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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 JUNE 30, 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 [ ]
66,267,053 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of July 31, 2003.
SCANSOFT, INC.
FORM 10-Q
SIX MONTHS ENDED JUNE 30, 2003
INDEX
PAGE
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets at June 30, 2003 and December 31, 2002.................. 3
b) Consolidated Statements of Operations for the three and six months ended
June 30, 2003 and June 30, 2002..................................................... 4
c) Consolidated Statements of Cash Flows for the six months ended 5
June 30, 2003 and June 30, 2002.....................................................
d) Notes to Consolidated Financial Statements.......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................. 34
Item 4. Controls and Procedures................................................................ 34
PART II: OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.................................... 34
Item 6. Exhibits and Reports on Form 8-K....................................................... 35
Signatures......................................................................................... 36
Exhibit Index...................................................................................... 37
2
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2003 2002
--------- ----------
ASSETS
Current assets:
Cash and cash equivalents .......................................................................... $ 17,045 $ 18,853
Accounts receivable, less allowances of $8,622 and $5,903, respectively ............................ 14,072 15,650
Receivables from related party ..................................................................... 1,204 1,518
Inventory .......................................................................................... 527 1,241
Prepaid expenses and other current assets .......................................................... 6,023 3,167
--------- ---------
Total current assets ............................................................................ 38,871 40,429
Goodwill ........................................................................................... 97,117 63,059
Other intangible assets, net ....................................................................... 45,331 33,823
Property and equipment, net ........................................................................ 3,439 2,846
Other assets ....................................................................................... 2,831 3,533
--------- ---------
Total assets .................................................................................... $ 187,589 $ 143,690
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................................................... $ 8,308 $ 7,085
Accrued expenses ................................................................................... 12,105 9,773
Deferred revenue ................................................................................... 2,279 1,790
Note payable ....................................................................................... 5,752 3,273
Deferred payment obligation for business acquisition ............................................... 1,124 --
Deferred payment obligation for technology license ................................................. 2,617 --
Other current liabilities .......................................................................... 1,256 1,666
--------- ---------
Total current liabilities ....................................................................... 33,441 23,587
Deferred revenue ..................................................................................... 416 244
Long-term note payable ............................................................................... 27,524 --
Other liabilities .................................................................................... 2,858 481
--------- ---------
Total liabilities ............................................................................... 64,239 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; 68,326,070 and 65,540,154 shares
issued and 66,208,692 and 63,422,776 shares outstanding, respectively ............................ 68 66
Additional paid-in capital ......................................................................... 276,624 269,858
Treasury stock, at cost (2,117,378 and 2,117,378 shares, respectively) ............................. (8,031) (8,031)
Deferred compensation .............................................................................. (122) (173)
Accumulated other comprehensive loss ............................................................... (331) (47)
Accumulated deficit ................................................................................ (149,489) (146,926)
--------- ---------
Total stockholders' equity ...................................................................... 123,350 119,378
--------- ---------
Total liabilities and stockholders' equity ...................................................... $ 187,589 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenue, third parties ......................................... $ 26,519 $ 25,281 $ 53,035 $ 47,697
Revenue, related parties ....................................... 1,224 903 2,544 2,252
-------- -------- -------- --------
Total revenue ............................................. 27,743 26,184 55,579 49,949
Costs and expenses:
Cost of revenue ......................................... 4,573 4,609 8,875 8,738
Cost of revenue from amortization of
intangible assets ...................................... 2,672 1,976 4,729 5,518
Research and development ................................ 8,350 7,067 15,527 14,053
Selling, general and administrative ..................... 13,868 10,928 27,129 20,639
Amortization of other intangible assets ................. 423 253 784 1,210
Restructuring and other charges ......................... 817 -- 1,346 1,041
-------- -------- -------- --------
Total costs and expenses ............................. 30,703 24,833 58,390 51,199
-------- -------- -------- --------
Income (loss) from operations .................................. (2,960) 1,351 (2,811) (1,250)
Other income (expense):
Interest income............................................... 58 176 99 230
Interest expense.............................................. (171) (91) (251) (176)
Other income(expense), net ................................... 501 (20) 562 (64)
-------- -------- -------- --------
Income (loss) before income taxes .............................. (2,572) 1,416 (2,401) (1,260)
Provision for (benefit) from income taxes ...................... 67 (534) 162 (328)
-------- -------- -------- --------
Net income (loss) .............................................. $ (2,639) $ 1,950 $ (2,563) $ (932)
======== ======== ======== ========
Net income (loss) per share: basic ............................. $ (0.04) $ 0.03 $ (0.04) $ (0.01)
======== ======== ======== ========
Net income (loss) per share: diluted ........................... $ (0.04) $ 0.03 $ (0.04) $ (0.01)
======== ======== ======== ========
Weighted average common shares: basic .......................... 65,821 67,595 64,979 63,173
======== ======== ======== ========
Weighted average common shares: diluted ........................ 65,821 76,677 64,979 63,173
======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
--------------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ....................................................................................... $ (2,563) $ (932)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation .............................................................................. 879 987
Amortization of intangible assets ......................................................... 5,513 6,728
Accounts receivable allowances ............................................................ 347 1,641
Non-cash portion of restructuring charges ................................................. -- 113
Stock-based compensation .................................................................. 51 50
Foreign exchange loss ..................................................................... (6) --
Non-cash interest expense ................................................................. 89 --
Gain on disposal or sale of property and equipment ......................................... -- 12
Changes in operating assets and liabilities, net of effects from business
acquisitions:
Accounts receivable .................................................................... 5,465 (3,889)
Inventory .............................................................................. 1,100 (1,332)
Prepaid expenses and other current assets .............................................. (1,122) (814)
Other assets ........................................................................... (1,695) (436)
Accounts payable ....................................................................... 609 1,594
Accrued expenses ....................................................................... (2,152) 801
Other liabilities ...................................................................... 265 --
Deferred revenue ....................................................................... (410) (2,616)
-------- --------
Net cash provided by operating activities ............................................... 6,370 1,907
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment .............................................. (1,039) (1,773)
Cash expenditures for licensing agreements ................................................... (6,113) --
Cash paid for acquisitions, including transaction costs net of cash received ................. (4,341) (2,387)
-------- --------
Net cash used in investing activities ..................................................... (11,493) (4,160)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of note payable ...................................................................... (3,273) (111)
Payments of capital lease obligation ......................................................... -- (158)
Payments under deferred payment obligation ................................................... (820) (1,414)
Proceeds from issuance of common stock, net of issuance costs ................................ 6,767 5,690
Proceeds from issuance of common stock under employee stock compensation plans ............... 1,154 2,339
-------- --------
Net cash provided by financing activities ............................................... 3,828 6,346
-------- --------
Effects of exchange rate changes on cash and cash equivalents .................................. (513) (145)
-------- --------
Net increase (decrease) in cash and cash equivalents ........................................... (1,808) 3,948
Cash and cash equivalents at beginning of period ............................................... 18,853 14,324
-------- --------
Cash and cash equivalents at end of period ..................................................... $ 17,045 $ 18,272
======== ========
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 June 30, 2003 and 2002 and the
results of operations for the three and six months ended June 30, 2003 and 2002
and cash flows for the six months ended June 30, 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 and all other subsequent periodic filings including
the Form 10-Q for the three months ended March 31, 2003 filed on May 15, 2003.
The results for the three and six months ended June 30, 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.
On January 30, 2003, the Company entered into a forward exchange contract
to hedge the foreign currency exposure of its 5.0 million euro note payable to
Philips. The contract and the note payable each have a term that expires on
December 31, 2003. Based upon period-end exchange rates, the Company estimates
the fair value of the forward exchange contract approximates the fair value of
the note payable. For the three and six months ended June 30, 2003, the Company
recorded net exchange rate gains of approximately
6
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
$1,000 and $7,000, respectively, in other comprehensive income on the note
payable and associated forward exchange contract.
Recently Issued Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The Company believes that
the adoption of SFAS No. 150 will not have a material impact on its current
financial position and results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 is effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. The Company believes that the adoption of SFAS No. 149 will
not have a material impact on its current financial position and results of
operations.
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". 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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
-------------------------------------------- ------- ------- ------- --------
Net income (loss) -- as reported ........................................ $(2,639) $ 1,950 $(2,563) $ (932)
Add back: Stock-based compensation included in net income
(loss), as reported ..................................................... 25 24 51 50
Deduct: Total stock-based employee compensation expense
determined under the fair value-based-method ............................ (2,202) (2,316) (4,538) (3,936)
------- ------- ------- -------
Net loss -- pro forma ................................................... $(4,816) $ (342) $(7,050) $(4,818)
======= ======= ======= =======
Net income (loss) per share -- as reported: basic and diluted $ (0.04) $ 0.03 $ (0.04) $ (0.01)
Net loss per share - pro forma: basic and diluted ....................... $ (0.07) $ (0.00) $ (0.11) $ (0.08)
7
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. INVENTORY
Inventory consists of the following (in thousands):
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
Raw materials.... $ 60 $ 26
Finished goods... 467 1,215
-------- ---------
$ 527 $ 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, before determination of the purchase
price adjustment to be determined by the parties as described below, totaled
$39.5 million, including transaction costs of $2.1 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; 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 $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 fair value of the
conversion feature based on the Black-Scholes option pricing model 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 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.
8
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following purchase price allocation is preliminary 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 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 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
9
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 5.0 million euros, associated with
certain restructuring actions taken through December 31, 2003, primarily
headcount and facilities related charges associated with operations based in
Germany. 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. Through June 30, 2003,
the Company entered into severance agreements with a total of 70 employees of
Philips, resulting in severance costs totaling $1.3 million. Of this amount,
severance costs of $1.0 million were subject to reimbursement to the Company by
Philips pursuant to the purchase agreement. As such, a related receivable was
recorded, of which $0.9 million remains outstanding at June 30, 2003. The
remainder ($0.3 million of the total severance costs) was recorded by the
Company as a current liability as part of the purchase price allocation in
accordance with EITF 95-3, "Recognition of Liabilities in Connection with a
Purchase Business Combination."
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues ................... $ 27,743 $ 30,175 $ 56,695 $ 57,354
Net loss ................... $ (2,639) $ (316) $ (3,186) $ (6,044)
Net loss per diluted
share ...................... $ (0.04) $ (0.00) $ (0.05) $ (0.10)
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.
6. GOODWILL
As discussed in Note 5, the Company completed the Philips acquisition on
January 30, 2003 adding $34.1 million to goodwill.
10
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
GROSS NET
CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT
---------- ---------- ----------
JUNE 30, 2003
Patents and core technology... $ 54,080 $ 24,438 $ 29,642
Completed technology.......... 28,171 16,962 11,209
Trademarks.................... 5,671 2,067 3,604
Non-competition agreement..... 4,048 4,048 --
Acquired favorable lease...... 553 553 --
Customer relationships........ 2,130 1,254 876
Other......................... 200 200 --
---------- ---------- ----------
$ 94,853 $ 49,522 $ 45,331
========== ========== ==========
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. The period of exclusivity expires after seven
years, unless terminated earlier as permitted under the agreement. Total
consideration to be paid by the Company for the license was $13.0 million. On
June 30, 2003, the terms and conditions of the agreement were amended, resulting
in a $1.2 million reduction in the license fee. The initial payment of $6.4
million due on or before June 30, 2003 was paid in accordance with the terms of
the license agreement. The two remaining payments totaling $5.6 million will be
paid as follows: 1) $2.8 million on March 31, 2004 and 2) $2.8 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 $11.4 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 expected
future revenues for the products or (b) the straight-line basis over the period
of expected use, five years. The $0.6 million 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 June 30, 2003, payments due on or before
June 30, 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.
11
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Aggregate amortization expense was $3.1 million and $5.5 million for the
three and six months ended June 30, 2003, respectively. Of these amounts, $2.7
million and $4.7 million, respectively, were included in cost of revenue and
$0.4 million and $0.8 million, respectively, were recorded in operating
expenses. Amortization expense for the remaining period of fiscal year 2003, the
four succeeding fiscal years and thereafter as of June 30, 2003 is as follows
(in thousands):
COST OF OTHER OPERATING
YEAR ENDING REVENUE EXPENSES TOTAL
-------------- ----------- ---------------- ----------
2003......... $ 5,329 $ 727 $ 6,056
2004......... 10,243 1,043 11,286
2005......... 5,842 550 6,392
2006......... 4,762 335 5,097
2007......... 4,746 293 5,039
Thereafter... 9,929 1,532 11,461
--------- -------- ----------
Total........ $ 40,851 $ 4,480 $ 45,331
========= ======== ==========
8. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
JUNE 30, DECEMBER 31,
2003 2002
------------ ------------
Compensation..................... $ 2,368 $ 2,122
Sales and marketing incentives... 2,614 1,802
Restructuring and other charges.. 1,351 665
Royalties........................ 173 238
Professional fees................ 630 472
Acquisition liabilities.......... 1,488 1,654
Other............................ 3,481 2,820
---------- --------
$ 12,105 $ 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 a charge of
approximately $0.5 million in severance-related restructuring costs in the three
month period ended March 31, 2003.
During the three months ended June 30, 2003, the Company committed to a
plan to transfer certain research and development activities currently located
at its corporate headquarters to Budapest resulting in the elimination of 21
employees. The Company recorded a restructuring charge in the amount of $0.4
million for severance payments to these employees. In addition, the Company
recorded a charge in the amount of $0.4 million for severance payments to a
former member of the senior management team.
At June 30, 2003, the remaining restructuring accrual from the current and
prior restructuring activities amounted to $1.4 million. The balance is
comprised of $0.2 million of lease exit costs and $1.2 million of
employee-related severance costs, of which $0.3
12
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
million are for severance to the former Caere President and CEO, $0.2 million
are for severance costs related to the 2003 Philips related restructuring
actions and $0.7 million are for severance costs related to the actions taken
during the three months ended June 30, 2003 as noted above. The lease exit costs
and severance due to the former Caere President and CEO will be paid through
January 2004 and March 2005, respectively. Severance costs related to the 2003
Philips related restructuring actions will be paid through December 31, 2003.
Severance costs related to restructuring actions undertaken during the quarter
ended June 30, 2003 will be paid through March 2009.
The following table sets forth the restructuring and other charges 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............. 576 465 1,041
Non-cash write-off.......................... -- (113) (113)
Cash payments............................... (764) (133) (897)
------- -------- ---------
Balance at December 31, 2002................ 446 219 665
Restructuring and other charges ............ 1,346 -- 1,346
Cash payments............................... (584) (76) (660)
------- -------- ---------
Balance at June 30, 2003.................... $ 1,208 $ 143 $ 1,351
======= ======== =========
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 month period ended June 30, 2002 includes the assumed
conversion of the Series B Preferred Stock, which participates in dividends with
common stock when and if declared, as well as the weighted average impact of
vested 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2003 2002 2003 2002
------- ------ ------- ------
Weighted average number of common shares
outstanding ............................... 65,821 64,033 64,979 63,173
Assumed conversion of Series B Preferred
stock ................................. -- 3,562 -- --
------ ------ ------ ------
Weighted average common shares: basic ...... 65,821 67,595 64,979 63,173
Effect of dilutive common equivalent shares:
Stock options ........................... -- 8,498 -- --
Convertible debenture ................... -- -- -- --
Warrants ................................ -- 480 -- --
Unvested restricted stock ............... -- 104 -- --
------ ------ ------ ------
Weighted average common shares: diluted .... 65,821 76,677 64,979 63,173
====== ====== ====== ======
For the three and six months ended June 30, 2003, diluted net loss per share
excludes 15,310,919 common share equivalents. For the three months ended June
30, 2002, stock options to purchase 43,000 shares of common stock were
outstanding but were excluded from the calculation of diluted net income per
share because the options' exercise prices were greater than the average market
price of
13
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
the Company's common stock during the period. For the six months ended June 30,
2002, diluted net loss per share excludes 11,722,362 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.
11. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), net of taxes, was ($2.9) million and
($2.8) million for the three and six months ended June 30, 2003, respectively,
and was $2.2 million and ($0.6) million for the three and six months ended June
30, 2002, respectively. Total comprehensive income for the six months ended June
30, 2003, consisted of net loss of ($2.6) million and foreign currency
translation losses of ($0.3) million partially offset by a $7,000 foreign
exchange gain related to the forward hedge on the 5.0 million euro promissory
note to Philips (Note 12).
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 $10.0 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 June 30, 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. 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.
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.
The Company amended this Loan and Security Agreement, as of June 30, 2003
thereby removing the fixed charge coverage ratio covenant for the quarter ended
June 30, 2003. As of June 30, 2003, based upon the calculated borrowing base,
available borrowings totaled approximately $4.0 million. The Company can make no
guarantees as to its ability to satisfy its future financial covenant
calculations. As of June 30, 2003, there was no outstanding balance under this
Credit Facility.
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. As of June 30, 2003, the Company was
in compliance with all covenants.
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 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 outstanding principal and accrued interest under the
Note.
14
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In connection with the Philips acquisition on January 30, 2003, the Company
issued a 5.0 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 prepaid by the Company at any time without penalty. In
connection with the issuance of the Philips Note, the Company entered into a
forward foreign currency exchange contract on January 31, 2003 to hedge the
foreign exchange exposure on the Philips Note. The amount of the forward foreign
currency 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. At June 30, 2003, the promissory
note was valued at $5.8 million and was recorded as a note payable due
currently.
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.
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 August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone, in exchange for 0.860 of a share of our common stock for each
outstanding share of SpeechWorks stock. On July 15, 2003, Elliott Davis filed an
action against SpeechWorks in the United States District Court for the Western
District for New York (Buffalo) claiming patent infringement. Damages are sought
in an unspecified amount. In the lawsuit, Davis alleges that SpeechWorks is
infringing United States Patent No. 4,802,231 entitled "Pattern Recognition
Error Reduction System" (the "`231 Patent"). The '231 Patent generally discloses
techniques for a pattern recognition system and method wherein errors are
reduced by creating independent error templates which correspond to patterns
which tend to be erroneously matched and linked error templates which are linked
to specified reference templates which are stored for comparison. Although
15
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SpeechWorks has several products in the speech recognition technology field,
ScanSoft believes that the products do not infringe the '231 Patent because
SpeechWorks does not use the claimed techniques. The Company is evaluating its
response to the Complaint, which it plans to file on or before August 25, 2003.
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, in addition to other defenses, they do not
use the claimed techniques. Damages are sought in an unspecified amount. The
Company filed an Answer on December 23, 2002. 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 June 28, 2002. The Company
believes this claim has no merit, and intends to defend the action vigorously.
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 expired 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, financial
position and cash flows 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.
16
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 two parties pursuant to such
provisions. Each of these two 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
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.
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
North America............. $ 19,545 $ 18,581 $ 40,152 $ 37,206
Other foreign countries... 8,198 7,603 15,427 12,743
--------- --------- --------- ---------
Total................... $ 27,743 $ 26,184 $ 55,579 $ 49,949
========= ========= ========= =========
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Digital Capture......... $ 12,555 $ 12,886 $ 25,142 $ 29,255
Speech.................. 15,188 13,298 30,437 20,694
--------- --------- --------- ---------
Total................. $ 27,743 $ 26,184 $ 55,579 $ 49,949
========= ========= ========= =========
17
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 38% and 36% of our
consolidated revenue for the three and six months June 30, 2003, respectively,
and approximately 34% and 32% of our consolidated revenue for the three and six
months June 30, 2002, respectively.
16. SUBSEQUENT EVENT
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone, in exchange for 0.860 of a share of ScanSoft common stock for each
outstanding share of SpeechWorks stock. This transaction resulted in the
issuance of approximately 32.5 million shares of ScanSoft common stock,
representing approximately 33% of the outstanding common stock of ScanSoft after
the completion of the acquisition. The purchase price of approximately $175.2
million, including estimated transaction costs of $4.5 million was determined
based on the shares of ScanSoft common stock issued multiplied by $5.26 per
share (the average closing price of ScanSoft common stock for a total of five
days, immediately prior and subsequent to the announcement of the acquisition).
Estimated transaction costs are subject to change due to additional direct,
incremental costs which may be incurred as a result of integration activities.
The acquisition of SpeechWorks does not result in a Change in Control. (Note
12).
The acquisition of SpeechWorks enhances the ability of the combined company
to promote its products and comprehensively address the needs of the system
integrators in the United States telephony markets. The addition of SpeechWorks'
professional services organization will enable the combined company to support
major accounts, channel partners and telecommunications firms, as well as
deliver complete solutions. In addition, the acquisition enhances the combined
company's strengths in key vertical markets, including multiple deployments in
travel/hospitality, financial services and government, thereby expanding the
combined company's market share in these key markets and expertise in developing
applications and solutions for these industries. These incremental intangible
benefits, which are reflected in the purchase consideration, resulted in
goodwill.
The Company's results of operations for the three and six months ended June
30, 2003 reported on this Form 10-Q, do not include the effect of operations for
SpeechWorks as the acquisition was completed on August 11, 2003, subsequent to
quarter-end.
As of the date of this report filed on Form 10-Q, the closing balance sheet
as of August 11, 2003 was not available from SpeechWorks. Also, severance costs
associated with restructuring actions resulting from the acquisition are
anticipated. As a result, it is impractical to provide information with respect
to the purchase price allocation as of the date of closing. It is anticipated
that the majority of the purchase price of $175.2 million will be allocated to
goodwill and other intangible assets.
18
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 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
19
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 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 August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone, in exchange for 0.860 of a share of ScanSoft common stock for each
outstanding share of SpeechWorks stock. This transaction resulted in the
issuance of approximately 32.5 million shares of ScanSoft common stock,
representing approximately 33% of the outstanding common stock of ScanSoft after
the completion of the acquisition. The purchase price of approximately $175.2
million, including estimated transaction costs of $4.5 million was determined
based on the shares of ScanSoft common stock issued multiplied by $5.26 per
share (the average closing price of ScanSoft common stock for a total of five
days, immediately prior and subsequent to the announcement of the acquisition).
Estimated transaction costs are subject to change due to additional direct,
incremental costs which may be incurred as a result of integration activities.
The acquisition of SpeechWorks does not result in a Change in Control.
RESULTS OF OPERATIONS
The following table presents, as a percentage of total revenue, certain
selected financial data for the three and six months ended June 30, 2003 and
2002:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2003 2002 2003 2002
------- ------- ------ ------
Total revenue ........................................... 100.0% 100.0% 100.0% 100.0%
Cost and expenses:
Cost of revenue .................................... 16.5% 17.6% 15.9% 17.5%
Cost of revenue from amortization of
intangible assets ................................ 9.6% 7.5% 8.5% 11.0%
Research and development ........................... 30.1% 27.0% 27.9% 28.1%
Selling, general and administrative ................ 50.0% 41.7% 48.8% 41.3%
Amortization of other intangible assets ............ 1.5% 1.0% 1.4% 2.4%
Restructuring and other charges, net ............... 2.9% 0.0% 2.4% 2.1%
----- ---- ----- -----
Total costs and expenses .................... 110.6% 94.8% 104.9% 102.4%
----- ---- ----- -----
Income (loss) from operations ........................... (10.6)% 5.2% (4.9)% (2.4)%
----- ---- ----- -----
Other income (expense), net ............................. 1.4% 0.2% 0.7% (0.0)%
----- ---- ----- -----
Income (loss) before income taxes ....................... (9.2)% 5.4% (4.2)% (2.4)%
Provision for (benefit) from income taxes ............... 0.2% (2.0)% 0.3% (0.6)%
----- ---- ----- -----
Net income (loss) ....................................... (9.4)% 7.4% (4.5)% (1.8)%
===== ==== ===== =====
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
20
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.
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 June 30, 2003 increased by $1.6
million or 6% from the comparable period in 2002. This growth in revenue was the
result of increased revenue generated from speech and language products. Revenue
from speech and language products was $15.2 million and $13.3 million for the
three months ended June 30, 2003 and 2002, respectively. The increase of $1.9
million in speech revenue was primarily due to $4.0 million in incremental
revenue from products associated with the Philips acquisition, an increase of
$0.5 million resulting from greater market acceptance of Dragon Naturally
Speaking (DNS) and the launch of DNS 7.0 during the first quarter of 2003, and
$0.6 million of revenue related to other desktop dictation products for which we
gained exclusive reseller rights in March 2003. This increase was partially
offset by a decline in the overall Text-to-Speech (TTS) market, most notably in
non-automotive embedded TTS. We expect to see continued downward pressure on
revenues from non-automotive embedded TTS and network speech solutions in the
third quarter of 2003. Revenue from ScanSoft's digital capture products was
$12.6 million and $12.9 million for the three months ended June 30, 2003 and
2002, respectively. The net decrease of $0.3 million in revenue from our digital
capture products was due primarily to an overall decrease in our Optical
Character Recognition (OCR) product family, primarily OmniPage, offset by
increased sales of our paper management products, specifically PaperPort 9.0
launched in March 2003.
Total revenue for the six months ended June 30, 2003 increased by $5.6
million or 11% from the comparable period in 2002. The growth in revenue was the
result of revenue generated from our speech and language products. Revenue from
speech and language products was $30.4 million and $20.7 million for the six
months ended June 30, 2003 and 2002, respectively. The increase of $9.7 million
in speech revenue was primarily due to $5.8 million in incremental revenue from
products associated with the Philips acquisition, an increase of $3.5 million in
revenue resulting from greater market acceptance of Dragon Naturally Speaking
and the launch of DNS 7.0 during the first quarter of 2003, and $0.6 million of
revenue related to other desktop dictation products for which we gained
exclusive reseller rights in March 2003. Revenue from our digital capture
products was $25.1 million and $29.3 million for the six months ended June 30,
2003 and 2002, respectively. The net decrease of $4.2 million in revenue from
our digital capture products from 2002 was due primarily to the recognition in
the first quarter 2002 of revenue previously deferred associated with completed
OEM services, and lower sales of our OmniPage product, offset by the launch of
PaperPort 9.0 in March 2003.
Geographic revenue classification is based on the country in which the sale
is invoiced. Revenue for the three months ended June
21
30, 2003 was 70% North America and 30% international versus 71% and 29%,
respectively for the comparable period in 2002. Revenue for the six months ended
June 30, 2003 was 72% North America and 28% international, versus 75% North
America and 25% international for the comparable period in 2002.
A number of the Company's OEM partners distribute their products throughout
the world and do not provide us with the geographical dispersion of their
products. We believe, if provided with this information, our geographical
revenue classification would indicate a higher international percentage. Based
on an estimate that factors our OEM partners' geographical revenue mix to our
revenues generated from these OEM partners, revenue for the three months ended
June 30, 2003 is approximately 62% North America and 38% international, compared
to 66% and 34%, respectively, for the comparable period in 2002. Revenue for the
six months ended June 30, 2003, based on this estimate, is approximately 64%
North America and 36% international, compared to 68% North America and 32%
international. The increase in our international revenue is driven primarily
from Europe. The increase is the result of increased sales and marketing
resources, the addition of resellers, the release of Dragon Naturally Speaking
7.0 and increased demand from OEMs for our RealSpeak product (text to speech).
The following table presents the breakdown of our total revenue by
distribution channel:
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------------
2003 2002 2003 2002
----- ---- ----- -----
VAR/Retail 36% 44% 36% 42%
Direct ... 29% 19% 29% 20%
OEM ...... 35% 37% 35% 38%
--- --- --- ---
100% 100% 100% 100%
=== === === ===
The increase in our direct revenues and the corresponding decrease in our
other sales channels, as a percentage of revenue, for the three and six months
ended June 30, 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, during the three month period ended March 31, 2003.
Cost of Revenue
Cost of revenue for the three months ended June 30, 2003 was $4.6 million or
16.5% of revenue, compared to $4.6 million or 17.6% of revenue in the comparable
period of 2002. Cost of revenue for the six months ended June 30, 2003 was $8.9
million or 15.9% of revenue, compared to $8.7 million or 17.5% for the same
period in 2002. The increase in cost of revenue in absolute dollars for the six
months ended June 30, 2003 is directly attributable to the overall increase in
revenue and increased technical support costs of $1.0 million primarily related
to the creation of a customer service department in Europe, partially offset by
a decline of $0.8 million in product costs primarily related to lower sales of
non-automotive embedded TTS products. The decrease in cost of revenue as a
percentage of total revenue was primarily due to an increase in higher-margin
license revenue during the first half of 2003. Taking into consideration the
recently completed acquisition of SpeechWorks, and specifically its higher
percentage of professional services revenue, the Company anticipates cost of
revenue as a percentage of revenue for the fiscal year ended December 2003 to
increase by several percentage points over the June 30, 2003 year-to-date
percentage.
Cost of Revenue from Amortization of Intangible Assets
Cost of revenue from amortization of intangible assets for the three months
ended June 30, 2003 was $2.7 million or 9.6% of revenue, compared to $2.0
million or 7.5% for the comparable period in 2002. The increase in cost of
revenue from amortization of intangible assets for the three months ended June
30, 2003 was due to $0.6 million of amortization related to an exclusive
worldwide license to certain desktop dictation products and technologies
acquired by the Company during the first quarter of 2003 and $0.1 million
related to the Philips acquisition, which was completed on January 30, 2003.
Cost of revenue from amortization of intangible assets for the six months ended
June 30, 2003 was $4.7 million or 8.5% of revenue, compared to $5.5 million or
11.0% for the same period in 2002. The decrease in cost of revenue from
amortization of intangible assets for the six months ended June 30, 2003
compared the comparable period in 2002 was due to $1.6 million of intangible
assets that became fully amortized during fiscal year 2002, partially offset by
amortization related to intangible assets acquired during the first quarter of
2003.
Research and Development Expense
Research and development expenses were $8.4 million or 30.1% of revenue for
the three months ended June 30, 2003, compared to $7.1 million or 27.0% of
revenue for the comparable period in 2002. Research and development costs for
the six months ended June
22
30, 2003 were $15.5 million or 27.9% of revenue, compared to $14.1 million or
28.1% for the comparable period in 2002. The increase in research and
development expenses for both the three and six months ended June 30, 2003 is
the result of increased headcount and related costs associated with the Philips
acquisition. Taking into consideration the recently completed acquisition of
SpeechWorks, the Company expects research and development expenses as a
percentage of revenue to increase initially, but to decline as a percentage of
revenue over the remainder of the year as revenue from both the Philips and
SpeechWorks products grow and research and development spending is held
constant.
Selling, General and Administrative Expense
Selling, general and administrative expenses for the three months ended
June 30, 2003 were $13.9 million or 50.0% of revenue, compared to $10.9 million
or 41.7% of revenue for the same period in 2002. Selling, general and
administrative expenses for the six months ended June 30, 2003 were $27.1
million or 48.8% of revenue, compared to $20.6 million or 41.3% for the six
months ended June 30, 2002. The increase in selling, general and administrative
expense in absolute dollars for the three and six months ended June 30, 2003 was
primarily the result of increased compensation costs of approximately $1.5
million and $3.0 million, respectively, resulting from the addition of 29 sales
and marketing employees and 12 general and administrative employees primarily
due to the Philips acquisition. The remaining increase in selling, general and
administrative expenses for the three and six months ended June 30, 2003, is due
primarily to increased channel marketing expenses of $0.2 million and $0.9
million, respectively, increased professional fees of approximately $0.2 million
and $0.7 million, respectively, and transition expenses associated with the
Philips integration. Taking into consideration the recently completed
acquisition of SpeechWorks, the Company expects selling, general and
administrative expenses as a percentage of revenue for the second half of the
fiscal year to decline for the second half of the fiscal year.
Amortization of Other Intangible Assets
Amortization of intangible assets for the three months ended June 30, 2003
was $0.4 million compared to $0.3 million for the comparable period in 2002.
Amortization of intangible assets for the six months ended June 30, 2003 was
$0.8 million compared to $1.2 million for the comparable period in 2002. The
decrease in this amortization expense for the six months ended is due to $0.6
million of intangible assets that became fully amortized during fiscal year
2002. This reduction was partially offset by $0.3 million of amortization
related to the Philips acquisition.
Restructuring and Other Charges
During the three month period ended June 30, 2003, the Company committed to
a plan to transfer certain research and development activities currently located
at the corporate headquarters to Budapest resulting in the elimination of 21
employees. The Company recorded a restructuring charge in the amount of $0.4
million for severance payments to these employees. In addition, the Company
recorded a charge in the amount of $0.4 million for severance payments to a
former member of the senior management team.
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, 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.
For the six months ended June 30, 2003, the Company paid a total of $0.6
million in severance payments, of which $0.5 million relates to the March 2002
restructuring and $0.1 million relates to severance paid to the former Caere
President and CEO, pursuant to a 2000 restructuring charge.
At June 30, 2003, the remaining restructuring accrual from the current and
prior restructuring activities amounted to $1.4 million. The balance is
comprised of $0.2 million of lease exit costs and $1.2 million of
employee-related severance costs, of which $0.3 million are for severance to the
former Caere President and CEO, $0.2 million are for severance costs related to
the 2003 Philips related restructuring actions and $0.7 million are for
severance costs related to actions taken during the quarter ended June 30, 2003.
23
The lease exit costs and severance due to the former Caere President and CEO
will be paid through January 2004 and March 2005, respectively. Severance costs
related to the 2003 Philips related restructuring actions will be paid through
December 31, 2003. Severance costs related to restructuring actions undertaken
during the three month period ended June 30, 2003 will be paid through March
2009.
Income (Loss) from Operations
As a result of the above factors, loss from operations was $(3.0) million
for the three months ended June 30, 2003 or (10.6)% of revenue, compared to
income of $1.4 million or 5.2% of revenue for the comparable period in 2002.
Loss from operations was $(2.8) million for the six months ended June 30, 2003
or (4.9)% of revenue, compared to $(1.3) million or (2.4)% of revenue for the
comparable period in 2002.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest earned on cash
and cash equivalents, offset by interest incurred for borrowings under notes
payable, and foreign currency exchange gains and losses. Other income (expense),
net was $388,000 for the three months ended June 30, 2003, compared to $65,000
for the same period in 2002. Other income (expense), net was $410,000 for the
six months ended June 30, 2003 compared to ($10,000) for the same period in
2002. The change in other income (expense), net for both the three and six
months ended June 30, 2003 from the comparable periods of 2002 is the result of
higher foreign currency gains, offset by higher interest expense.
Income (Loss) Before Income Taxes
Income (loss) before income taxes was $(2.6) million for the three months
ended June 30, 2003 or (9.2)% of revenue, compared to $1.4 million or 5.4% of
revenue for the comparable period in 2002. Loss before income taxes was $(2.4)
million for the six months ended June 30, 2003 or (4.2)% of revenue, compared
with a loss of ($1.3) million or (2.4%) of revenue for the comparable period in
2002.
Income Taxes
The provision for income taxes was $67,000 for the three months ended June
30, 2003 and consists of federal alternative minimum, state and foreign
withholding taxes. The benefit from income taxes of ($534,000) for the three
months ended June 30, 2002 consisted of foreign and state tax provisions of
$123,000 and $243,000, respectively, for which no operating loss carryforwards
were available to offset the related taxable income, offset by a federal tax
benefit of ($900,000) related to a refund of taxes paid by Caere Corporation
prior to its acquisition by the Company.
The provision for income taxes was $162,000 for the six months ended June
30, 2003 and consisted of federal alternative minimum, state and foreign
withholding taxes.
The (benefit) from income taxes of ($328,000) for the six months ended June
30, 2002 consisted of foreign and state tax provisions of $171,000 and $401,000,
respectively, offset by the federal tax benefit of ($900,000).
Net Income (Loss)
As a result of all these factors, net loss totaled $(2.6) million or (9.4)%
of revenue for the three months ended June 30, 2003, compared to $2.0 million or
7.4% of revenue for the comparable period in 2002. Net loss totaled $(2.6)
million or (4.5)% of revenue for the six months ended June 30, 2003, compared
with a net loss of ($0.9) million or (1.8)% of revenue for the comparable period
in 2002
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2003, we had cash and cash equivalents of $17.0 million and
net working capital of $5.4 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 six months ended June 30,
2003 was $6.4 million compared to $1.9 million for the comparable period in
2002. Cash provided by operations in the 2003 period came primarily from income
from operations, after
24
adjustments for non-cash amortization and depreciation, a significant reduction
in accounts receivable balances resulting from collections, and lower inventory
balances partially offset by payments of accrued expenses, including those
assumed in the Philips acquisition, and an increase in other current assets. The
increase in accounts receivable allowances at June 30, 2003 as compared to
December 31, 2002 is attributable to increased shipments of our products to
distributors in connection with our release of two new products, Dragon
Naturally Speaking 7.0 and PaperPort 9.0 during the three-month period ended
March 31, 2003. Historically, we have not incurred any significant losses on our
accounts receivable balances.
Net cash used in investing activities for the six months ended June 30,
2003 was $11.5 million compared to $4.2 million for the comparable period in
2002. Net cash used in investing activities during the 2003 period consisted of
$1.0 million in capital expenditures, which included costs to build-out
facilities in both North America and Europe, $4.3 million of payments associated
with acquisitions and $6.1 million of payments associated with an exclusive
licensing agreement. Net cash used in investing activities during 2002 consisted
of $1.8 million in capital expenditures to build-out facilities in both North
America and Europe, $0.5 million associated with acquisitions, and $1.9 million
related to the payment of acquisition-related liabilities.
Net cash provided by financing activities for the six months ended June 30,
2003 was $3.8 million compared to $6.3 million for the comparable period in
2002. Net cash provided by financing activities during the six months ended June
30, 2003 consisted of proceeds of $1.2 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 underwritten offering of our common stock. This was offset by a $0.8 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
net proceeds of $5.7 million from the private placement of our common stock and
$2.3 million from the exercise of stock options, offset by a $0.2 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 $1.4 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 June
30, 2003:
Payments Due by Period
----------------------------------------------------
More
Less than 1-3 3-5 than 5
Contractual Obligations Total 1 year years years years
- -------------------------------------------------------------------------- ------- --------- --------- --------- ------
(in thousands)
Convertible debenture .................................................... $27,524 -- $27,524 -- $--
Deferred payment associated with Philips acquisition, including imputed
interest ................................................................. 1,124 1,124 -- -- --
Euro denominated note (5 million) associated with Philips acquisition .... 5,752 5,752 -- -- --
Deferred payments for technology license ................................. 5,139 2,617 2,522 -- --
Operating leases ......................................................... 7,306 2,050 4,310 946 --
Caere acquisition related costs .......................................... 1,256 1,256 -- -- --
Imputed interest ......................................................... 488 210 278 -- --
------- ------- ------- ------- ----
Total contractual cash obligations ....................................... $48,589 $13,009 $34,634 $ 946 $--
======= ======= ======= ======= ====
Through June 30, 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 (loss) of
approximately $6.3 million for 2002 and $(2.6) million for the six months ended
June 30, 2003, and have an accumulated deficit of $149.5 million at June 30,
2003. We believe that we have the ability to maintain operating expenses at
levels
25
commensurate with revenues to maintain positive cash flows from operations. We
also believe that our existing working capital, including the cash received in
connection with the SpeechWorks acquisition, cash flows from future operations
and available borrowings under our line of credit facility, as amended, will be
sufficient to meet our operating, investing and financing needs, for at least
the next twelve months, including the integration and debt obligations incurred
in connection with the Philips acquisition, the recently completed acquisition
of SpeechWorks and the planned repurchase of up to $25 million of our common
stock.
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 May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. We do not expect that the
adoption of SFAS No. 150 will have a material impact on our current financial
position and results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 is effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. We do not expect that the adoption of SFAS No. 149 will
have a material impact on our current financial position and results of
operations.
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 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 cyclical nature 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
26
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:
-- 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 a net loss of $(2.6) million and net income of
$0.1 million in the quarters ended June 30, 2003 and March 31, 2003 and net
income of $6.3 million for the fiscal year ended December 31, 2002,
respectively. If we are unable to regain profitability, the market price for our
stock may decline, perhaps substantially.
27
OUR BUSINESS COULD BE HARMED IF WE DO NOT SUCCESSFULLY MANAGE THE
INTEGRATION OF THE BUSINESSES THAT WE ACQUIRE, INCLUDING OUR RECENTLY COMPLETED
ACQUISITION OF SPEECHWORKS. 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 recently completed
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;
-- POTENTIAL DIFFICULTY IN SUCCESSFULLY IMPLEMENTING, UPGRADING AND
DEPLOYING IN A TIMELY AND EFFECTIVE MANNER NEW OPERATIONAL INFORMATION
SYSTEMS AND UPGRADES OF OUR FINANCE, ACCOUNTING AND PRODUCT
DISTRIBUTION SYSTEMS;
-- DIFFICULTY IN INCORPORATING ACQUIRED TECHNOLOGY AND RIGHTS INTO OUR
PRODUCTS AND TECHNOLOGY;
-- UNANTICIPATED EXPENSES AND DELAYS IN COMPLETING ACQUIRED DEVELOPMENT
PROJECTS AND TECHNOLOGY INTEGRATION;
-- MANAGEMENT OF GEOGRAPHICALLY REMOTE UNITS BOTH IN THE UNITED STATES
AND INTERNATIONALLY;
-- IMPAIRMENT OF RELATIONSHIPS WITH PARTNERS AND CUSTOMERS;
-- ENTERING MARKETS OR TYPES OF BUSINESSES IN WHICH WE HAVE LIMITED
EXPERIENCE; AND
-- POTENTIAL LOSS OF KEY EMPLOYEES OF THE ACQUIRED COMPANY.
As a result of these and other risks, we may not realize anticipated
benefits from our acquisitions. Any failure to achieve these benefits or failure
to successfully integrate acquired businesses and technologies could seriously
harm our business. The size of the SpeechWorks acquisition significantly
increases both the scope and consequences of our integration risks.
OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED AS A RESULT OF PURCHASE
ACCOUNTING TREATMENT, AND THE CORRESPONDING IMPACT OF AMORTIZATION OF OTHER
INTANGIBLES RELATING TO OUR RECENTLY COMPELTED ACQUISITION OF SPEECHWORKS, IF
THE RESULTS OF THE COMBINED COMPANY DO NOT OFFSET THESE ADDITIONAL EXPENSES.
Under accounting principles generally accepted in the United States of
America, ScanSoft will account for the acquisition of SpeechWorks using the
purchase method of accounting. Under purchase accounting, ScanSoft will record
the market value of its common stock issued in connection with the acquisition
and the amount of direct transaction costs as the cost of acquiring SpeechWorks.
ScanSoft will allocate that cost to the individual assets acquired and
liabilities assumed, including various identifiable intangible assets such as
acquired technology, acquired trade names, and acquired customer relationships
and assumed above-market lease liabilities based on their respective fair
values. Intangible assets generally will be amortized over a four to ten year
period. The amount of purchase price allocated to goodwill will be approximately
$113.5 million and the amount allocated to identifiable intangible assets will
be approximately $13.9 million. Goodwill is not subject to amortization but is
subject to at least an annual impairment analysis, which may result in an
impairment charge if the carrying value exceeds its implied fair value. If other
identifiable intangible assets were amortized in equal quarterly amounts over a
six-year period following completion of the acquisition of SpeechWorks, the
accounting charge attributable to these items would be approximately $0.6
million per quarter and $2.3 million per fiscal year. As a result, purchase
accounting treatment of the acquisition could decrease net income for ScanSoft
in the foreseeable future, which could have a material and adverse effect on the
market value of ScanSoft common stock.
28
THE COMBINED COMPANY WILL BE MANAGED BY A MANAGEMENT TEAM CONSISTING OF
CURRENT SCANSOFT AND SPEECHWORKS EXECUTIVES, AND THIS MANAGEMENT TEAM MAY
UNDERTAKE A STRATEGY AND BUSINESS DIRECTION WHICH IS DIFFERENT FROM THAT WHICH
WOULD BE UNDERTAKEN BY SCANSOFT'S CURRENT MANAGEMENT TEAM.
The new management team of the combined company will consist of certain
current ScanSoft and SpeechWorks executives. The manner in which the new
management team conducts the business of the combined company, and the direction
in which the new management team moves the business, may differ from the manner
and direction in which the current management of either ScanSoft or SpeechWorks
would direct the combined or separate companies on a stand-alone basis. Such
control by the new management team, together with the effects of future market
factors and conditions, could ultimately evolve into an integration and business
strategy that, when implemented, differs from the strategy and business
direction currently recommended by ScanSoft's or SpeechWorks' current respective
management and board of directors. The new management team, and any change in
business or direction, may not improve, and could adversely impact, the combined
company's financial condition and results of operations.
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 34% and 35% of our consolidated revenue for the
year ended December 31, 2002 and for the six months ended June 30, 2003,
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 completed the acquisition of
SpeechWorks on August 11, 2003, 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,
29
respectively, and in connection with the SpeechWorks acquisition, we issued 32.5
million shares of our common stock. We may continue to issue equity securities
for future acquisitions and working capital purposes that could dilute our
existing stockholders. In connection with the L&H acquisition, we issued a
promissory note for $3.5 million. Under the terms of the Philips acquisition, we
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 51% AND 42%, RESPECTIVELY, OF OUR
REVENUE FOR THE YEAR ENDED DECEMBER 31, 2002 AND FOR THE SIX MONTHS ENDED JUNE
30, 2003. 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 year ended December 31, 2002, our document and
PDF conversion products represented approximately 39% of our revenue and our
digital paper management products represented approximately 12% of our revenue.
For the six months ended June 30, 2003, our document and PDF conversion products
represented approximately 25% of our revenue, and our digital paper management
products represented approximately 17% of our revenue. A significant 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 August 11, 2003, we acquired all of the outstanding stock of SpeechWorks
International, Inc. ("SpeechWorks"), a leading provider of software products and
professional services that enable enterprises, carriers and government
organizations to offer automated, speech-activated services over any telephone,
in exchange for 0.860 of a share of our common stock for each outstanding share
of SpeechWorks stock. On July 15, 2003, Elliott Davis filed an action against
SpeechWorks in the United States District Court for the Western District for New
York (Buffalo) claiming patent infringement. Damages are sought in an
unspecified amount. In the lawsuit, Davis alleges that SpeechWorks is infringing
United States Patent No. 4,802,231 entitled "Pattern Recognition Error Reduction
System" (the "`231 Patent"). The '231 Patent generally discloses techniques for
a pattern recognition system and method wherein errors are reduced by creating
independent error templates which correspond to patterns which tend to be
erroneously matched and linked error templates which are linked to specified
reference templates which are stored for comparison. Although SpeechWorks has
several products in the speech recognition technology field, we believe that the
products do not infringe the '231
30
Patent because SpeechWorks does not use the claimed techniques. We are
evaluating our response to the Complaint, which we plan to file on or before
August 25, 2003.
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. Damages are sought in an unspecified amount. 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, in addition to other
defenses, our products do not use the claimed techniques. We filed an Answer on
December 23, 2002. 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 June 28, 2002. We
believe this claim has no merit, and we intend to defend the action vigorously.
On August 16, 2001, we were sued by Horst Froessl for patent infringement.
Damages are sought in an unspecified amount. We filed an Answer and Counterclaim
on September 19, 2001. We believe this claim has no merit, and we intend to
defend the action vigorously.
We believe that the final outcome of the current litigation matters
described above will not have a significant adverse effect on our financial
position and results of operations and we believe that we will not be required
to expend a significant amount of resources defending such claims. However,
should we not prevail in these litigation matters 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.
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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
year ended December 31, 2002, two distribution and fulfillment partners, Ingram
Micro and Digital River, accounted for 25% and 17% of our consolidated revenue,
respectively. During the six-month period ended June 30, 2003, Ingram Micro and
Digital River accounted for 22% and 15% of our consolidated revenue,
respectively. A disruption 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 June 30, 2003, Ingram Micro, Tech Data
and Digital River represented 10%, 3% and 8% of our net accounts receivable,
respectively. At December 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 year ended December 31, 2002 and June 30, 2003,
represented 27% and 28% 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 36% of our
consolidated revenue for the year ended December 31, 2002 and June 30, 2003,
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;
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-- 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.
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 June 30, 2003, Xerox
beneficially owned approximately 22.7% of our outstanding common stock,
including warrants exercisable for up to 525,732 shares of our common stock and
3,562,238 shares of our outstanding Series B Preferred Stock, each of which is
convertible into one share of our common stock. The number of shares of common
stock issuable upon exercise of the Xerox warrant may increase in accordance
with a formula defined in the warrant agreement. The State of Wisconsin
Investment Board (SWIB) is our second largest stockholder, owning approximately
16.1% of our common stock as of June 30, 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;
33
-- 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.
In January 2003, the Company entered into a forward exchange contract to
hedge the foreign currency exposure of its 5.0 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 June 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our management, with
the participation of our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period
covered by this report. Based on that evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures as of the end of the period covered by this report were effective in
ensuring that information required to be disclosed by us in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms. We believe that a control system, no matter how well designed
and operated, cannot provide absolute assurance that the objectives of the
control system are met, and no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within a
company have been detected.
(b) Changes in internal controls. There was no change in our internal
control over financial reporting (as defined in Rule 13a-15(f) of the Exchange
Act) that occurred during the period covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 20, 2003, the Company held its Annual Meeting of Stockholders. At such
meeting the following actions were voted upon:
(a) To elect a Board of five (5) directors to hold office until the next
annual meeting of stockholders or until their respective successors
have been elected and qualified:
DIRECTOR VOTES FOR WITHHELD
-------- --------- --------
Paul A. Ricci 49,685,448 11,938,967
Mark B. Myers 60,099,621 1,524,794
Katharine A. Martin 49,128,564 12,495,851
Robert G. Teresi 48,826,268 12,798,147
Robert J. Frankenberg 60,725,186 899,229
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(b) To ratify the appointment to PricewaterhouseCoopers LLP as the
independent public accountants for the period ending December 31, 2003.
VOTES FOR VOTES AGAINST ABSTAINED BROKER NON-VOTES
--------- ------------- --------- ----------------
49,083,844 12,419,326 121,245 0
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 May 6, 2003, ScanSoft furnished a current report on Form 8-K under Item
12 regarding the announcement of its financial results for the quarter ended
March 31, 2003 and included a copy of the press release under Item 7.
On June 20, 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.
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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 August 14, 2003.
SCANSOFT, INC.
By: /s/ Gerald C. Kent, Jr.
--------------------------------
Gerald C. Kent, Jr.
Vice President, Chief Accounting
Officer and Controller
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EXHIBIT
INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1(1) Agreement and Plan of Reorganization, dated as of April 23,
2003, by and among the Registrant, Spiderman Acquisition
Corporation and SpeechWorks International, Inc.
3.1(2) Amended and Restated Certificate of Incorporation of the
Registrant.
3.2(3) Amended and Restated Bylaws of the Registrant.
10.1(4)** Employment Agreement, dated April 23, 2003, between the
Registrant and Stuart R. Patterson.
10.2(3)** Amendment No. 1, dated April 28, 2003, to Employment
Agreement, dated August 21, 2000, by and between the
Registrant and Michael K. Tivnan.
10.3(3) Loan and Security Agreement, dated as of October 31, 2002,
as amended on May 7, 2003, between the Registrant and Silicon
Valley Bank.
10.4 Loan Modification Agreement, effective as of June 30, 2003,
between the Registrant and Silicon Valley Bank.
31.1 Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a) or 15d-14(a).
31.2 Certification of Chief Financial Officer Pursuant to
Rule 13a-14(a) or 15d-14(a).
32.1 Certification Pursuant to 18 U.S.C. Section 1350.
- ----------
** Denotes Management compensatory plan or arrangement.
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 (No. 33-106184) filed with the Commission on June 17, 2003.
(2) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2001, filed with the Commission
on May 11, 2001.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2003, filed with the Commission
on May 15, 2003.
(4) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement on Form S-4 (No. 33-106184) filed with the
Commission on July 1, 2003.
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