revenue, certain
selected financial data for the three months ended March 31, 2003 and 2002:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
--------- ---------
Total revenue............................................. 100.0% 100.0%
Cost and expenses:
Cost of revenue........................................ 15.5% 17.4%
Cost of revenue from amortization of intangible assets. 7.4% 14.9%
Research and development............................... 25.8% 29.4%
Selling, general and administrative.................... 47.6% 40.9%
Amortization of other intangible assets................ 1.3% 4.0%
Restructuring and other charges, net................... 1.9% 4.4%
------ ------
Total costs and expenses............................ 99.5% 111.0%
------ ------
Income (loss) from operations............................. 0.5% (11.0)%
Other income (expense), net............................... 0.0% (0.3)%
------ ------
Income (loss) before income taxes......................... 0.5% (11.3)%
Provision for income taxes................................ 0.3% 0.8%
------ ------
Net income (loss)......................................... 0.2% (12.1)%
------ ------
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 distributors and value-added
resellers provide rights of return for as long as the distributors or resellers
hold the inventory. As a result, we recognize revenues from sales to
distributors and resellers only when products have been sold by the
distributors or resellers to retailers and end-users. Title and risk of loss
pass to the distributor or reseller upon shipment, at which time the transaction
is invoiced and payment is due. Based on reports from distributors and
resellers of their inventory balances at the end of each period, we record an
allowance against accounts receivable for the sales price of all inventory
subject to return. If we experience significant returns from distributors or
resellers, our liquidity may be adversely impacted. We make an estimate of sales
returns by retailers or end users to us directly or through our distributors
or resellers based on historical returns experience. The provision for these
estimated returns is recorded as a reduction of revenue at the time that the
related revenue is recorded. Historically, we have not experienced significant
returns from retailers or end-users. If actual returns differ significantly from
our estimates, such differences could have a material impact on our results of
operations for the period in which the actual returns become known.
Royalty revenue derived from sales to OEM customers is recognized when
software copies are deployed based upon reports of actual deployments received
from OEM customers and payment is due.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cost of revenue consists primarily of material and fulfillment costs,
third-party royalties, salaries for product support personnel, and engineering
costs associated with certain contracts which are accounted for under the
percentage-of-completion method of accounting.
Cost of revenue from amortization of intangible assets includes the
amortization of acquired patents and core and completed technology.
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, 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.
Amortization of other intangible assets excludes amortization of acquired
patents and core and completed technology which is included in cost of revenue
from amortization of intangible assets.
Total Revenue
Total revenue for the three months ended March 31, 2003 increased by $4.1
million or 17% from the comparable period in 2002. This growth in revenue was
the result of revenue generated from our speech and language products. Revenue
from our speech and language products was $15.2 million and $7.4 million for the
three months ended March 31, 2003 and 2002, respectively. The increase of $7.8
million in speech revenue was due to an increase of $2.9 million resulting from
greater market acceptance and the launch of Dragon Naturally Speaking 7.0,
increased demand from OEMs for our Real Speak product (text to speech) of $3.3
million and $1.9 million in incremental revenue from products acquired in the
Philips acquisition, which occurred on January 30, 2003. Revenue from our
digital capture products was $12.6 million and $16.4 million for the three
months ended March 31, 2003 and 2002, respectively. The net decrease of $3.8
million in revenue from our digital capture products from 2002 was due primarily
to the recognition in the first quarter 2002 of deferred revenue items
associated with completed OEM services, and the lower sales of our OmniPage
product, offset by the launch of PaperPort 9.0.
Geographic revenue classification is based on the country in which the sale
is invoiced. Revenue for the quarter ended March 31, 2003 was 74% North America
and 26% international, versus 78% North America and 22% international for the
same period 2002.
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 we were 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 period ending March
31, 2003 was approximately 67% North America and 33% international versus 70%
North America and 30% international for the comparable period in 2002. The
increase in our international revenue percentage for the period ending March 31,
2003 was a direct result of our increased focus on international markets.
The following table presents the breakdown of our total revenue by
distribution channel:
QUARTER ENDED
MARCH 31,
---------
2003 2002
---- ----
VAR/Retail............................................ 36% 40%
Direct................................................ 28% 22%
OEM................................................... 36% 38%
--- ---
100% 100%
=== ===
The increase in our direct revenues and the corresponding decrease in our
other sales channels, as a percent of revenue, for the first quarter 2003 as
compared to the same period 2002, was due to the launch of two of our flagship
products, PaperPort 9.0 and Dragon Naturally Speaking 7.0.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Cost of Revenue
Cost of revenue for the three months ended March 31, 2003 was $4.3 million
or 15.5% of revenue, compared to $4.1 million or 17.4% for the comparable period
in 2002. The increase in cost of revenue in absolute dollars for the three-month
period ended March 31, 2003 was directly attributable to the overall increase in
our direct revenue. The decrease in cost of revenue as a percentage of total
revenue was due to continued productivity gains in the Company's manufacturing
and fulfillment operations and an increase in higher-margin license revenue.
Cost of Revenue from Amortization of Intangible Assets
Cost of revenue from amortization of intangible assets for the three months
ended March 31, 2003 was $2.1 million or 7.4% of revenue, compared to $3.5
million or 14.9% for the comparable period in 2002. The decrease in cost of
revenue from amortization of intangible assets of $1.4 million was due to $1.6
million of intangible assets that became fully amortized during fiscal year
2002. This reduction was partially offset by $0.1 million of amortization
related to the Philips acquisition completed on January 30, 2003.
Research and Development Expense
Research and development expense for the three months ended March 31, 2003
was $7.2 million or 25.8% of revenue, compared to $7.0 million or 29.4% for the
comparable period in 2002. The increase in research and development expense of
$0.2 million was primarily the result of increased headcount associated with the
Philips acquisition. Before consideration of the SpeechWorks acquisition,
research and development expenses are expected to decline as a percentage of
revenue over the remainder of the year as revenue from the Philips products grow
and research and development spending is held flat.
Selling, General and Administrative Expense
Selling, general and administrative expense for the three months ended
March 31, 2003 was $13.3 million or 47.6% of revenue, compared to $9.7 million
or 40.9% for the comparable period in 2002. The increase in selling, general and
administrative expense in absolute dollars was primarily the result of increased
headcount costs resulting from the addition of 19 sales and marketing employees
associated with the Philips acquisition. The remaining increase in general and
administrative expenses is due primarily to increased legal expenses associated
with the Philips integration. Before consideration of the SpeechWorks
acquisition, as a percentage of revenue, the Company expects selling, general
and administrative expenses for the full year to approximate 40% of revenue.
Amortization of Other Intangible Assets
Amortization of other intangible assets for the three months ended March
31, 2003, was $0.4 million or 1.3% of revenue, compared to $1.0 million or 4.0%
for the comparable period in 2002. The decrease in this amortization expense is
due to $0.6 million of intangible assets that became fully amortized during
fiscal year 2002. This reduction was partially offset by $0.1 million of
amortization related to the Philips acquisition.
Restructuring and Other Charges, Net
In connection with the Philips acquisition, we eliminated 25 ScanSoft
personnel across all functional areas resulting in approximately $0.5 million in
severance related restructuring costs in the three month period ended March 31,
2003.
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 L&H acquisition on December
12, 2001. As a result, we exited certain facilities in both North America and
Europe, eliminating 21 employee positions, including 12 in research and
development and 9 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 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.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Income (Loss) from Operations
As a result of the above factors, income from operations was $0.1 million
for the three months ended March 31, 2003 or 0.5% of revenue, compared with a
loss of ($2.6) million or (11.0)% for the comparable period in 2002.
Other Income (Expense), Net
Interest income was $41,000 and $54,000 for the three months ended March 31,
2003 and 2002, respectively. Interest expense was $81,000 and $85,000 for the
three months ended March 31, 2003 and 2002, respectively. Other expense for the
three months ended March 31, 2003 consists primarily of foreign exchange gains
of $107,000 and other expenses of $46,000, compared to foreign exchange losses
of $19,000 and other expenses of $25,000 for the three months ended March 31,
2002.
Income (Loss) Before Income Taxes
Income before income taxes was $0.2 million for the three months ended March
31, 2003 or 0.5% of revenue, compared with a loss of ($2.7) million or (11.3)%
for the comparable period in 2002.
Income Taxes
The provision for income taxes for the three months ended March 31, 2003 was
$0.1 million or 0.3% of revenue, compared to $0.2 million or 0.8% in the
comparable period for 2002. The provision for income taxes consists primarily of
foreign tax provisions for which no net operating loss carryforwards are
available to offset income and foreign withholding and state income taxes.
Net Income (Loss)
As a result of all these factors, net income totaled $0.1 million for the
three months ended March 31, 2003, compared with a loss of ($2.9) million or
(12.1)% for the comparable period in 2002.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003, we had cash and cash equivalents of $20.3 million and
net working capital of $5.3 million as compared to $18.9 million in cash and
cash equivalents and net working capital of $16.8 million at December 31, 2002.
Net cash provided by operating activities for the three months ended March
31, 2003 was $2.9 million compared to $0.2 million for the comparable period in
2002. Cash provided by operations in the 2003 period came primarily from
operating income, net of non-cash adjustments, and an increase in accounts
payable, offset by payments of accrued expenses assumed in the Philips
acquisition. The increase in accounts receivable allowances at March 31, 2003 as
compared to December 31, 2002 is attributable to higher shipments of our
products to distributors at the end of the quarter ended March 31, 2003 period
in connection with our release of two new products, Dragon Naturally Speaking
7.0 and PaperPort 9.0. Historically, we have not incurred any significant losses
on our accounts receivable balances.
Net cash used in investing activities for the three months ended March 31,
2003 was $4.9 million compared to $1.8 million for the comparable period in
2002. Net cash used in investing activities during the 2003 period consisted of
$0.6 million in capital expenditures, which included costs to build out
facilities in both North America and Europe and $4.3 million of payments
associated with acquisitions. Net cash used in investing activities during 2002
consisted of $0.7 million in capital expenditures to build-out facilities in
both North America and Europe, $0.5 million for the acquisition of the L&H
Audiomining assets and $0.7 million related to the payment of acquisition
related liabilities.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Net cash provided by financing activities for the three months ended March
31, 2003 was $3.6 million compared to $0.1 million for the comparable period in
2002. Net cash provided by financing activities during the three months ended
March 31, 2003 consisted of proceeds of $0.5 million from the issuance of common
stock in connection with employee stock compensation plans and net proceeds of
$6.8 million excluding offering costs of $1.3 million paid in the prior year,
from the public issuance of our common stock. This was offset by a $0.4 million
payment to the former Caere President and CEO in connection with the settlement
of the non-competition and consulting agreement, and the payment of the $3.3
million note payable related to the acquisition of Lernout & Hauspie assets
during 2001. Net cash provided by financing activities during 2002 consisted of
proceeds of $1.2 million from the exercise of stock options, offset by a $0.1
million payment on our capital lease obligation, a $0.1 million principal
payment on a note payable that was issued in connection with the acquisition of
the L&H assets and a $1.0 million payment to the former Caere President and CEO
in connection with the settlement of the non-competition and consulting
agreement.
On January 30, 2003, we completed the Philips acquisition. As consideration
for the acquisition, we paid 3.1 million euros ($3.4 million) in cash at
closing, subject to adjustment in accordance with the provisions of the purchase
agreement, as amended, and agreed to pay an additional 1.0 million euros in cash
due no later than December 31, 2003, issued a 5.0 million euro note due December
31, 2003 and bearing 5.0% interest per annum and issued a $27.5 million
three-year, zero-interest subordinated debenture, convertible at any time at
Philips' option into shares of our common stock at $6.00 per share.
The following table outlines our contractual payment obligations as of March
31, 2003:
PAYMENTS DUE BY PERIOD
--------------------------------------------
CONTRACTUAL WITHIN WITHIN
OBLIGATIONS TOTAL 1 YEAR 2 YEARS THEREAFTER
----------- ---------- --------- --------- ----------
(IN THOUSANDS)
Convertible debenture ........................................................... $ 27,524 -- -- $ 27,524
Deferred payment associated with Philips acquisition, including imputed interest 1,052 1,052 -- --
Euro denominated note (5 million) associated with Philips acquisition ........... 5,407 5,407 -- --
Deferred payments for technology license ........................................ 12,328 9,434 2,894 --
Operating leases................................................................. 8,099 2,123 2,142 3,834
Caere acquisition related costs.................................................. 2,048 2,048 --
Imputed interest ................................................................ 652 246 406 --
---------- --------- --------- --------
Total contractual cash obligations............................................... $ 57,110 $ 20,310 $ 5,442 $ 31,358
========== ========= ========= ========
Through March 31, 2003, we have not entered into any off balance sheet
arrangements or transactions with unconsolidated entities or other persons.
Historically and through December 31, 2001 we sustained recurring losses
from operations in each reporting period. We reported net income of
approximately $6.3 million for 2002 and $0.1 million for the three months ended
March 31, 2003, and have an accumulated deficit of $146.9 million at March 31,
2003. We believe that we have the ability to maintain operating expenses at
levels commensurate with revenues to maintain positive cash flows from
operations. We also believe that our existing working capital, cash flows from
future operations and available borrowings under our line of credit facility
will be sufficient to meet our operating, investing and financing needs, for at
least the next twelve months, including the integration of the Philips
acquisition and the pending acquisition of SpeechWorks, and the debt obligations
incurred in connection with the Philips acquisition.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FOREIGN OPERATIONS
We develop and sell our products throughout the world. As a result of the
Caere acquisition in March 2000, the L&H acquisition in December 2001, and our
recent Philips acquisition, 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 2003, we are exposed to changes in foreign currencies including the
euro and Japanese yen. Changes in the value of the euro or other foreign
currencies relative to the value of the United States 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. However,
in connection with the Philips acquisition on January 30, 2003, we entered into
a forward hedge in the amount of $5.3 million to meet our obligation to pay the
5.0 million euro promissory note issued as part of the acquisition.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") issued EITF No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." EITF
No. 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple revenue-generating activities.
EITF No. 00-21 establishes three principles: revenue should be recognized
separately for separate units of accounting, revenue for a separate unit of
accounting should be recognized only when the arrangement consideration is
reliably measurable and the earnings process is substantially complete, and
consideration should be allocated among the separate units of accounting in an
arrangement based on their fair value. EITF No. 00-21 is effective for all
revenue arrangements entered into in fiscal periods beginning after June 15,
2003, with early adoption permitted. We do not expect the adoption of EITF No.
00-21 to have a material impact on our results of operations or financial
condition.
FACTORS THAT MAY AFFECT FUTURE RESULTS
ScanSoft's business operates in an intensely competitive environment and
operations are subject to risks and uncertainties. Such risks and uncertainties
include, but are not limited to (1) the loss of, or a significant curtailment
of, purchases by any one or more principal customers; (2) the cyclicality of the
retail software industry; (3) the inability to protect ScanSoft's proprietary
technology and intellectual property; (4) the inability to attract or retain
skilled employees; (5) technological obsolescence of current products and the
inability to develop new products; (6) the inability to respond to competitive
technology and competitive pricing pressures; and (7) the ability to sustain
product revenues upon the introduction of new products. Our quarterly operating
results may fluctuate and differ materially from one quarter to the next which
could have an impact on our stock price.
There can be no assurance that any cash generated by operations will be
sufficient to satisfy our liquidity requirements, and we may be required to sell
additional equity or debt securities, or obtain additional lines of credit. The
sale of additional equity or convertible debt securities may result in
additional dilution to our stockholders. It may be difficult to sell additional
equity or obtain debt financing, and this could result in significant
constraints on ScanSoft's ongoing investments to grow revenue and develop new
products.
You should also carefully consider the additional risks described below
when evaluating our company. 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.
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:
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- 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;
- CUSTOMERS DELAYING, CANCELING OR LIMITING THEIR PURCHASES AS RESULT OF
THE THREAT OR RESULTS OF TERRORISM OR MILITARY ACTIONS TAKEN BY THE
UNITED STATES OR ITS ALLIES;
- 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;
- 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. We sustained
recurring losses from operations in each reporting period through December 31,
2001. We reported net income of $0.1 million and $6.3 million for the three
months ended March 31, 2003 and the fiscal year ended December 31, 2002,
respectively. If we do not maintain profitability, the market price for our
stock may decline, perhaps substantially.
OUR BUSINESS COULD BE HARMED IF WE DO NOT SUCCESSFULLY MANAGE THE
INTEGRATION OF THE BUSINESSES THAT WE ACQUIRE, INCLUDING OUR PLANNED MERGER WITH
SPEECHWORKS AND THE RECENTLY COMPLETED ACQUISITION OF THE SPEECH PROCESSING
TELEPHONY AND VOICE CONTROL BUSINESS UNITS OF PHILIPS. As part of our business
strategy, we have in the past acquired, and expect to continue to acquire, other
businesses and technologies. Our recent acquisitions of the speech and language
technology operations of Lernout & Hauspie Speech Products N.V. and certain of
its affiliates, including L&H Holdings USA, Inc. (collectively, L&H) and the
Speech Processing Telephony and Voice Control business units from Philips
required substantial integration and management efforts. Our pending acquisition
of SpeechWorks International, Inc., will pose similar, and potentially greater,
challenges. Acquisitions of this nature 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;
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- 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 acquired businesses and technologies could seriously
harm our business. The size of the SpeechWorks merger significantly increases
both the scope and consequences of our integration risks.
THE PENDING MERGER WITH SPEECHWORKS MAY NOT BE COMPLETED, WHICH COULD
NEGATIVELY IMPACT OUR STOCK PRICE, FUTURE BUSINESS AND OPERATIONS. The pending
merger with SpeechWorks is subject to a number of closing conditions,
including, among other things, the approval by our stockholders of the issuance
of shares of our common stock in connection with the merger, expiration or
termination of the waiting periods under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, the approval of the stockholders of
SpeechWorks and other customary closing conditions. There can be no assurance
that these conditions will be met and the merger will be completed. If the
merger is not completed for any reason, we could be subject to a number of
material risks, including the following:
- WE WOULD NOT REALIZE THE BENEFITS WE EXPECT BY BEING PART OF A COMBINED
COMPANY WITH SPEECHWORKS;
- THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE TO THE EXTENT THAT
THE CURRENT MARKET PRICE OF OUR SHARES REFLECTS THE MARKET ASSUMPTION
THAT THE PROPOSED MERGER WILL BE COMPLETED; AND
- WE MUST PAY SUBSTANTIAL COSTS RELATED TO THE MERGER, SUCH AS LEGAL,
ACCOUNTING AND FINANCIAL ADVISOR AND PRINTING FEES, EVEN IF THE MERGER
IS NOT COMPLETED.
A LARGE PART OF OUR REVENUE IS DEPENDENT ON CONTINUED DEMAND FOR OUR
PRODUCTS FROM OEM PARTNERS. A SIGNIFICANT REDUCTION IN OEM REVENUE WOULD
SERIOUSLY HARM OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION AND
STOCK PRICE. 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 not be successfully implemented or marketed
by our licensees.
OEM revenue represented 36% and 38% of our consolidated revenue for the
three-month periods ended March 31, 2003 and 2002, respectively. A select few of
our OEM partners account for a majority of our OEM revenues. 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.
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 completed the purchase of certain businesses
and intellectual property from Philips and announced the pending acquisition of
Speechworks 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, and in
connection with the proposed SpeechWorks acquisition, we expect to issue 32.6
million shares of our common stock, subject to adjustment based on the number of
shares of SpeechWorks common stock outstanding at the closing of the merger. 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
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Philips acquisition, we paid 3.1 million euros in cash at closing, subject to
adjustment in accordance with the provisions of the purchase agreement, as
amended, and agreed to pay an additional 1.0 million euros in cash prior to
December 31, 2003, issued a 5.0 million euro note due December 31, 2003 and
bearing 5.0% interest per annum and issued a $27.5 million three-year,
zero-interest subordinated debenture, convertible at any time at Philips' option
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.
SALES OF OUR DOCUMENT AND PDF CONVERSION PRODUCTS AND OUR DIGITAL PAPER
MANAGEMENT PRODUCTS REPRESENTED APPROXIMATELY 43% OF OUR REVENUE FOR THE
THREE-MONTH PERIOD ENDED MARCH 31, 2003 AND APPROXIMATELY 51% FOR THE
THREE-MONTH PERIOD ENDED MARCH 31, 2002. ANY REDUCTION IN REVENUE FROM THESE
PRODUCT AREAS COULD SERIOUSLY HARM OUR BUSINESS. Historically, a few product
areas have generated a substantial portion of our revenues. For the three months
ended March 31, 2003, our document and PDF conversion products represented
approximately 26% of our revenue and our digital paper management products
represented approximately 17% of our revenue. For the three months ended March
31, 2002, our document and PDF conversion products represented approximately 36%
of our revenue, and our digital paper management products represented
approximately 15% of our revenue. Although the relative share of our revenue
derived from these products decreased due to the inclusion of sales of our
speech products, a reduction in the revenue contribution from 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.
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 some 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.
On November 27, 2002, AllVoice Computing plc filed an action against us in
the United States District Court for the Southern District of Texas claiming
patent infringement. In the lawsuit, AllVoice alleges that we are infringing
United States Patent No. 5,799,273 entitled "Automated Proofreading Using
Interface Linking Recognized Words to Their Audio Data While Text Is Being
Changed" (the "'273 Patent"). The '273 Patent generally discloses techniques for
manipulating audio data associated with text generated by a speech recognition
engine. Although we have several products in the speech recognition technology
field, we believe that these products do not infringe the '273 Patent because
our products do not use the claimed techniques. We believe this claim has no
merit, and we intend to defend the action vigorously.
On December 28, 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
believe this claim has no merit, and we intend to defend the action vigorously.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 or if we are required to
expend a significant amount of resources defending such claims, 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 may be subject to significant damages or injunctions and our
operating results and financial position could be harmed.
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 product 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 and Nuance Communications. 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.
WE RELY ON A SMALL NUMBER OF DISTRIBUTION AND FULFILLMENT PARTNERS,
INCLUDING 1450, DIGITAL RIVER, INGRAM MICRO AND TECH DATA, 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 network of over 2000 channel partners, 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 and fulfillment partners, including 1450, Digital River,
Ingram Micro and Tech Data to serve this network of channel partners. For the
three-month period ended March 31, 2003, two distribution and fulfillment
partners, Ingram Micro and Digital River, accounted for 25% and 17% of our
consolidated revenue, respectively. During the three-month period ended March
31, 2002, Ingram Micro and Digital River accounted for 27% and 11% of our
consolidated revenue, respectively. A disruption
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
in these distribution and fulfillment partner relationships could negatively
affect our results of operations in the short term. Any disruption for which we
are unable to compensate could have a more sustained impact on our results of
operations.
A SIGNIFICANT PORTION OF OUR ACCOUNTS RECEIVABLE IS CONCENTRATED AMONG OUR
THREE LARGEST DISTRIBUTION AND FULFILLMENT PARTNERS, INGRAM MICRO, INC., TECH
DATA CORPORATION, AND DIGITAL RIVER, INC. Our products are sold through, and a
substantial portion of our accounts receivable is derived from, three
distribution and fulfillment partners. At March 31, 2003, Ingram Micro, Tech
Data and Digital River represented 16%, 3% and 15% of our net accounts
receivable, respectively. At March 31, 2002, Ingram Micro, Tech Data and Digital
River represented 16%, 11% and 9%, of our net accounts receivable, respectively.
In addition, although we perform ongoing credit evaluations of our distribution
and fulfillment partners' financial condition and maintain reserves for
potential credit losses, we do not require collateral. While, to date, such
losses have been within our expectations, we cannot assure you that these
actions will be sufficient to meet future contingencies. If any of these
distribution and fulfillment partners were unable to pay us in a timely fashion
or if we were to experience significant credit losses in excess of our reserves,
our results of operations, cash flows and financial condition would be seriously
harmed.
A SIGNIFICANT PORTION OF OUR REVENUE IS DERIVED FROM SALES IN EUROPE AND
ASIA. OUR RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH THESE AND OTHER INTERNATIONAL REGIONS 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 three-month periods ended March 31, 2003 and March
31, 2002, represented 26% and 22% of our consolidated revenue for those periods,
respectively. Most of these international revenues are produced by sales in
Europe and Asia. 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 33% and 30% of our
consolidated revenue for the quarters ended March 31, 2003 and March 31, 2002,
respectively.
Therefore, in addition to risks to our business based on a potential
downturn in the world economy, a region-specific downturn affecting countries in
Western Europe and/or Asia could have a negative effect on our future results of
operations.
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,
in connection with the Philips acquisition, we have added 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;
- 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. However, in connection with the Philips
acquisition on January 30, 2003, we entered into a forward hedge in the amount
of $5.3 million to meet our obligation to pay the 5.0 million euro promissory
note (Philips Note) issued as part of the acquisition. Our exposure to currency
rate fluctuations could affect our results of operations and cash flows.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
THE STOCKHOLDINGS OF OUR TWO LARGEST STOCKHOLDERS MAY ENABLE THEM TO
INFLUENCE MATTERS REQUIRING STOCKHOLDER APPROVAL. As of March 31, 2003, Xerox
beneficially owned approximately 22.8% 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
17.9% of our common stock as of March 31, 2003. 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 PREFERRED SHARES RIGHTS AGREEMENT;
- 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY RISK
The Company faces exposure to adverse movements in foreign currency exchange
rates, as a significant portion of its revenues, expenses, assets, and
liabilities are denominated in currencies other than the U.S. Dollar, primarily
the Euro Dollar. These exposures may change over time as business practices
evolve. The Company evaluates its foreign currency exposures on an ongoing
basis and makes adjustments to its foreign currency risk management program as
circumstances change.
In certain instances, the Company enters into forward exchange contracts to
hedge against foreign currency fluctuations. These contracts are used to reduce
the Company's risk associated with exchange rate movements, as the gains or
losses on these contracts are intended to offset the exchange rate losses or
gains on the underlying exposures. The Company does not engage in foreign
currency speculation. The success of the Company's foreign currency risk
management program depends upon the ability of the forward exchange contracts
to offset the foreign currency risk associated with the hedged transaction. To
the extent that the amount or duration of the forward exchange contract and
hedged transaction vary, the Company could experience unanticipated foreign
currency gains or losses that could have a material impact on the Company's
results of operations.
The Company entered into a forward exchange contract to hedge the foreign
currency exposure of its 5 million euro note payable to Philips. A forward
exchange contract to exchange a total of $5.3 million for 5.0 million Euros with
a weighted-average settlement price of 1.0636 Euro/USD, with an original term of
11 months, was outstanding at March 31, 2003.
29
ITEM 4. CONTROLS AND PROCEDURES
(a) Within the 90-day period prior to the filing of this Quarterly Report
on Form 10-Q, the Company's management, including its principal executive
officer and principal financial officer, conducted an evaluation of the
effectiveness of the design and operation of its disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934 (the "Exchange Act")). Based on that evaluation, the
Company's principal executive officer and principal financial officer concluded
that, as of the date of the evaluation, its disclosure controls and procedures
were 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. It should be noted that the
design of any system of controls is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
(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. We have not
identified any significant deficiencies or material weaknesses in our internal
controls, and therefore there were no corrective actions taken.
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 February 14, 2003, ScanSoft filed a report on Form 8-K reporting under
Item 2 the acquisition of the Philips' Speech Processing Telephony and Voice
Control businesses.
On March 24, 2003, ScanSoft filed an amendment to Form 8-K, filed on
February 14, 2003, to report under Item 2 the acquisition of the Philips's
Speech Processing Telephony and Voice Control businesses, and to include under
Item 7 audited and pro forma financial information with respect to such acquired
businesses, as required by Rule 3-05 and Article 11 of Regulation S-X,
respectively.
30
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 May 15, 2003.
SCANSOFT, INC.
By: /s/ Gerald C. Kent, Jr.
----------------------------------------
Gerald C. Kent, Jr.
Vice President, Chief Accounting Officer
and Controller
31
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
May 15, 2003
32
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
May 15, 2003
33
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
2.1(1) Purchase Agreement, dated October 7, 2002, between Koninklijke Philips
Electronics N.V. and the Registrant.
2.2(2) Amendment No. 1 to Purchase Agreement, dated as of December 20, 2002,
between Koninklijke Philips Electronics N.V. and the Registrant.
2.3(2) Amendment No. 2 to Purchase Agreement, dated as of January 29, 2003,
between Koninklijke Philips Electronics N.V. and the Registrant.
3.1 Amended and Restated Bylaws of Registrant.
10.1** Letter, dated February 17, 2003, from the Registrant to Jeanne McCann
regarding certain employment matters.
10.2** Letter, dated September 26, 2002, from the Registrant to Robert J.
Weideman regarding certain employment matters.
10.3** Amendment No. 1, dated April 28, 2003, to Employment Agreement, dated
August 21, 2000, by and between the Registrant and Michael K. Tivnan.
10.4(2) Technology Transfer and License Agreement, dated as of January 30,
2003, between Koninklijke Philips Electronics N.V. and the Registrant.
10.5(2) Promissory Note, dated January 30, 2003, between Koninklijke Philips
Electronics N.V. and the Registrant.
10.6(2) Zero Coupon Convertible Subordinated Note, dated January 30, 2003,
between Koninklijke Philips Electronics N.V. and the Registrant.
10.7(2) Plan of Distribution Agreement, dated January 30, 2003, between
Koninklijke Philips Electronics N.V. and the Registrant.
10.8+ Reseller Agreement, dated as of March 31, 2003, by and between the
Registrant and International Business Machines.
10.9 Loan and Security Agreement, dated as of October 31, 2002, as amended
on May 7, 2003, between the Registrant and Silicon Valley Bank.
99.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ----------
** Denotes Management compensatory plan or arrangement.
+ Confidential treatment requested on portions of this exhibit.
Unredacted versions of this exhibit have been filed separately with the
Commission.
(1) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement of Form S-1 (No. 33-100647) filed with the
Commission on December 6, 2002.
(2) Incorporated by reference from the Registrant's Amendment No. 4 to
Registration Statement of Form S-1 (No. 33-100647) filed with the
Commission on February 7, 2003.
34