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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, 2004
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 OF (IRS EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
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 [ ]
105,632,168 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of August 2, 2004.
SCANSOFT, INC.
FORM 10-Q
SIX MONTHS ENDED JUNE 30, 2004
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets at June 30, 2004 and
December 31, 2003 3
b) Consolidated Statements of Operations for the three and
six months ended June 30, 2004 and June 30, 2003 4
c) Consolidated Statements of Cash Flows for the six months
ended June 30, 2004 and June 30, 2003 5
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 36
Item 4. Controls and Procedures 36
PART II: OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 6. Exhibits and Reports on Form 8-K 38
Signatures
Certifications
Exhibit Index
2
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JUNE 30, DECEMBER 31,
2004 2003
--------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 22,648 $ 42,584
Marketable securities 5,196 --
Accounts receivable, less allowances of $9,551 and
$10,200, respectively (Note 6) 38,806 40,271
Receivables from related parties (Note 18) 124 2,133
Inventory 355 427
Prepaid expenses and other current assets 7,072 9,264
--------- ---------
Total current assets 74,201 94,679
Goodwill 246,231 243,266
Other intangible assets, net 47,296 54,286
Long term marketable securities 17,144 --
Property and equipment, net 7,703 6,977
Other assets 4,097 2,732
--------- ---------
Total assets $ 396,672 $ 401,940
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,951 $ 7,244
Accrued compensation 7,548 7,871
Accrued expenses (Note 9) 12,161 13,481
Deferred revenue 10,322 13,672
Note payable (Note 13) 589 904
Deferred payment obligation for technology license 2,650 2,754
Other current liabilities 3,319 4,448
--------- ---------
Total current liabilities 44,540 50,374
Deferred revenue 204 490
Long-term notes payable, net of current portion 27,830 27,859
Deferred tax liability 1,697 1,264
Other liabilities 16,240 18,727
--------- ---------
Total liabilities 90,511 98,714
--------- ---------
Commitments and contingencies (Notes 8, 13 and 14)
Stockholders' equity:
Series B 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;
108,172,743 and 105,327,485 shares issued and 105,437,277 and
102,592,019 shares outstanding, respectively 108 105
Additional paid-in capital 474,156 464,350
Treasury stock, at cost (2,735,466 and 2,735,466 shares, respectively) (10,925) (10,925)
Deferred compensation (4,852) (1,743)
Accumulated other comprehensive loss (1,290) (748)
Accumulated deficit (155,667) (152,444)
--------- ---------
Total stockholders' equity 306,161 303,226
--------- ---------
Total liabilities and stockholders' equity $ 396,672 $ 401,940
========= =========
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)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ----------------------------
2004 2003 2004 2003
--------- -------- --------- --------
(AS RESTATED) (AS RESTATED)
Revenue:
Product licenses ................................ $ 34,648 $ 25,663 $ 65,504 $ 51,171
Professional services ........................... 11,436 856 21,444 1,864
Related parties ................................. 43 1,224 1,955 2,544
--------- -------- --------- --------
Total revenue ............................. 46,127 27,743 88,903 55,579
--------- -------- --------- --------
Costs and expenses:
Cost of product licenses .................... 3,541 2,916 7,017 6,186
Cost of professional services ............... 7,939 1,657 14,665 2,689
-- stock based compensation ................. 40 -- 60 --
Cost of revenue from amortization of
intangible assets ......................... 2,805 2,672 5,621 4,729
Research and development
-- stock based compensation ................. 94 -- 137 --
-- all other expenses ....................... 8,611 8,350 17,829 15,527
Selling, general and administrative
-- stock based compensation ................. 396 26 652 51
-- all other expenses ....................... 21,585 13,842 43,300 27,078
Amortization of other intangible assets ..... 635 423 1,303 784
Restructuring and other charges ............. -- 817 801 1,346
--------- -------- --------- --------
Total costs and expenses .................. 45,646 30,703 91,385 58,390
--------- -------- --------- --------
Income (loss) from operations ................... 481 (2,960) (2,482) (2,811)
Other income (expense):
Interest income ............................... 154 58 259 99
Interest expense .............................. (106) (171) (238) (251)
Other income(expense), net .................... (254) 501 222 562
--------- -------- --------- --------
Income (loss) before income taxes ............... 275 (2,572) (2,239) (2,401)
Provision for income taxes ...................... 685 371 984 716
--------- -------- --------- --------
Net loss ........................................ $ (410) $ (2,943) $ (3,223) $ (3,117)
========= ======== ========= ========
Net loss per share: basic and diluted ........... $ (0.00) $ (0.04) $ (0.03) $ (0.05)
========= ======== ========= ========
Weighted average common shares: basic and diluted 103,881 65,821 101,637 64,979
========= ======== ========= ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
--------------------------
2004 2003
-------- --------
(AS RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,223) $ (3,117)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation 1,923 879
Amortization of other intangible assets 6,924 5,513
Accounts receivable allowances 711 347
Stock-based compensation, including restructuring portion 1,245 51
Foreign exchange gain (loss) 42 (6)
Non-cash interest expense 133 89
Deferred tax provision 433 554
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable 2,858 5,465
Inventory 61 1,100
Prepaid expenses and other current assets (1,135) (1,122)
Other assets (1,374) (1,695)
Accounts payable 588 609
Accrued expenses (2,827) (2,152)
Other liabilities (698) 265
Deferred revenue (2,800) (410)
-------- --------
Net cash provided by operating activities 2,861 6,370
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment (2,084) (1,039)
Capital expenditures for licensing agreements -- (6,113)
Maturities of marketable securities 260 --
Purchases of marketable securities (22,661) --
Cash received (paid) for acquisitions, including transaction costs, net (186) (4,341)
-------- --------
Net cash used in investing activities (24,671) (11,493)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of note payable and deferred acquisition payments (494) (3,273)
Payments under deferred payment agreement (410) (820)
Deferred payment for licensing agreements (2,800) --
Proceeds from issuance of common stock warrants 625 --
Proceeds from issuance of common stock, net of issuance costs -- 6,767
Proceeds from issuance of common stock under employee stock compensation plans 4,915 1,154
-------- --------
Net cash provided by financing activities 1,836 3,828
-------- --------
Effects of exchange rate changes on cash and cash equivalents 38 (513)
-------- --------
Net decrease in cash and cash equivalents (19,936) (1,808)
Cash and cash equivalents at beginning of period 42,584 18,853
-------- --------
Cash and cash equivalents at end of period $ 22,648 $ 17,045
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
5
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2004 and the results of
operations for the three and six months ended June 30, 2004 and 2003 and cash
flows for the six months ended June 30, 2004 and 2003. 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, 2003 filed with the Securities and Exchange
Commission on March 15, 2004 and all other subsequent periodic filings including
the Form 10-Q for the three months ended March 31, 2004 filed on May 10, 2004.
The results for the three and six months ended June 30, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004, or any future period.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities on the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The most significant estimates and assumptions included in the financial
statements are revenue recognition, including estimating valuation allowances,
specifically sales returns and other allowances, the recoverability of
intangible assets, including goodwill, and valuation allowances for deferred tax
assets. Actual amounts could differ significantly from these estimates.
Certain prior year financial statement amounts have been reclassified to
conform with the current year presentation.
2. RESTATEMENT OF TAX PROVISION
In connection with the third quarter of 2003, the Company determined that
an adjustment was required to properly reflect its tax provisions in the
Company's financial statements as presented in Form 10-Q as filed for the
quarterly periods ended March 31, 2003 and June 30, 2003. These non-cash tax
adjustments resulted from the Company's implementation of SFAS No. 142.
Historically, the Company had netted its deferred tax liability related to
goodwill against its deferred tax asset. Following the adoption of SFAS No. 142,
the temporary differences created by different treatment for book and tax of the
Company's goodwill can no longer be assumed to offset deductible temporary
differences which create deferred tax assets. Therefore, the Company was
required to record an additional tax expense to increase its deferred tax asset
valuation allowance in its financial statements for the three and six month
periods ending June 30, 2003 as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2003
------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (IN THOUSANDS, EXCEPT PER SHARE DATA)
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED
------- -------- ------- -------
Statement of Operations:
Provision for income taxes $ 67 $ 371 $ 162 $ 716
Net income (loss) $(2,639) $(2,943) $(2,563) $(3,117)
Net income (loss) per share-basic
and diluted $ (0.04) $ (0.04) $ (0.04) $ (0.05)
All financial statements and related footnotes have been restated to
reflect the adjustment.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Foreign Currency Translation
The functional currency of the Company's foreign subsidiaries is the local
currency, with the exception of the Company's subsidiary in Budapest, Hungary
for which the functional currency is the U.S. dollar. Assets and liabilities of
foreign subsidiaries that are denominated in foreign currencies are translated
into U.S. dollars at exchange rates in effect at the balance sheet date. Revenue
and
6
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
expense items are translated using the average exchange rates for the period.
Net unrealized gains and losses resulting from foreign currency translation are
included in other comprehensive income (loss), which is a separate component of
stockholders' equity, except for Budapest for which foreign currency translation
adjustments are recorded in other income (expense). Foreign currency transaction
gains and losses are included in results of operations. The Company reported in
other income, net foreign currency transaction gains and other translation gains
or losses of ($133,000) and ($119,000) for the three and six month periods ended
June 30, 2004, respectively. Net foreign currency transaction gains and other
translation gains or losses were $418,000 and $526,000 for the three and six
month periods ended June 30, 2003, respectively.
Capitalization of Internal Use Software Costs
The Company capitalizes development costs of software for internal use
required to be capitalized pursuant to Statement of Position No. 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". As of June 30, 2004, the Company had capitalized both
internal and external costs related to financial and human resource management
systems which are currently being customized to operate effectively on a
worldwide basis. The Company had capitalized costs of $1.7 million and $0.9
million, respectively, as of the periods ended June 30, 2004 and December 31,
2003.
Marketable Securities
The Company accounts for marketable securities in accordance with Statement
of Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". The Company determines the appropriate
classification of all marketable securities as held-to-maturity,
available-for-sale or trading at the time of purchase, and re-evaluates such
classification as of each balance sheet date. At June 30, 2004 all of the
Company's investments in marketable securities were classified as
available-for-sale, and as a result, were reported at fair value. Unrealized
gains and losses are reported as a component of accumulated other comprehensive
income (loss) in stockholders' equity. The amortized cost of debt securities is
adjusted for amortization of premiums and accretion of discounts from the date
of purchase to maturity. Such amortization is included in interest income as an
addition to or deduction from the coupon interest earned on the investments. The
Company follows its investment managers' methods of determining the cost basis
in computing realized gains and losses on the sale of its available-for-sale
securities, which includes both the specific identification and average cost
methods. Realized gains and losses are included in other income (expense).
4. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the
intrinsic value method as prescribed in Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. The Company follows the disclosure provisions of Statement of
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", as amended by SFAS No. 148, "Accounting For Stock-Based
Compensation-Transition and Disclosure". Deferred compensation is recorded for
restricted stock granted to employees based on the fair value of the Company's
common stock at the date of grant and is amortized over the period in which the
restrictions lapse. All stock-based awards to non-employees are accounted for at
their fair value in accordance with SFAS No. 123 and related interpretations.
Had compensation expense for the Company's stock-based compensation plans
been determined based on fair market value at the grant dates, as prescribed by
SFAS No. 123, the Company's net loss and pro forma net loss per share would have
been as follows (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
(IN THOUSANDS, EXCEPT PER (IN THOUSANDS, EXCEPT PER
SHARE DATA) SHARE DATA)
2004 2003 2004 2003
------- ------- ------- ------
Net loss -- as reported $ (410) $(2,943) $(3,223) $(3,117)
Add back: Stock-based compensation included in net
loss, as reported 530 26 1,245 51
Deduct: Total stock-based employee compensation
expense determined under the fair value-based-method (3,265) (2,202) (6,369) (4,538)
------- ------- ------- ------
Net loss - pro forma $(3,145) $(5,119) $(8,347) $(7,604)
------- ------- ------- ------
Net loss per share - as reported: basic and diluted $ (0.00) $ (0.04) $ (0.03) $(0.05)
Net loss per share -- pro forma: basic and diluted $ (0.03) $ (0.08) $ (0.08) $(0.12)
7
SCANSOFT, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INVESTMENTS
Cash and cash equivalents consist of the following:
JUNE 30,
2004
--------------
(IN THOUSANDS)
Cash $ 9,784
Money market funds 6,285
Corporate bonds 774
U.S. government agencies 5,805
---------
$ 22,648
=========
Marketable securities at amortized cost, including accrued interest, and at
fair value as of June 30, 2004, consist of the following:
JUNE 30,
2004
--------------
(IN THOUSANDS)
Corporate bonds $ 18,019
U.S. government agencies 4,321
--------
$ 22,340
========
6. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
JUNE 30, DECEMBER 31,
2004 2003
-------- ------------
(IN THOUSANDS)
Accounts receivable $ 41,101 $ 41,066
Unbilled accounts receivable 7,256 9,405
-------- ---------
48,357 50,471
Less -- allowances (9,551) (10,200)
-------- ---------
$ 38,806 $ 40,271
======== =========
Unbilled accounts receivable relate primarily to revenues earned under
royalty-based arrangements for which billing occurs in the month following
receipt of the royalty report and to revenues earned under customer contracts
accounted for under the percentage-of-completion method that have not yet been
billed based on the terms of the specific arrangement.
8
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. ACQUISITION OF TELELOGUE, INC.
On June 15, 2004, the Company acquired all of the outstanding shares of
Telelogue, Inc., a provider of automated directory assistance applications for
telecommunications service providers, based in New Jersey.
The acquisition of Telelogue enhances the Company's automated directory
assistance portfolio by adding key customer and partner relationships,
methodologies in voice user interface, and several patents used in the
successful automation of directory automation services. In addition, it adds new
reference accounts for both customer relationships and technology partners.
These incremental intangible benefits resulted in excess purchase price
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.
The consideration consists of cash payments equal to $2,206,000, of which
$500,000 was placed in escrow to cover certain indemnification obligations,
the assumption of certain obligations and a contingent payment of up to
$2,000,000 in cash to be paid, if at all, on or about July 15, 2005, upon the
achievement of certain performance goals. The total initial purchase price
of approximately $3,400,000, includes cash consideration of $2,206,000,
estimated transaction costs of $893,000 and debt assumed of $297,000. The merger
is a taxable event and has been accounted for as a purchase of a business.
The purchase price allocation is as follows (in thousands):
Total purchase consideration:
Cash ........................................ $ 2,206
Debt assumed ................................ 297
Transaction costs ........................... 893
-------
Total purchase consideration ................ $ 3,396
=======
Allocation of the purchase consideration:
Current assets .............................. $ 313
Property and equipment ...................... 637
Identifiable intangible assets .............. 550
Goodwill .................................... 3,084
-------
Total assets acquired ....................... 4,584
-------
Current liabilities ......................... (685)
Long term liabilities ....................... (503)
-------
Total liabilities assumed: .................. (1,188)
-------
$ 3,396
=======
Current assets acquired primarily relate to cash and accounts receivable.
Current liabilities assumed primarily relate to accrued expenses and deferred
revenue.
The following are the identifiable intangible assets acquired and the
respective periods over which the assets will be amortized on a straight-line
basis:
AMORTIZATION
AMOUNT PERIOD
(IN THOUSANDS) (IN YEARS)
-------------- ------------
Core technology ............ $220 7
Completed technology ....... 90 3
Customer relationships ..... 240 4
----
$550
====
9
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amount assigned to identifiable intangible assets acquired was based on
their respective fair values determined as of the acquisition date. The Company
did not attribute any value to "in-process research and development" projects in
connection with this acquisition. The Company believes that these identified
intangible assets have no residual value. The excess of the purchase price over
the tangible and identifiable intangible assets was recorded as goodwill and
amounted to approximately $3.1 million. In accordance with current accounting
standards, the goodwill is not being amortized and will be tested for impairment
as required by SFAS No. 142. The merger is a taxable event and has been
accounted for as a purchase of a business.
8. OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
GROSS CARRYING ACCUMULATED NET CARRYING USEFUL LIVES
AMOUNT AMORTIZATION AMOUNT (IN YEARS)
-------------- ------------ ------------ ------------
JUNE 30, 2004
Patents and core technology $ 53,975 $ 30,724 $ 23,251 1-9
Completed technology 13,562 3,285 10,277 1-4
Tradenames and trademarks 5,871 2,229 3,642 1-10
Non-competition agreement 10 9 1 1
Customer relationships 12,188 2,063 10,125 1-6
---------- ---------- ---------
$ 85,606 $ 38,310 $ 47,296
========== ========== =========
DECEMBER 31, 2003
Patents and core technology $ 53,673 $ 26,718 $ 26,955
Completed technology 14,081 1,928 12,153
Tradenames and trademarks 5,871 1,874 3,997
Non-competition agreement 10 4 6
Customer relationships 12,438 1,263 11,175
---------- ---------- ---------
$ 86,073 $ 31,787 $ 54,286
========== ========== =========
On March 31, 2003, the Company entered into an agreement that granted 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 Company made an additional payment of $2.8 million on
April 5, 2004 and is required to make a final payment totaling $2.8 million on
or before March 31, 2005. As of June 30, 2004, this payment (including a present
value discount of $0.1 million) is classified as current deferred payment
obligation for technology license. Additionally, according to the terms of the
June 30, 2003 amendment, the Company was entitled to receive a cash refund on
the license based on certain return levels of products previously distributed.
The Company was notified during the quarter ended March 31, 2004 that a refund
of approximately $0.5 million was due. This refund was received during the
quarter ended June 30, 2004.
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. That amount is being amortized to cost of revenue 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 payment amounts and the net present value of the payments is being
charged to interest expense over the payment period.
Aggregate amortization expense was $3.4 million and $6.9 million for the
three and six months ended June 30, 2004, respectively. Of these amounts, $2.8
million and $5.6 million, respectively, were included in cost of revenue and
$0.6 million and $1.3 million, respectively, were recorded in operating
expenses. 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. Estimated amortization expense for each of the five succeeding fiscal
years as of June 30, 2004 is as follows (in thousands):
10
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SELLING,
COST OF GENERAL AND
YEAR ENDING REVENUE ADMINISTRATIVE TOTAL
- ----------- -------- -------------- --------
2004 (July 1 - December 31, 2004) $ 5,403 $ 1,427 $ 6,830
2005 6,405 2,563 8,968
2006 5,325 2,322 7,647
2007 5,295 2,189 7,484
2008 3,430 1,913 5,343
Thereafter 7,671 3,353 11,024
-------- -------- --------
Total $ 33,529 $ 13,767 $ 47,296
======== ======== ========
9. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
JUNE 30, DECEMBER 31,
2004 2003
-------- ------------
Accrued sales and marketing incentives $ 3,137 $ 2,540
Accrued restructuring and other charges 835 1,861
Accrued royalties 498 510
Accrued professional fees 1,577 1,735
Accrued acquisition liabilities 58 143
Accrued transaction costs 64 834
Accrued other 5,992 5,858
-------- --------
$ 12,161 $ 13,481
======== ========
10. RESTRUCTURING AND OTHER CHARGES
During the three months ended March 31, 2004, the Company recorded a charge
of $0.8 million related to separation agreements with two former members of the
senior management team. Included in this amount are non-cash compensation
charges of $0.4 million related to the acceleration of restricted common stock
and stock options.
At June 30, 2004, the remaining restructuring accrual from current and
prior restructuring activities amounted to $0.8 million. This amount is
comprised of $0.3 million of lease exit costs and $0.5 million of
employee-related severance costs, of which $0.1 million are for severance to the
former Caere President and CEO and $0.4 million are for severance costs related
to actions taken during 2004 and 2003.
The severance due to the former Caere President and CEO will be paid
through March 2005. The majority of severance costs related to employee
termination actions undertaken during 2003 will be paid through September 2004.
Certain other severance costs related to restructuring actions undertaken during
2003 will be paid through March 2009. Severance costs relating to the March 2004
separation agreements will be paid during 2004.
11
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the 2004 and 2003 restructuring and other
charges accrual activity (in thousands):
LEASE
EMPLOYEE EXIT ASSET
RESTRUCTURING AND OTHER CHARGES ACCRUAL RELATED COSTS IMPAIRMENT TOTAL
- --------------------------------------- --------- ----- ---------- -------
Balance at December 31, 2002 $ 446 $ 219 -- $ 665
Restructuring and other charges 3,267 337 89 3,693
Non-cash charges -- -- (89) (89)
Cash payments (2,161) (247) -- (2,408)
------- ----- ---- -------
Balance at December 31, 2003 1,552 309 $ -- 1,861
------- ----- ---- -------
Restructuring and other charges 801 -- -- 801
Non-cash charges (348) -- -- (348)
Cash payments (1,458) (21) -- (1,479)
------- ----- ---- -------
Balance at June 30, 2004 $ 547 $ 288 $ -- $ 835
======= ===== ==== =======
11. 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. 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. All potential dilutive common shares are excluded from the
computation of net loss per share for the three and six month periods ended June
30, 2004 and 2003, respectively, because they are antidilutive.
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,
------------------- ---------------------
2004 2003 2004 2003
------- ------- ------- -------
Weighted average number of common shares
outstanding.................................... 103,881 65,821 101,637 64,979
Assumed conversion of Series B Preferred
stock...................................... -- -- -- --
------- ------- ------- -------
Weighted average common shares: basic........... 103,881 65,821 101,637 64,979
Effect of dilutive common equivalent shares:
Stock options................................ -- -- -- --
Convertible debenture........................ -- -- -- --
Warrants..................................... -- -- -- --
Unvested restricted stock.................... -- -- -- --
------- ------- ------- -------
Weighted average common shares: diluted......... 103,881 65,821 101,637 64,979
======= ======= ======= =======
For the three and six month periods ended June 30, 2004, diluted net loss
per share excludes 13,174,884 common share equivalents. For the three and six
month periods ended June 30, 2003, diluted net loss per share excludes
15,310,919 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 the period presented.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF No. 03-6, "Participating Securities and Two-Class Method under FASB
Statement No 128, Earning per Share." EITF No. 03-6 addresses a number of
questions regarding the computation of earnings per share ("EPS") by companies
that have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when, and if,
it declares dividends on its common stock. The issue also provides further
guidance in applying the two-class method of calculating EPS. It clarifies what
constitutes a
12
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
participating security and how to apply the two class method of computing EPS
once it is determined that a security is participating, including how to
allocate undistributed earning to such a security. The consensuses reached on
EITF No. 03-6 is effective for fiscal periods beginning after March 31, 2004.
Prior period earnings per share amounts will be restated to conform to the
consensuses to ensure comparability year over year. The Company has evaluated
the impact, the adoption of EITF No. 03-6 would have on its results of
operations and financial condition, and determined that as the Company is
currently operating in a net loss position, the adoption of EITF No. 03-6 had no
impact on its results of operations and financial condition.
12. COMPREHENSIVE INCOME (LOSS)
Total comprehensive loss, net of taxes, was ($0.7) million and ($3.8)
million for the three and six months ended June 30, 2004, respectively, and was
($3.2) million and ($3.4) million for the three and six months ended June 30,
2003, respectively. Total comprehensive income for the six months ended June 30,
2004, consisted of net loss of ($3.2) million, foreign currency translation
losses of ($0.3) million and ($0.3) million of unrealized loss on marketable
securities classified as available-for-sale.
13. DEBT AND CREDIT FACILITIES
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"). The Company amended this Loan and Security Agreement, as of March
31, 2004, for the period through March 31, 2006. Under this amendment, the
Company must comply with both a minimum adjusted quick ratio and minimum
tangible net worth calculation, as defined in the Loan Agreement. Depending on
the Company's adjusted quick ratio, borrowings under the Credit Facility bear
interest at the Bank's prime rate plus 0.0% or 0.75%, (5.00% at June 30, 2004),
as defined in the Loan Agreement. The maximum aggregate amount of borrowings
outstanding at any one time was amended to the lesser of $20.0 million or a
borrowing base equal to the aggregate amounts un-drawn on outstanding letters of
credit, minus either 80% or 70% of eligible accounts receivable, as defined in
the Loan Agreement, based on the Company's adjusted quick 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. As of June 30, 2004, the Company
was in compliance with all covenants.
As of June 30, 2004, no amounts were outstanding under the Credit Facility
and $16.1 million was available for borrowing in addition to approximately $1.4
million committed under this line of credit for outstanding Letters of Credit.
The Company can make no guarantees as to its ability to satisfy its future
financial covenant calculations.
Equipment Line of Credit
In connection with the acquisition of SpeechWorks, the Company assumed $1.5
million of principal amounts outstanding under a one-year equipment
line-of-credit with a bank which expired on June 30, 2003. As of June 30, 2004,
a balance of $0.8 million remains outstanding. Borrowings under this line are
collateralized by the fixed assets purchased and bear interest at the bank's
prime rate (5.00% at June 30, 2004), which is payable in equal monthly payments
over a period of 36 months. In accordance with the terms of the equipment line
of credit, as of June 30, 2004, principal payments of $0.5 million are due
during the year ending December 31, 2004, $0.3 million are due during the year
ending December 31, 2005 and $0.1 million are due during the year ended December
31, 2006. Under the financing agreement, the Company is obligated to comply with
certain financial covenants related to total tangible net assets and was in
compliance as of June 30, 2004.
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. 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
13
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjustments from time to time as provided in the Convertible Note. The
Convertible Note 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 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 provision which provides Philips the right to require the Company to
redeem the Convertible Note or any remaining portion of the principal amount, on
the date a "Change in Control" occurs. The Convertible Note provides that a
"Change in Control" is deemed to have occurred when any person or entity
acquires beneficial ownership of shares of capital stock of the Company
entitling such person or entity to exercise 40% or more of the total voting
power of all shares of capital stock of the Company, or the Company sells all or
substantially all of its assets, subject to certain exceptions. The Company's
acquisition of SpeechWorks did not result in a Change in Control.
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. These claims have been referred to counsel, and they
are in various stages of evaluation and negotiation. 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, the Company receives information concerning possible
infringement by third parties of the Company's intellectual property rights,
whether developed, purchased or licensed by the Company. In response to any such
circumstance, the Company has counsel investigate the matter thoroughly and the
Company takes all appropriate action to defend its rights in these matters.
On August 5, 2004, Compression Labs, Inc. filed an action against the
Company in the United States District Court for the Eastern District of Texas
for patent infringement. In the lawsuit, Compression Labs alleges that the
Company is infringing United States Patent No. 4,698,672 entitled "Coding System
for Reducing Redundancy." The Company has not yet evaluated the merits of this
lawsuit.
On April 23, 2004, Millennium L.P. filed an action against the Company in
the United States District Court for the Southern District of New York claiming
patent infringement. Damages are sought in an unspecified amount. In the
lawsuit, Millennium alleges that the Company is infringing United States Patent
No. 5,258,855 entitled "Information Processing Methodology"; No. 5,369,508
entitled "Information Processing Methodology"; No. 5,625,465 entitled
"Information Processing Methodology"; No. 5,768,416 entitled "Information
Processing Methodology"; and No. 6,094,505 entitled "Information Processing
Methodology." We believe this claim has no merit, and we intend to defend the
action vigorously.
On July 15, 2003, Elliott Davis ("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 that correspond to patterns that tend to be
erroneously matched and linked error templates that are linked to specified
reference templates that are stored for comparison. In addition, on November 26,
2003, Davis filed an action against the Company in the United States District
Court for the Western District for New York (Buffalo) claiming that the Company
infringed the '231 Patent. Damages are sought in an unspecified amount. Although
ScanSoft has, both prior to and as a result of the SpeechWorks acquisition,
several products in the speech recognition technology field, ScanSoft believes
that the products do not infringe the '231 Patent because neither the Company
nor SpeechWorks use the claimed techniques. SpeechWorks filed an Answer and
Counterclaim to Davis's Complaint in its case on August 25, 2003 and the Company
filed an Answer and Counterclaim to Davis's Complaint in its case on December
22, 2003. The Company believes Davis's claims have no merit and intends to
defend the actions vigorously.
14
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 August 16, 2001, Horst Froessl sued the Company in the United States
District Court for the Northern District of California for patent infringement.
That action has been resolved for an immaterial amount, and the Company was
dismissed from the action on March 24, 2004.
The Company believes that the final outcome of the current litigation
matters described above will not have a significant adverse effect on its
financial position and results of operations. However, even if the Company's
defense is successful, the litigation could require significant management time
and will be costly. Should the Company not prevail in these litigation matters,
its operating results, financial position and cash flows could be adversely
impacted.
Guarantees and Other
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. 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.
In accordance with the terms of the SpeechWorks merger agreement, the
Company is required to indemnify the former members of the SpeechWorks board of
directors, on similar terms as described above, for a period of five years from
the acquisition date. As a result, the Company recorded a liability related to
the fair value of the obligation of $1.0 million in connection with the purchase
accounting for the acquisition. Additionally in accordance with the terms of the
merger agreement, the Company purchased a director and officer insurance policy
related to this obligation for a period of three years from the date of
acquisition.
In accordance with the provisions of FASB issued FASB Interpretation No. 45
("FIN 45"), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, the following table
represents the deferred revenue activity related to the Company's obligations
under maintenance and support contracts for the six month period ended June 30,
2004 (in thousands):
Beginning balance as of December 31, 2003 $ 4,056
Additions due to new billings during 2004 3,475
Maintenance revenue recognized during the 2004 (2,839)
--------
Ending balance as of June 30, 2004 $ 4,692
========
14. STOCKHOLDERS' EQUITY
Preferred Stock
The Company is authorized to issue up to 40,000,000 shares of preferred
stock, par value $0.001 per share. The Company has designated 100,000 shares as
Series A Preferred Stock and 15,000,000 as Series B Preferred Stock. In
connection with the acquisition
15
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of ScanSoft, the Company issued 3,562,238 shares of Series B Preferred Stock to
Xerox Corporation ("Xerox"). On March 19, 2004, the Company announced that
Warburg Pincus, a global private equity firm, had agreed to purchase all
outstanding shares of the Company's stock held by Xerox Corporation for
approximately $80 million, including the 3,562,238 shares of Series B preferred
stock. The Series B Preferred Stock is convertible into shares of common stock
on a one-for-one basis. The Series B Preferred Stock has a liquidation
preference of $1.30 per share plus all declared but unpaid dividends. The Series
B Preferred Stock holders are entitled to non-cumulative dividends at the rate
of $0.05 per annum per share, payable when, as and if declared by the Board of
Directors. To date no dividends have been declared by the Board of Directors.
Holders of Series B Preferred Stock have no voting rights, except those rights
provided under Delaware law. The undesignated shares of preferred stock will
have rights, preferences, privileges and restrictions, including voting rights,
dividend rights, conversion rights, redemption privileges and liquidation
preferences, as shall be determined by the Board of Directors upon issuance of
the preferred stock. The Company has reserved 3,562,238 shares of its common
stock for issuance upon conversion of the Series B Preferred Stock.
Common Stock Warrants
The Company issued Xerox a ten-year warrant with an exercise price for each
warrant share of $0.61. Pursuant to the terms of this warrant, it is exercisable
for the purchase of 525,732 shares of the Company's common stock. On March 19,
2004, the Company announced that Warburg Pincus, a global private equity firm
had agreed to purchase all outstanding shares of the Company's stock held by
Xerox Corporation, including the warrant referenced above, for approximately $80
million. In connection with this transaction, Warburg Pincus acquired warrants
to purchase 2.5 million additional shares of the Company's common stock for
total consideration of $0.6 million. The warrants have a six year life and a
exercise price of $4.94. The Company received this payment of $0.6 million
during the quarter ended June 30, 2004.
In connection with the March 31, 2003 acquisition of the certain
intellectual property assets related to multimodal speech technology, the
Company issued a warrant, expiring October 31, 2005, for the purchase of 78,000
shares of ScanSoft common stock 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.
In connection with the SpeechWorks acquisition, the Company issued a
warrant to its investment banker, expiring on August 11, 2009, for the purchase
of 150,000 shares of ScanSoft common stock at an exercise price of $3.98 per
share. The warrant does not become exercisable until August 11, 2005 and was
valued at $0.2 million based upon the Black-Scholes option pricing model with
the following assumptions: expected volatility of 60%, a risk-free interest rate
of 4.03%, an expected term of 8 years, no dividends and a stock price of $3.92
based on the Company's stock price at the time of issuance.
In connection with the acquisition of SpeechWorks, the Company assumed the
remaining outstanding warrants issued by SpeechWorks to America Online ("AOL")
to purchase up to 219,421 shares, as converted, of common stock in connection
with a long-term marketing arrangement. The warrant is currently exercisable at
a price of $14.49 per share and expires on June 30, 2007. The value of the
warrant was insignificant.
On December 17, 2003, pursuant to a letter agreement, dated October 17,
2003, the Company issued a warrant to a former employee of SpeechWorks, expiring
December 17, 2004, for the purchase of 11,180 shares of its common stock at an
exercise price of $7.70 per share, and 2,552 shares of its common stock at an
exercise price of $5.64 per share. The warrant was valued at approximately
$18,000 based upon the Black-Scholes option pricing model with the following
assumptions: expected volatility of 80%, a risk-free interest rate of 1.63%, an
expected term of 1 year, no dividends and a stock price of $5.62 based on the
Company's stock price at the time of issuance.
Stock Repurchase
On August 6, 2003, the Company's board of directors authorized the
repurchase of up to $25 million of the Company's common stock over the following
12 months, however, the Company may suspend or discontinue the repurchase
program at any time. From August 6, 2003 through December 31, 2003, the Company
repurchased 618,088 common shares at a purchase price of $2.9 million;
16
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company records treasury stock at cost. The Company did not repurchase any
common stock during the three or six month periods ended June 30, 2004.
As of June 30, 2004, the Company had repurchased a total of 2,735,466
common shares under this and previous repurchase programs. The Company intends
to use the repurchased shares for its employee stock plans and for potential
future acquisitions.
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 of $2.4 million, the net proceeds to
the Company amounted to approximately $5.5 million.
15. RESTRICTED COMMON STOCK
During the three months ended March 31, 2004, the Company issued 647,291
shares of restricted common stock to members of the Company's senior management
team. Unvested restricted common stock may not be sold, transferred or assigned
and are subject to forfeiture in the event an employee ceases to be employed by
the Company. The difference between the purchase price and the fair value of the
Company's common stock on the date of issue based on the listed exchange price
of $3.7 million has been recorded as deferred compensation and additional
paid-in-capital. The deferred compensation is being recognized as compensation
expense ratably over the vesting period resulting in $0.3 million and $0.4
million of stock compensation expense during the three and six month periods
ended June 30, 2004.
During the three months ended June 30, 2004, the Company issued 105,602
shares of restricted common stock to certain employees of the Company, including
a member of the senior management team. Unvested restricted common stock may not
be sold, transferred or assigned and are subject to forfeiture in the event an
employee ceases to be employed by the Company. The difference between the
purchase price and the fair value of the Company's common stock on the date of
issue based on the listed exchange price of $0.5 million has been recorded as
deferred compensation and additional paid-in-capital. The deferred compensation
is being recognized as compensation expense ratably over the vesting period
resulting in $20,000 of stock compensation expense during the three month period
ended June 30, 2004.
16. 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,
------------------------ -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
North America............ $ 33,236 $ 19,545 $ 62,667 $ 40,152
Other foreign countries.. 12,891 8,198 26,236 15,427
--------- --------- --------- ---------
Total.................. $ 46,127 $ 27,743 $ 88,903 $ 55,579
========= ========= ========= =========
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Digital Capture......... $ 16,226 $ 12,555 $ 30,686 $ 25,142
Speech.................. 29,901 15,188 58,217 30,437
--------- --------- --------- ---------
Total................. $ 46,127 $ 27,743 $ 88,903 $ 55,579
========= ========= ========= =========
17
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 30% and 32% of our
consolidated revenue for the three and six months June 30, 2004, respectively,
and approximately 38% and 36% of our consolidated revenue for the three and six
months June 30, 2003, respectively.
17. PRO FORMA RESULTS
The following table reflects unaudited pro forma results of operations of
the Company assuming that the Philips, SpeechWorks, LocusDialog and Telelogue
acquisitions had occurred on January 1, 2003 (in thousands, except per share
data):
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2004 2003 2004 2003
-------- -------- -------- --------
Revenues............. $ 46,271 $ 41,992 $ 88,200 $ 79,234
Net loss............. $ (1,651) $(13,116) $ (5,485) $(23,335)
Net loss per diluted
share................ $ (0.02) $ (0.13) $ (0.05) $ (0.24)
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 this period.
18. RELATED PARTIES
On March 19, 2004, the Company announced that Warburg Pincus, a global
private equity firm, had agreed to purchase all outstanding shares of the
Company's stock held by Xerox Corporation for approximately $80 million. At
December 31, 2003, Xerox owned approximately 15% of the Company's outstanding
common stock and all of the Company's outstanding Series B Preferred Stock. In
addition, Xerox had the opportunity to acquire additional shares of common stock
pursuant to a warrant (Note 14).
As a result of the Xerox and Warburg Pincus transaction, Xerox is no longer
a related party as of June 30, 2004. The Company does not engage in transactions
in the normal course of its business with Warburg Pincus.
The Company and Xerox have entered into multiple non-exclusive agreements
in which the Company grants Xerox the royalty-bearing right to copy and
distribute certain versions of the Company's software programs with Xerox's
multi-function peripherals. Xerox accounted for 4%, and 5% of the Company's
total net revenues during each of the three month periods ended March 31, 2004
and 2003, respectively. In the six month period ended June 30, 2003, Xerox
revenue was $2.5 million.
In connection with the Caere acquisition in the first quarter of 2000 and
pursuant to a concurrent non-competition and consulting agreement, the Company
agreed to pay in cash to the former Caere President and CEO, a current member of
the Board of Directors of the Company, on the second anniversary of the merger,
March 13, 2002, the difference between $13.50 and the closing price per share of
ScanSoft common stock at that time, multiplied by 486,548. On March 5, 2002, the
Company negotiated a deferred payment agreement with the former Caere President
and CEO to terminate this agreement. Under the terms of the deferred payment
agreement, the Company paid $1.0 million in cash on March 5, 2002 and agreed to
make future cash payments totaling $3.3 million, with such amounts payable in
equal quarterly installments of approximately $0.4 million over the following
two years. During the three months ended March 31, 2004, the Company paid a
quarterly installment under this agreement of $0.4 million. The total
consideration of this agreement was accounted for in the original Caere purchase
price and had no effect on the results of operations. There is no remaining
liability as of June 30, 2004.
18
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED
At June 30, 2004, a member of the Company's Board of Directors, and a
former member of the SpeechWorks Board of Directors, is a senior executive at
Convergys Corporation. The Company and Convergys have entered into multiple
non-exclusive agreements in which Convergys resells the Company's software.
During the six months ended June 30, 2004, Convergys accounted for approximately
$0.1 million in total net revenues. As of June 30, 2004, Convergys owed the
Company $0.1 million, pursuant to these agreements, which are included in
receivables from related parties.
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 FUTURE REVENUES, COST OF REVENUES, RESEARCH AND DEVELOPMENT
EXPENSES, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES, AMORTIZATION
OF OTHER INTANGIBLE ASSETS AND GROSS MARGIN;
-- GROWTH AND OPPORTUNITIES WITHIN OUR TARGET MARKETS;
-- OUR STRATEGY RELATING TO SPEECH AND LANGUAGE TECHNOLOGIES;
-- 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 "Risk Factors" 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 OF THE BUSINESS
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,
services, channels and business processes.
On June 15, 2004, we acquired all of the outstanding shares of Telelogue,
Inc. ("Telelogue), a provider of automated directory assistance applications for
telecommunications service providers, in exchange for cash consideration. The
consideration consists of an
19
amount equal to $2,000,000 in cash (less certain expenses), of which $500,000
was placed in escrow to cover certain indemnification obligations, the
assumption of certain obligations and a contingent payment of up to $2,000,000
in cash to be paid, if at all, on or about July 15, 2005, upon the achievement
of certain performance goals.
On March 30, 2004, we amended our loan and security agreement with Silicon
Valley Bank for a revolving loan in a principal amount not to exceed $20.0
million, collateralized by substantially all of our personal property, but not
our intellectual property. At the date of this quarterly report on Form 10-Q, no
amounts were outstanding under the Credit Facility and $15.6 million was
available for borrowing, with approximately $1.4 million committed under this
line of credit for outstanding Letters of Credit.
On December 19, 2003, we acquired all of the outstanding shares of
LocusDialog Inc. ("LocusDialog"), a provider of speech-enabled, auto-attendant
applications, such as call routing and auto attendant functions. LocusDialog has
installed nearly 1,000 applications worldwide, handling approximately 500
million calls annually. Consideration for the transaction comprised 2.3 million
shares of our common stock at a per share value of $5.31 (the average closing
price of ScanSoft common stock for a total of five days immediately prior to and
subsequent to the announcement of the acquisition) having a value of $12.4
million and transaction costs of $0.7 million.
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, telecommunications 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. This transaction resulted in the
issuance of approximately 32.5 million shares of our common stock, representing
approximately 33% of our outstanding common stock after the completion of the
acquisition. The SpeechWorks purchase price of $175.5 million includes the value
of the ScanSoft common stock issued at a per share value of $5.26 (the average
closing price of ScanSoft common stock for a total of five days immediately
prior to and subsequent to the announcement of the acquisition) and transaction
costs of $4.5 million. Included in the transaction costs is a warrant, valued at
$0.2 million, for the purchase of 150,000 shares of our common stock. In
addition, the purchase price includes the value of 184,850 shares of restricted
common stock issued to replace previously outstanding SpeechWorks restricted
common stock, of $0.7 million, based on the closing price of our common stock on
the date of acquisition. The value of the unvested restricted common stock has
been recorded as deferred compensation.
On January 30, 2003, we completed the acquisition of the Speech Processing
Telephony and Voice Control business units of Royal Philips Electronics N.V.
("Philips"), and related intellectual property, on the terms set forth in the
purchase agreement dated October 7, 2002, as amended. 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 these business units and intellectual property, 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 prior to December 31, 2003,
issued a 5.0 million euro note payable 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. Prior to December 31, 2003, we paid both
the 5.0 million euro promissory note and the additional 1.0 million euro payable
in accordance with the provisions of the purchase agreement. In addition, prior
to December 31, 2003, in accordance with provisions of the purchase agreement,
the parties agreed upon a purchase price adjustment resulting in a decrease to
the total purchase consideration, and a payment to be made by Philips to
ScanSoft of approximately $3.0 million. ScanSoft received this payment on
January 5, 2004.
20
OVERVIEW OF RESULTS OF OPERATIONS
The following table presents, as a percentage of total revenue, certain
selected financial data for each of the three and six month periods ended
June 30:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2004 2003 2004 2003
----- ----- ----- -----
Revenues:
Product licenses .............................. 75.2% 96.9% 75.9% 96.6%
Professional services ......................... 24.8 3.1 24.1 3.4
----- ----- ----- -----
Total revenue ............................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues:
Cost of product licenses ...................... 7.7 10.5 7.9 11.1
Cost of professional services - stock based
compensation ................................ -- -- -- --
-- all other expenses ....................... 17.2 6.0 16.5 4.8
Cost of revenue from amortization of intangible
assets(1) ................................... 6.1 9.6 6.3 8.5
----- ----- ----- -----
Total cost of revenues ...................... 31.0 26.1 30.7 24.4
----- ----- ----- -----
Research and development
-- stock based compensation ................. 0.2 -- 0.2 --
-- all other expenses ....................... 18.7 30.1 20.1 27.9
Selling, general and administrative
-- stock based compensation ................. 0.9 0.1 0.7 0.1
-- all other expenses ....................... 46.8 49.9 48.7 48.7
Amortization of other intangible assets (1) ... 1.4 1.5 1.5 1.4
Restructuring and other charges, net (2) ...... -- 2.9 1.0 2.4
----- ----- ----- -----
Total costs and expenses .................... 99.0 110.6 102.9 104.9
----- ----- ----- -----
Income (loss) from operations ................... 1.0 (10.6) (2.9) (4.9)
----- ----- ----- -----
Other income (expense), net ..................... (0.4) 1.4 0.3 0.7
----- ----- ----- -----
Income (loss) before income taxes ............... 0.6 (9.2) (2.6) (4.2)
Provision for (benefit) from income taxes ....... 1.5% 1.4% 1.1% 1.4%
----- ----- ----- -----
Net income (loss) ............................... (0.9)% (10.6)% (3.7)% (5.6)%
----- ----- ----- -----
- ----------
(1) See Note 8 of Notes to Consolidated Financial Statements.
(2) See Note 10 of Notes to Consolidated Financial Statements.
21
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
professional services, which include, but are not limited to, custom software
applications and other services considered essential to the functionality of the
software, training, and maintenance associated with software license
transactions. Our speech technologies enable voice-activated services over a
telephone, transform speech into text and text into speech, and permit voice
control of devices and applications. Our digital capture technologies transform
text, images and files into various digital formats. During the three month
period ended June 30, 2004, Speech and Digital Capture represented approximately
65% and 35%, respectively, of our net revenue.
Cost of product license revenue consists primarily of material and
fulfillment costs and third party royalties paid to other vendors.
Cost of professional services revenue consists primarily of engineering
costs, both internal and external, associated with certain contracts which are
accounted for under the percentage-of-completion method of accounting and
project-specific travel expenses.
Cost of revenue from amortization of intangible assets consists of 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 internal 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.
Stock-based compensation expenses result from non-cash charges for common
shares issued with exercise or purchase prices that are less than the fair
market value of the common stock on the date of grant.
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, 2004 increased by $18.4
million, or 66%, from the comparable period in 2003. The overall growth in
revenue is attributed to $7.8 million growth from our product revenue and $10.6
million in growth from professional services. Total revenue for the six months
ended June 30, 2004 increased by $33.3 million, or 60%, from the comparable
period 2003. The overall revenue growth for the first half of 2004 was made up
of $13.7 million in product revenues and $19.6 million in professional services
revenue.
Geographic revenue classification is based on the country in which the sale
is invoiced. Revenue for the three months ended June 30, 2004 was 72% North
America and 28% international versus 70% and 30%, respectively for the
comparable period in 2003. Revenues for the six months ended June 30, 2004 were
segregated geographically 70% North America and 30% international, versus 72%
North America and 28% international for the same period in 2003.
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, 2004 is approximately 69% North America and 31% international, compared
to 62% and 38%, respectively, for the comparable period in 2003. Based on this
allocation, the revenues for the first half 2004 is approximately 68% North
America and 32% international, as compared to 64% North America and 36%
international for the same period, 2003.
22
For fiscal year 2004, we expect revenue growth of 37% to 48% from the
fiscal year 2003 total. We believe that growth will occur throughout all of our
product lines.
Within the networked speech market, our anticipated growth is attributable
to certain competitive advantages, such as superior products, channel expertise,
packaged applications and professional services. By leveraging our advantages,
we expect to gain market share by providing solutions for industries including
financial services, telecommunications, healthcare, utilities, government, and
travel and entertainment. Our anticipated growth in network speech will largely
result from two specific applications - call center automation and directory
assistance.
Within the embedded speech market, we anticipate continued growth,
specifically in the automotive, electronic games and handsets markets, resulting
in a significant increase over 2003 revenues. We expect to benefit from a number
of continued design wins and new applications and devices that our customers and
partners bring to global markets. In addition, we expect certain legislation and
safety initiatives for using devices in automobiles to contribute to future
demand for our solutions. Additionally, we intend to extend our solutions
further in the learning and accessibility markets.
Within our productivity applications, we expect to benefit from three
important trends -- IT spending in healthcare, networked scanning, and PDF
solutions. We expect to invest in and see growth from our dictation product
applications through opportunities in healthcare organizations looking for
productivity solutions that can automate processes, cut costs, and offer an
alternative to outsourcing. In digital capture, our OmniPage and PaperPort
products are positioned to take advantage of the growing networked scanning
markets through our major OEM partners. Within the PDF market, we have seen
early success from our PDF products and expect to see growth as we continue to
invest in this line of products.
We expect a similar mix of product and service revenue as presented in our
three most recent quarters. The majority of our services revenue is
attributable to our networked speech initiatives where we sell solutions that
comprise a combination of technologies, applications and professional services.
Trends and markets that affect our product revenues in networked and embedded
revenue can also be ascribed to our services revenue.
Product Revenue
Product revenue for the three months ended June 30, 2004 increased by $7.8
million, or 29%, from the comparable period in 2003. The increase in revenue
from the comparable period 2003 is attributed to a $4.4 million increase in
speech revenue, as well as a $3.4 million increase in digital capture revenue.
Product revenue for the six months ended June 30, 2004 increased by $13.7
million, or 26%, from the comparable period in 2003. The increase in revenue
from the comparable period 2003 is ascribed to a $8.9 million increase in speech
revenue, as well as a $4.8 million increase in digital capture revenue.
The growth in speech revenue is attributed to growth and increased demand
in all speech segments - enterprise, telephony, embedded, and dictation was
primarily due to the acquisition of SpeechWorks, Locus Dialog, and Telelogue.
For the three months ended June 30, 2004, the acquisitions contributed
approximately $8.4 million in revenue, an increase of 48% over legacy ScanSoft
speech solutions for enterprise, telephony and embedded markets. This increase
was partially offset in comparison by a $2.7 million decrease in our legacy
ScanSoft speech revenue. In addition, our dictation productivity applications
decreased $1.3 million in the three months ended June 30, 2004, due entirely to
the launch of Dragon Naturally Speaking v.7 in late Q1 and early Q2 of last
year.
For the six months ended June 30, 2004, the acquisitions contributed
approximately $14.8 million in revenue, an increase of 26% over legacy ScanSoft
speech solutions for enterprise, telephony and embedded markets. This increase
was partially offset in comparison by a $5.1 million decrease in our legacy
ScanSoft speech revenue and a $3.0 million decrease due to a large OEM
transaction with one customer in March 2003, that was not repeated again in
2004. In addition, our dictation productivity applications decreased $0.7
million in the six months ended June 30, 2004, due entirely to the launch of
Dragon Naturally Speaking v.7 in late Q1 and early Q2 of last year.
The $3.4 million increase in our digital capture revenue for the three
months ended June 30, 2004, was due primarily to an increase of $3.5 million,
from our PDF Converter product line, which was launched in September 2003. We
experienced an overall increase in our OCR product revenues of $1.4 million,
which included a $2.1 million year-over-year increase within our OmniPage
product line, as well as a $0.4 million increase in our Capture Development Kit
products. This was offset partially by a $1.2 million decrease in our TextBridge
product line as certain OEM partners migrate from TextBridge to OmniPage
products. In addition, we experienced a decrease of $1.7 million year-over-year
in our paper management revenue due to the launch of PaperPort 9.0 late in March
2003.
The $4.8 million increase in our digital capture revenue for the six months
ended June 30, 2004, was due primarily to an increase of $4.8 million, from our
PDF Converter product line, which was launched in September 2003. We experienced
an overall increase in our OCR product revenues of $2.7 million, which included
a $3.4 million year-over-year increase within our OmniPage product line, as well
as a $0.6 million increase in our Capture Development Kit products. This was
offset partially by a $2.0 million decrease in our TextBridge product line as
certain OEM partners migrate from TextBridge to OmniPage products. In addition,
we experienced a decrease of $3.0 million year-over-year in our paper management
revenue due to the launch of PaperPort 9.0 late in March 2003.
23
The following table presents the breakdown of our product revenue by
distribution channel:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------- ---------------
2004 2003 2004 2003
---- ---- ---- ----
VAR/Retail ... 37% 38% 38% 38%
Direct ....... 16% 29% 17% 29%
OEM .......... 47% 33% 45% 33%
--- --- --- ---
100% 100% 100% 100%
=== === === ===
The increase in our OEM product revenues as a percentage of revenue, for
the three and six months ended June 30, 2004 as compared to the same period
2003, was primarily due to the acquisitions of SpeechWorks and Locus Dialog.
Additionally, the Direct channel decreased, as a percentage of product revenue,
due to launches of both our Dragon Naturally Speaking v7.0 and PaperPort v9.0 in
Q1 and Q2 of 2003, which are both distributed directly.
Service Revenue
Service revenue for the three months ended June 30, 2004 increased by $10.6
million from the comparable period in 2003. Previously, service revenue was
immaterial, comprised of non-recurring engineering fees for speech and imaging
applications. The substantial increase in service revenue from the comparable
period 2003 is attributed to the formation of a professional services
organization in conjunction with the acquisition of SpeechWorks, which was
completed in August 2003. Additionally, we saw a $0.3 million increase in
service revenue from our digital capture products, as well as a $0.4 million
increase in service revenue from our dictation product lines.
Service revenue for the six months ended June 30, 2004 increased by $19.6
million from the comparable period in 2003. Previously, service revenue was
immaterial, comprised of non-recurring engineering fees for speech and imaging
applications. The substantial increase in service revenue from the comparable
period 2003 is attributed to the formation of a professional services
organization in conjunction with the acquisition of SpeechWorks, which was
completed in August 2003. Additionally, we recorded a $0.7 million increase in
service revenue from our digital capture products, as well as a $0.5 million
increase in service revenue from our dictation product lines.
Cost of Product License Revenue
Cost of product license revenue for the three months ended June 30, 2004
was $3.5 million, or 10.2%, of product license revenue, compared to $2.9
million, or 10.8%, for the comparable period in 2003. Cost of product license
revenue for the six months ended June 30, 2004 was $7.0 million, or 10.4%, of
product license revenue, compared to $6.2 million, or 11.5%, for the comparable
period in 2003. The increase in cost of product license revenue in absolute
dollars for these periods ended June 30, 2004 was directly attributable to the
overall increase in our product license revenue. The decrease in cost of product
license revenue as a percentage of revenue was due productivity gains in our
manufacturing and fulfillment operations, as well as decreased customer service
costs. For the remainder of 2004, we expect cost of product license revenue, as
a percentage of revenue, to be consistent with the six months ended June 30,
2004.
Cost of Professional Services Revenue
As we continue to grow our professional services business, we expect the
costs of professional service revenue to be more comparable to the three and six
month periods ended June 30, 2004 versus the same periods ended June 30, 2003.
Cost of professional services revenue for the three months ended June 30, 2004
was $7.9 million, or 69.4%, of professional services revenue, compared to $1.7
million, or 194%, for the comparable period in 2003. Cost of professional
services revenue for the six months ended June 30, 2004 was $14.7 million, or
68.4%, of professional services revenue, compared to $2.7 million, or 144%, for
the comparable period in 2003. The increase in cost of professional services
revenue in absolute dollars for the three-month period ended June 30, 2004 was
directly attributable to the increase in engineering costs related to
professional services revenue resulting from the Philips and SpeechWorks
acquisitions and increased technical support costs primarily related to the
creation of a customer service department in Europe. We expect cost of revenues
as a percentage of total revenues to increase slightly during the third quarter,
as we increased professional services staffing to meet our solutions demand.
But, we expect this ratio to decrease during the fourth quarter as a result of
higher utilization of our new services personnel and anticipated increases in
revenue during the fourth quarter.
Cost of professional services-stock based compensation is related to the
issuance of common stock to certain of our executives with exercise or purchase
prices that are less than
24
the fair market value of the common stock on the date of grant.
Cost of Revenue from Amortization of Intangible Assets
Cost of revenue from amortization of intangible assets for the three months
ended June 30, 2004 was $2.8 million, or 6.1%, of total revenue, compared to
$2.7 million, or 9.6%, for the comparable period in 2003. The increase in cost
of revenue from amortization of intangible assets for the three months ended
June 30, 2004 in absolute dollars is attributable to $0.2 million related to the
SpeechWorks acquisition which was completed on August 11, 2003 and $0.1 million
related to the LocusDialog acquisition which was completed on December 19, 2003,
partially offset by $0.1 million of intangible assets that became fully
amortized during fiscal year 2003.
Cost of revenue from amortization of intangible assets for the six months
ended June 30, 2004 was $5.6 million, or 6.3%, of total revenue, compared to
$4.7 million, or 8.5%, for the comparable period in 2003. The increase in cost
of revenue from amortization of intangible assets in absolute dollars is
attributable to $0.5 million of amortization related to the exclusive worldwide
license of certain desktop dictation products acquired on March 31, 2003, $0.1
million related to the Philips acquisition which was completed on January 30,
2003, $0.2 million related to the SpeechWorks acquisition which was completed on
August 11, 2003 and $0.3 million related to the LocusDialog acquisition which
was completed on December 19, 2003. This was partially offset by $0.1 million of
intangible assets that became fully amortized during fiscal year 2003. During
2004, we expect cost of revenue from amortization of intangible assets to be
approximately $11.0 million based on our current level of intangible assets.
Research and Development Expense
Research and development expense for the three months ended June 30, 2004
was $8.6 million, or 18.7%, of total revenue, compared to $8.4 million, or
30.1%, for the comparable period in 2003. The increase in research and
development expenses for the three months ended June 30, 2004 in absolute
dollars is due to increased costs of $0.8 million related to speech and language
development efforts, partially offset by decreased costs of $0.6 million
associated with imaging development efforts. The increase in speech and language
development efforts is primarily related to increased headcount and related
costs of approximately $1.1 million resulting from both the Philips and
SpeechWorks acquisitions. The decrease in imaging related development efforts is
primarily related to a reduction of headcount and related costs of approximately
$0.6 million primarily resulting from the transfer of certain research and
development activities from our corporate headquarters to Budapest during the
three month period ended June 30, 2003.
Research and development expense for the six months ended June 30, 2004 was
$17.8 million, or 20.1%, of total revenue, compared to $15.5 million, or 27.9%,
for the comparable period in 2003. The increase in research and development
expenses for the six months ended June 30, 2004 is due to increased costs of
$3.5 million related to speech and language development efforts, partially
offset by decreased costs of $1.2 million associated with imaging development
efforts. The increase in speech and language development efforts is primarily
related to increased headcount and related costs of approximately $3.1 million
resulting from both the Philips and SpeechWorks acquisitions. The decrease in
imaging related development efforts is primarily related to a reduction of
headcount and related costs of approximately $0.9 million primarily resulting
from the transfer of certain research and development activities from our
corporate headquarters to Budapest during the three month period ended June 30,
2003.
While we will continue to invest significantly in research and development,
we expect research and development expenses as a percentage of revenue to
continue to decline during the second half of 2004 due to an increase in
revenue. Research and development expenses-stock based compensation is related
to the issuance of common stock to certain of our executives with exercise or
purchase prices that are less than the fair market value of the common stock on
the date of grant.
Selling, General and Administrative Expense
Selling, general and administrative expense for the three months ended June
30, 2004 was $21.6 million, or 46.8%, of total revenue, compared to $13.8
million, or 49.9%, for the comparable period in 2003. The increase in selling,
general and administrative expense for the three months ended June 30, 2004 was
the result of increased compensation costs of approximately $4.6 million
resulting from the addition of sales and marketing and general and
administrative employees primarily due to the fiscal year 2003 acquisitions. The
remaining increase in selling, general and administrative expenses is due
primarily to increased facilities charges of $1.2 million resulting from
increased rent and related insurance expenses, increased professional fees of
approximately $0.6 million, and travel expenses of $0.7 million for the three
month period ended June 30, 2004.
Selling, general and administrative expense for the six months ended June
30, 2004 was $43.3 million, or 48.7%, of total revenue, compared to $27.1
million, or 48.7%, for the comparable period in 2003. The increase in selling,
general and administrative expense for the six months ended June 30, 2004 was
the result of increased compensation costs of approximately $10.3 million
resulting from the addition of sales and marketing employees and general and
administrative employees primarily due to the fiscal year 2003 acquisitions. The
remaining increase in selling, general and administrative expenses is due
primarily to increased facilities charges of $2.8 million, resulting from
increased rent and related insurance expenses, increased professional fees of
approximately $1.0 million and travel expenses of $1.5 million. In
25
addition, during the three months ended June 30, 2004 we incurred approximately
$0.6 million related to compliance with recently issued regulatory requirements
bringing the total six months costs to $0.7 million. We expect selling, general
and administrative expenses in absolute dollars to remain consistent over the
remainder of 2004 but decline as a percentage of revenue as revenue increases.
Selling, general and administrative expenses-stock based compensation of
approximately $0.4 million and $0.7 million for the three and six month periods
ended June 30, 2004, is related to the issuance of common stock to certain of
our executives with exercise or purchase prices that are less than the fair
market value of the common stock on the date of grant.
Amortization of Other Intangible Assets
Amortization of other intangible assets for the three months ended June 30,
2004, was $0.6 million, or 1.4%, of total revenue, compared to $0.4 million, or
1.5%, for the comparable period in 2003. The increase in amortization of other
intangible assets is attributable to $0.4 million related to the SpeechWorks
acquisition which was completed on August 11, 2003, partially offset by $0.2
million of intangible assets that became fully amortized during fiscal year
2003.
Amortization of other intangible assets for the six months ended June 30,
2004, was $1.3 million or 1.5% of total revenue, compared to $0.8 million or
1.4% for the comparable period in 2003. The increase in amortization of other
intangible assets is attributable to $0.9 million related to the SpeechWorks
acquisition which was completed on August 11, 2003, partially offset by $0.3
million of intangible assets that became fully amortized during fiscal year
2003. During 2004, we expect amortization of other intangible assets to be
approximately $2.7 million based on our current level of intangible assets.
Restructuring and Other Charges, Net
During the six months ended June 30, 2004, we recorded a charge of $0.8
million related to separation agreements with two former members of our senior
management team. Included in this amount are non-cash compensation charges of
$0.4 million related to the acceleration of restricted common stock and stock
options.
During the three and six 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.
Income (Loss) from Operations
As a result of the above factors, income from operations was $0.5 million
for the three months ended June 30, 2004 or 1.0% of total revenue, compared to a
loss of $(3.0) million or (10.6)% of revenue for the comparable period in 2003.
Loss from operations was $(2.5) million for the six months ended June 30, 2004
or (2.9)% of total revenue, compared to $(2.8) million or (4.9)% of total
revenue for the comparable period in 2002.
Other Income (Expense), Net
Interest income was $0.2 million and $0.1 million for the three months
ended June 30, 2004 and 2003, respectively. Interest expense was $0.1 million
and $0.2 million for the three months ended June 30, 2004 and 2003,
respectively. Other expense of $0.3 million for the three months ended June 30,
2004 includes foreign currency losses of $0.1 million.
Interest income was $0.3 million and $0.1 million for the six months ended
June 30, 2004 and 2003, respectively. Interest expense was $0.2 million and $0.3
million for the six months ended June 30, 2004 and 2003, respectively. Other
income of $0.2 million for the six months ended June 30, 2004 consists primarily
of receipt of $0.6 million in settlements of a previously written off receivable
balance related to the Philips and SpeechWorks acquisitions, partially offset by
foreign currency losses.
Income (Loss) Before Income Taxes
Income before income taxes was $0.3 million for the three months ended June
30, 2004 or 0.6% of total revenue, compared with loss of ($2.6) million or
(9.3%) for the comparable period in 2003.
Loss before income taxes was ($2.2) million for the six months ended June
30, 2004 or (2.6%) of total revenue, compared with loss of ($2.4) million or
(4.3%) for the comparable period in 2003.
26
Income Taxes
The provision for income taxes for the three months ended June 30, 2004 was
$0.7 million, or 1.5%, of total revenue, compared to $0.4 million, or 1.3%, in
the comparable period for 2003. The provision for income taxes consists
primarily of foreign taxes relating to operations in Canada and Europe and
deferred tax provisions of $0.2 million arising out of differences between tax
and financial statement treatment of goodwill. The provision for income taxes
for the six months ended June 30, 2004 was $1.0 million, or 1.1%, of total
revenue, compared to $0.7 million, or 1.3%, in the comparable period for 2003.
The provision for income taxes consists of foreign taxes of $0.5 million
relating primarily to European operations, foreign withholding taxes of $0.1
million and deferred tax provisions of $0.4 million arising out of differences
between the tax and financial statement treatment of goodwill.
Net Income (Loss)
As a result of all these factors, net loss totaled ($0.4) million or (0.9%)
of total revenue for the three months ended June 30, 2004, compared with a loss
of ($2.9) million or (10.6%) of total revenue for the comparable period in 2003.
As a result of all these factors, net loss totaled ($3.2) million or (3.7%) of
total revenue for the six months ended June 30, 2004, compared with a loss of
($3.1) million or (5.6%) of total revenue for the comparable period in 2003.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, we had cash and cash equivalents of $22.6 million,
$22.3 million of marketable securities and net working capital of $29.7 million
as compared to $42.6 million in cash and cash equivalents and net working
capital of $44.3 million at December 31, 2003.
Net cash provided by operating activities for the six months ended June 30,
2004 was $2.9 million compared to $6.4 million for the comparable period in
2003. Cash provided by operations in the 2004 period came primarily from income
from operations, after adjustments for non-cash amortization, depreciation and
stock based compensation, significant collections of accounts receivable, offset
by payments of an increase in prepaid expenses and payments of accrued expenses
and a decrease in deferred revenue. Cash provided by operations in the 2003
period came primarily from income from operations, after 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.
Net cash used in investing activities for the six months ended June 30,
2004 was $24.7 million compared to cash used of $11.5 million for the comparable
period in 2003. Net cash used in investing activities during 2004 consisted of
$2.1 million in capital expenditures, $3.3 million of payments associated with
acquisitions and the purchase of $22.7 million of marketable securities,
partially offset by $3.1 million payment received due to a final purchase price
adjustment related to the Philips acquisition and $0.3 related to the maturity
of certain marketable securities. 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 provided by financing activities for the six months ended June 30,
2004 was $1.8 million compared to $3.8 million for the comparable period in
2003. Net cash provided by financing activities during 2004 consists of proceeds
of $4.9 million from the issuance of common stock in connection with employee
stock compensation plans and $0.6 million of proceeds form the issuance of
common stock warrants. This was offset by a $0.4 million payment to the former
Caere President and CEO in connection with the settlement of the non-competition
and consulting agreement, $2.8 million of payments associated with an exclusive
licensing agreement and $0.5 million related to payments on outstanding
equipment lines of credit. 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.
Although we generated $2.9 million and $5.2 million of cash from operations
during the six month period ended June 30, 2004 and the fiscal year ended 2003,
respectively, and exited the quarter with a cash and cash equivalents balance of
$23.3 million and marketable securities of $21.7 million, there can be no
assurance that we will be able to continue to generate cash from operations or
secure additional equity or debt financing if required. The large increase in
our cash and investment balances has come primarily from the SpeechWorks
27
acquisition. In connection with the Philips Speech Processing Telephony and
Voice Control Business Unit acquisition, we issued a $27.5 million, zero
interest convertible debenture due January 2006. In connection with the
SpeechWorks acquisition we acquired certain long-term lease obligations that
begin to come due in the next 12-24 months. Additionally, in connection with the
exclusive license agreement entered into on March 31, 2003, we made a payment of
$2.8 million on April 5, 2004 and are required to make a final payment totaling
$2.8 million on or before March 31, 2005. We have sustained recurring losses
from operations in each reporting period through December 31, 2001. We have
reported a net loss of $(3.2) million and $(5.5) million for the six month
period ended June 30, 2004 and the fiscal year ended December 31, 2003,
respectively. We had an accumulated deficit of $155.7 million at June 30, 2004.
We believe that the actions taken in connection with our acquisitions, including
restructuring actions and other cost reduction initiatives, have reduced
operating expenses to levels which, in combination with expected future
revenues, will continue to generate positive cash flow. Therefore, we believe
that cash flows from future operations in addition to cash on hand, including
our marketable securities and amounts available under our line of credit will be
sufficient to meet our working capital, investing, financing and contractual
obligations, including the debt obligation issued in connection with the Philips
acquisition, and the lease obligations assumed in the SpeechWorks acquisition,
as they become due for the foreseeable future.
The following table outlines our contractual payment obligations as of June
30, 2004:
PAYMENTS DUE BY PERIOD
-----------------------------------------------------
MORE
LESS THAN 2-3 4-5 THAN 5
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS YEARS
- ----------------------- --------- --------- --------- ------- --------
(IN THOUSANDS)
Convertible debenture $ 27,524 -- $ 27,524 -- $ --
Deferred payments for technology license 2,671 2,671 -- -- --
Operating leases 32,823 4,644 7,931 5,050 15,198
Equipment line of credit 788 603 185 -- --
Standby letters of credit 1,438 344 46 46 1,002
Royalty commitments 900 130 620 70 80
Purchase commitments 975 975 -- -- --
Imputed interest 129 129 -- -- --
--------- -------- --------- ------- --------
Total contractual cash obligations $ 67,248 $ 9,496 $ 36,306 $ 5,166 $ 16,280
========= ======== ========= ======= ========
Through June 30, 2004, we have not entered into any off balance sheet
arrangements or transactions with unconsolidated entities or other persons.
FOREIGN OPERATIONS
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. In certain circumstances, we have entered into forward exchange
contracts to hedge against foreign currency fluctuations on intercompany
balances with our foreign subsidiaries. We use these contracts to reduce our
risk associated with exchange rate movements, as the gains or losses on these
contracts are intended to offset any exchange rate losses or gains on the hedged
transaction. We do not engage in foreign currency speculation. Hedges 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.
On November 3, 2003, we entered into a forward exchange contract to hedge
our foreign currency exposure related to 3.5 million euros of intercompany
receivables from our Belgian subsidiary. The contract has a one year term that
expires on November 1, 2004. For the six month period ended June 30, 2004, we
recorded a net exchange rate gain of approximately $42,000 in other
comprehensive income on the intercompany receivable and associated forward
exchange contract. On November 5, 2003, we entered into a forward exchange
contract to hedge our foreign currency exposure related to 7.5 million Singapore
dollars of intercompany receivables from our Singapore subsidiary. The contract,
as amended, expires on July 31, 2004. For the six month period ended June 30,
2004, we recorded a net exchange rate gain of approximately $0.1 million on the
intercompany receivable and associated forward exchange contract.
With our increased international presence in a number of geographic
locations and with international revenues projected to increase in 2004, we are
exposed to changes in foreign currencies including the euro, Canadian dollar,
Japanese yen and the Hungarian forint. Changes in the value of the euro or other
foreign currencies relative to the value of the U.S. dollar could adversely
affect future revenues and operating results.
28
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF No. 03-6, "Participating Securities and Two-Class Method under FASB
Statement No 128, Earning Per Share." EITF No. 03-6 addresses a number of
questions regarding the computation of earnings per share ("EPS") by companies
that have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when, and if,
it declares dividends on its common stock.
The issue also provides further guidance in applying the two-class method of
calculating EPS. It clarifies what constitutes a participating security and how
to apply the two class method of computing EPS once it is determined that a
security is participating, including how to allocate undistributed earning to
such a security. The consensus reached on EITF No. 03-6 is effective for fiscal
periods beginning after March 31, 2004. Prior period earnings per share amounts
should be restated to conform to the consensus to ensure comparability year over
year. We have evaluated the impact, the adoption of EITF No. 03-6 would have on
our results of operations and financial condition, and determined that as we are
currently operating in a net loss position, the adoption of EITF No. 03-6 has no
impact on our results of operations and financial position.
RISK FACTORS
You should carefully consider the risks described below when evaluating our
company and when deciding whether to invest in us. The risks described below are
not the only ones we face. 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 if any of these risks actually occurs. As a result, the trading
price of our common stock may decline and you can lose part or all of your
investment in our common stock.
Risks Related to Our Business
Our operating results may fluctuate significantly from period to period,
and this may cause our stock price to decline. Our revenue and operating results
have fluctuated in the past and, and we expect our revenue and operating results
to continue to fluctuate in the future. Given this fluctuation, we believe that
quarter to quarter comparisons of our revenue and operating results are not
necessarily meaningful or an accurate indicator of our future performance. As a
result, our results of operations 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 contribute to 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;
-- rapid shifts in demand for products given the highly cyclical nature
of the retail software industry;
-- the loss of, or a significant curtailment of, purchases by any one or
more of our principal customers;
-- concentration of operations with one manufacturing partner and ability
to control expenses related to the manufacture, packaging and shipping
of our boxed software products;
-- customers delaying their purchase decisions in anticipation of new
versions of products;
-- introduction of new products by us or our competitors;
-- seasonality in purchasing patterns of our customers, where purchases
tend to slow in the third fiscal quarter;
-- 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;
29
-- write-offs of excess or obsolete inventory and accounts receivable
that are not collectible;
-- increased expenditures incurred pursuing new product or market
opportunities;
-- inability to adjust our operating expenses to compensate for
shortfalls in revenue against forecast; 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, and we may not be able to reduce our
expenses quickly to respond to a shortfall in projected revenue. Therefore, our
failure to meet revenue expectations would seriously harm our operating results,
financial condition and cash flows.
We have a history of operating losses, and we may incur losses in the
future, which may require us to raise additional capital on unfavorable terms.
We sustained recurring losses from operations in each reporting period through
December 31, 2001. We reported a net loss of $(3.2) million and $(5.5) million
for the six-month period ended June 30, 2004 and the fiscal year ended December
31, 2003, respectively. We had an accumulated deficit of $155.7 million at June
30, 2004. If we are unable to regain profitability, the market price for our
stock may decline, perhaps substantially. We cannot assure you that our revenues
will grow or that we will achieve or maintain profitability in the future. If we
do not achieve profitability, we may be required to raise additional capital to
maintain or grow our operations. The terms of any additional capital, if
available at all, may be highly dilutive to existing investors or contain other
unfavorable terms, such as a high interest rate and restrictive covenants.
Our business could be harmed if we do not successfully manage the
integration of the businesses that we acquire. As part of our business strategy,
we have in the past acquired, and expect to continue to acquire, other
businesses and technologies. Our acquisition 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), our
acquisition of the Speech Processing Telephony and Voice Control business units
from Philips, our acquisition of SpeechWorks International, Inc. and our
acquisition of LocusDialog, Inc. required substantial integration and management
efforts. Our recently completed acquisition of Telelogue, Inc. will likely pose
similar challenges. Acquisitions of this nature involve a number of risks,
including:
-- difficulty in transitioning and integrating the operations and
personnel of the acquired businesses, including different and complex
accounting and financial reporting systems;
-- 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.
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 acquisitions completed during 2003 and 2004. Under
accounting principles generally accepted in the United States of America, we
have accounted for our acquisitions using the purchase method of accounting.
Under
30
purchase accounting, we record the market value of our common stock or
other form of consideration issued in connection with the acquisition and the
amount of direct transaction costs as the cost of acquiring the company or
business. We have allocated 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
based on their respective fair values. Intangible assets generally will be
amortized over a five to ten year period. 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. As a result of this future amortization, purchase accounting treatment of
these acquisitions could decrease our net income in the foreseeable future,
which could have a material and adverse effect on the market value of our common
stock.
Acquisitions may cause dilution to our existing stockholders or require us
to use or raise additional cash. In connection with past acquisitions, we issued
a substantial number of shares of our common stock as transaction consideration.
We may continue to issue equity securities for future acquisitions that would
dilute our existing stockholders, perhaps significantly depending on the terms
of the acquisition. From time to time, we have also used cash or issued debt
instruments as transaction consideration. These debt instruments typically
contain various restrictions and covenants relating to our ability to operate
our business. We may incur debt in connection with future acquisitions, which,
if available at all, may place additional restrictions on our ability to operate
our business.
A large portion of our product revenue is dependent on continued demand for
our products from OEM partners, and 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. These types
of partners are knows as OEM partners. OEM revenue represented 44% and 57% of
our consolidated revenue for the year ended December 31, 2003 and for the six
months ended June 30, 2004, respectively. The commercial success of our licensed
products depends to a substantial degree on the efforts of these OEM partners in
developing and marketing their 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 OEM partners. If our OEM partners do
not adequately incorporate our technologies into their products, or if our OEM
partners do not generate significant sales from products that incorporate our
technologies, our revenues and results of operations will be adversely affected.
Moreover, a select few of our OEM partners account for a majority of our OEM
revenues. Since these 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, the loss of any of these significant
OEM partners as a customer would seriously harm our business, results of
operations, financial condition and our stock price.
Sales of our document and PDF conversion products and our digital paper
management products represented approximately 40% and 32%, of our revenue for
the year ended December 31, 2003 and for the six month period ended June 30,
2004, respectively, and any reduction in revenue from these product areas could
seriously harm our business. Historically, a small number of product areas have
generated a substantial portion of our revenues. For the year ended December 31,
2003, our document and PDF conversion products represented approximately 26% of
our revenue and our digital paper management products represented approximately
14% of our revenue. For the six months ended June 30, 2004, our document and PDF
conversion products represented approximately 20% of our revenue and our digital
paper management products represented approximately 12% of our revenue. A
significant reduction in the revenue contribution in absolute dollars from these
product areas could seriously harm our business, results of operations,
financial condition, cash flows and stock price.
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, and any adverse change in our relationship with such partners may
adversely impact our ability to deliver products. 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 six month period ended June 30, 2004, two
distribution and fulfillment partners, Ingram Micro and Digital River, accounted
for 14% and 8% of our consolidated revenue, respectively. For the year ended
December 31, 2003, Ingram Micro and Digital River, accounted for 16% and 13% of
our consolidated revenue, respectively. A disruption in these distribution and
fulfillment partner relationships could negatively affect our ability to deliver
products, and hence our results of operations in the short term. Any prolonged
disruption for which we are unable to arrange alternative fulfillment
capabilities could have a more sustained adverse impact on our results of
operations.
A significant portion of our accounts receivable is concentrated among our
largest customers, and non-payment by any of them will adversely affect our
financial condition. 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 or other form of
security
31
from our major customers to secure payment. While, to date, losses due to
non-payment from customers have been within our expectations, we cannot assure
you that instances or extent of non-payment will not increase in the future. At
June 30, 2004, Ingram Micro, Tech Data and Digital River represented 13%, 3% and
4%, of our net accounts receivable, respectively. At December 31, 2003, Ingram
Micro, Tech Data and Digital River represented 20%, 5% and 5%, of our net
accounts receivable, respectively. If these or any of our other significant
customers 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.
Speech technologies may not achieve widespread acceptance by businesses,
which could limit our ability to grow our speech business. We have invested and
expect to continue to invest heavily in the acquisition, development and
marketing of speech technologies. 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 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:
-- 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 and we may not recover the costs
associated with our investment in our speech technologies.
The markets in which we operate are highly competitive and rapidly
changing, and we may be unable to compete successfully. There are a number of
companies that develop or may develop products that compete in our targeted
markets. 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, Fonix, IBM, Nuance
Communications and Rhetorical. 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.
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 if we are unable to realize synergies among our acquired
products and technologies, our business will suffer.
The failure to successfully implement, upgrade and deploy in a timely and
effective manner new information systems and upgrades of our finance and
accounting systems to address certain issues identified in connection with our
fiscal 2003 year-end audit could harm our business. In connection with its audit
of our 2003 consolidated financial statements, PricewaterhouseCoopers LLP
("PwC"), our independent auditors, advised in a management letter to our Audit
Committee of four conditions that could adversely affect our ability to
initiate, record, process and report financial data consistent with management's
assertions. These conditions include the fact that we may lack the necessary
corporate accounting resources to meet the accelerated filing deadline
requirements in 2004 mandated by the SEC, while at the same time staffing the
demands of our worldwide Oracle implementation and Sarbanes-Oxley requirements.
Another condition cited is that we have a dependence on key personnel in our
finance and accounting organization, the loss of whom could impair our ability
to perform timely financial reporting, especially prior to the completion of our
worldwide Oracle
32
implementation and our readiness efforts related to our obligations under
Section 404 of the Sarbanes-Oxley Act of 2002. In addition, we discuss the other
two conditions raised by PwC later in this document under Item 4. Controls and
Procedures.
From 1997 through June 30, 2004, we have made eight significant business
acquisitions. As a result, we continue to have several financial systems in use.
The incompatibility between these systems requires significant manual efforts
within finance and accounting to complete our financial reporting. Therefore,
substantial knowledge of our policies and procedures and the process for
initiating, recording, processing, summarizing and reporting financial
information is resident in the knowledge of personnel involved in the financial
reporting process.
To improve the efficiency and quality of our accounting and financial
reporting systems, we commenced, in the third quarter of 2003, a worldwide
implementation of the Oracle e-Business suite. In addition, we have retained a
third-party consulting firm that is assisting management and staff to formalize
and document our business and financial processes and controls in preparation
for our compliance with Section 404 of the Sarbanes-Oxley Act of 2002. While we
believe that these actions will address the conditions raised in PwC's letter,
we have been and will continue to be required to devote substantial resources to
these activities during 2004. Failure to successfully implement these systems or
formalize and document these processes and controls in a timely, effective and
efficient manner could result in the disruption of our operations, our inability
to comply with our Sarbanes-Oxley obligations and the inability to report our
financial results in a timely manner.
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, 2003 and the six-month
period ended June 30, 2004 represented 28% and 29% of our consolidated revenue
for those periods, respectively. Most of these international revenues are
generated 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 35% and 32%
of our consolidated revenue for the year ended December 31, 2003 and the six
month period ended June 30, 2004, respectively. In addition, some of our
products are developed and manufactured outside the United States. A significant
portion of the development and manufacturing of our speech products are
completed in Belgium, and a significant portion of our digital capture research
and development is conducted in Hungary. In connection with the Philips
acquisition, we have added an additional research and development location in
Germany, and in connection with the acquisition of Locus Dialog, we have added
an additional research and development location in Montreal, Canada.
Accordingly, 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;
-- compliance with foreign and domestic laws and regulations;
-- 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. In certain circumstances, we have entered into forward exchange
contracts to hedge against foreign currency fluctuations on intercompany
balances with our foreign subsidiaries. We use these contracts to reduce our
risk associated with exchange rate movements, as the gains or losses on these
contracts are intended to offset any exchange rate losses or gains on the hedged
transaction. We do not engage in foreign currency speculation. Hedges 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
33
exposure. With our increased international presence in a number of geographic
locations and with international revenues projected to increase in 2004, we are
exposed to changes in foreign currencies including the euro, Canadian dollar,
Japanese yen and the Hungarian forint. Changes in the value of the euro or other
foreign currencies relative to the value of the U.S. dollar could adversely
affect future revenues and operating results.
If we are unable to attract and retain key 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.
RISKS RELATED TO OUR INTELLECTUAL PROPERTY AND TECHNOLOGY.
Unauthorized use of our proprietary technology and intellectual property
will adversely affect our business and results of operations. Our success and
competitive position depend in large part on our ability to obtain and maintain
intellectual property rights protecting our products and services. We rely on a
combination of patents, copyrights, trademarks, service marks, trade secrets,
confidentiality provisions and licensing arrangements to establish and protect
our intellectual property and proprietary rights. Unauthorized parties may
attempt to copy aspects of our products or to obtain, license, sell or otherwise
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 and that do not
infringe our rights. In these cases, we would be unable to prevent our
competitors from selling or licensing these similar or superior technologies. 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, and we could be exposed to significant
litigation or licensing expenses or be prevented from selling our products if
such claims are successful. 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 5, 2004, Compression Labs, Inc. filed an action against us in the
United States District Court for the Eastern District of Texas for patent
infringement. In the lawsuit, Compression Labs alleges that we are infringing
United States Patent No. 4,698,672 entitled "Coding System for Reducing
Redundancy." We have not yet evaluated the merits of this lawsuit.
On April 23, 2004, Millennium L.P. filed an action against us in the United
States District Court for the Southern District of New York claiming patent
infringement. Damages are sought in an unspecified amount. In the lawsuit,
Millennium alleges that we are infringing United States Patent No. 5,258,855
entitled "Information Processing Methodology"; No. 5,369,508 entitled
"Information Processing Methodology"; No. 5,625,465 entitled "Information
Processing Methodology"; No. 5,768,416 entitled "Information Processing
Methodology"; and No. 6,094,505 entitled "Information Processing Methodology."
We believe this claim has no merit, and we intend to defend the action
vigorously.
On July 15, 2003, Elliott Davis ("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 addition, on November 26, 2003, Davis filed an action
against ScanSoft in the United States District Court for the Western District
for New York (Buffalo) also claiming patent infringement. Damages are sought in
an unspecified amount. SpeechWorks filed an Answer and
34
Counterclaim to Davis's Complaint in its case on August 25, 2003 and ScanSoft
filed an Answer and Counterclaim to Davis's Complaint in its case on December
22, 2003. We believe these claims have no merit, and we intend to defend the
actions vigorously.
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. We filed an
Answer on December 23, 2002. 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. However, even if our defense is successful,
the litigation could require significant management time and could be costly.
Should we not prevail in these litigation matters, we may be unable to sell
and/or license certain of our technologies we consider to be proprietary, and
our operating results, financial position and cash flows could be adversely
impacted.
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 may also
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 reputation, financial results and
competitive position.
RISKS RELATED TO OUR CORPORATE STRUCTURE AND ORGANIZATION AND OUR COMMON STOCK.
The holdings of our two largest stockholders may enable them to influence
matters requiring stockholder approval. On March 19, 2004, Warburg Pincus, a
global private equity firm agreed to purchase all outstanding shares of our
stock held by Xerox Corporation for approximately $80 million. As of June 30,
2004, Warburg Pincus beneficially owned approximately 11.2% of our outstanding
common stock, including warrants exercisable for up to 3,025,732 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 State of
Wisconsin Investment Board (SWIB) is our second largest stockholder, owning
approximately 9.2% of our common stock as of June 30, 2004. Because of their
large holdings of our capital stock relative to other stockholders, Warburg and
SWIB, acting individually or together, 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.
Compliance with changing regulation of corporate governance and public
disclosure may result in additional expenses. Changing laws, regulations and
standards relating to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002, new regulations promulgated by the Securities and
Exchange Commission and Nasdaq National Market rules, are resulting in increased
general and administrative expenses for companies such as ours. These new or
changed laws, regulations and standards are subject to varying interpretations
in many cases, and as a result, their application in practice may evolve over
time as new guidance is provided by regulatory and governing bodies, which could
result in higher costs necessitated by ongoing revisions to disclosure and
governance practices. We are committed to maintaining high standards of
corporate governance and public disclosure. As a result, we intend to invest
resources to comply with evolving laws, regulations and standards, and this
investment may result in increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities. If our efforts to comply with new or changed laws,
regulations and standards differ from the activities intended by regulatory or
governing bodies, our business may be harmed.
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 certificate of incorporation, bylaws and
Delaware law, as well as other organizational documents 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:
35
-- a preferred shares rights agreement;
-- authorized "blank check" preferred stock;
-- prohibiting cumulative voting in the election of directors;
-- limiting the ability of stockholders to call special meetings of
stockholders;
-- requiring all stockholder actions to be taken at meetings of our
stockholders; and
-- establishing advance notice requirements for nominations of directors
and for stockholder proposals.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We face exposure to adverse movements in foreign currency exchange rates,
as a significant portion of our revenues, expenses, assets, and liabilities are
denominated in currencies other than the U.S. Dollar, primarily the euro, the
Canadian dollar, the Japanese yen and the Hungarian forint. These exposures may
change over time as business practices evolve. We evaluate our foreign currency
exposures on an ongoing basis and make adjustments to our foreign currency risk
management program as circumstances change.
The Company invests in certain debt securities classified as
available-for-sale. These securities are subject to market risk and their fair
values could decline over time.
In certain instances, we have entered into forward exchange contracts to
hedge against foreign currency fluctuations. These contracts are used to reduce
our 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. We do not engage in foreign currency speculation. The
success of our 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, we could experience
unanticipated foreign currency gains or losses that could have a material impact
on our results of operations. In addition, the failure to identify new exposures
and hedge them in a timely manner may result in material foreign currency gains
and losses.
On November 3, 2003, we entered into a forward exchange contract to hedge
our foreign currency exposure related to 3.5 million euros of inter-company
receivables from our Belgian subsidiary to the United States. The contract has a
one-year term that expires on November 1, 2004. On November 5, 2003, we entered
into a forward exchange contract to hedge our foreign currency exposure related
to 7.5 million Singapore dollars of inter-company receivables from our Singapore
subsidiary to the United States. The contract, as amended, expired on July 31,
2004.
While the contract amounts of derivative instruments provide one measure of
the volume of these transactions, they do not represent the amount of our
exposure to changes in foreign currency exchange rates. Because the terms of the
derivative instrument and underlying exposure are matched generally at
inception, changes in foreign currency exchange rates should not expose us to
significant losses in earnings or net cash outflows when exposures are properly
hedged.
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, except as provided below, 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
36
materially affect, our internal control over financial reporting. Subsequent to
the end of the first quarter of 2004, we adopted additional procedures related
to our worldwide bank reconciliation processes.
In connection with their audit of our 2003 consolidated financial
statements, PricewaterhouseCoopers LLP ("PwC"), our independent auditors,
advised in a management letter to management and our Audit Committee of four
conditions that could adversely affect our ability to initiate, record, process
and report financial data consistent with management's assertions. These
conditions include, in summary: (i) our significant accounting transactions,
including related judgments and estimates, may not be supported by a
sufficiently formal process or sufficiently comprehensive documentation; and
(ii) we had insufficiently documented our estimate of returns from second-tier
resellers. In addition, we have earlier in this document discussed the other two
conditions raised by PwC. (see page 32).
In the third quarter of 2003, we commenced the planning and worldwide
implementation of the Oracle e-Business suite, which we anticipate completing by
the end of fiscal year 2004. Simultaneously with the Oracle implementation, we
commenced our Section 404 (Sarbanes-Oxley Act of 2002) compliance efforts. In
conjunction with these efforts, we initiated the design, development and
implementation of processes and controls that we believe, will address the
conditions raised in PwC's management letter. We currently expect these efforts
to extend into the second half of fiscal 2004. To the knowledge of our Chief
Executive Officer and Chief Financial Officer, the financial statements, and
other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 14, 2004, the Company held its Annual Meeting of Stockholders. At such
meeting the following actions were voted upon:
(a) To elect a Board of eight (8) 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 84,547,395 9,857,006
Mark B. Myers 84,988,758 9,415,643
Katharine A. Martin 84,622,225 9,782,176
Robert G. Teresi 84,162,162 10,242,239
Robert J. Frankenberg 84,082,292 10,322,109
Robert M. Finch 85,044,959 9,359,442
John C. Freker, Jr. 83,675,753 10,728,648
William H. Janeway 85,104,444 9,299,957
(b) To amend our Certificate of Incorporation to increase authorized
shares of common stock to 280,000,000:
VOTES FOR VOTES AGAINST ABSTAINED
--------------- ----------------- -----------
85,484,671 8,746,935 172,795
(c) To approve the Amended and Restated 2000 Stock Option Plan to
increase shares reserved thereunder to 7,250,000:
VOTES FOR VOTES AGAINST ABSTAINED BROKER NON-VOTES
------------- --------------- ----------- -------------------
55,824,547 8,638,887 96,225 29,844,742
(d) To amend our 1995 Employee Stock Purchase Plan to increase shares
reserved thereunder to 2,500,000:
VOTES FOR VOTES AGAINST ABSTAINED BROKER NON-VOTES
------------- --------------- ----------- ------------------
59,839,237 4,631,019 89,403 29,844,742
(e) To ratify the appointment of PricewaterhouseCoopers LLP as the
independent public accountants for the period ending December 31,
2004.
VOTES FOR VOTES AGAINST ABSTAINED
------------ --------------- -----------
92,755,237 1,586,990 62,174
37
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 June 30, 2004, ScanSoft filed a report on Form 8-K reporting under Item
2 the acquisition of Telelogue, Inc.
38
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 9, 2004.
SCANSOFT, INC.
By: /s/ David A. Gerth
--------------------------------
David A. Gerth
Chief Financial Officer
39
EXHIBIT
INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- ----------------------------------------------------------------------
2.1* Agreement and Plan of Merger, dated as of May 4, 2004, as amended on
May 28, 2004, by and among ScanSoft, Inc., Tennis Acquisition
Corporation, Telelogue, Inc., Pequot Venture Partners II, L.P., PVP II
Telelogue Prom Note 2 Grantor Trust, Palisade Private Partnership II,
L.P., and NJTC Venture Fund SBIC LP, Martin Hale as stockholder
representative and U.S. Bank National Association as escrow agent.
3.1 Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of Registrant
10.1** Employment Agreement, dated March 9, 2004, by and between the
Registrant and John Shagoury.
10.2** Letter, dated May 23, 2003, from the Registrant to Steven Chambers
regarding certain employment matters.
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.
* Incorporated by reference from the Registrant's Form 8-K, filed with the
Commission on June 30, 2004.
** Denotes Management compensatory plan or arrangement.
40