UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K/T
(Mark One)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM JANUARY 1, 2004 TO SEPTEMBER
30, 2004
COMMISSION FILE NUMBER 0-27038
SCANSOFT, INC.
(Exact name of Registrant as Specified in its Charter)
DELAWARE 94-3156479
(State of Incorporation) (I.R.S. Employer Identification No.)
9 CENTENNIAL DRIVE
PEABODY, MASSACHUSETTS 01960 (978) 977-2000
(Address of Principal Executive Offices, (Registrant's Telephone Number,
Including Zip Code) Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
PREFERRED SHARE PURCHASE RIGHTS
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K/T or any amendment to
this Form 10-K/T. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the outstanding common equity held by
non-affiliates of the Registrant as of the last business day of the Registrant's
most recently completed second fiscal quarter was approximately $341,451,698
based upon the last reported sales price on the Nasdaq National Market for such
date. For purposes of this disclosure, shares of Common Stock held by officers
and directors of the Registrant and by persons who hold more than 5% of the
outstanding Common Stock have been excluded because such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily
conclusive.
The number of shares of the Registrant's Common Stock, outstanding as of
December 31, 2004, was 106,249,600.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be delivered to
stockholders in connection with the Registrant's 2005 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K/T.
SCANSOFT, INC.
TABLE OF CONTENTS
PAGE
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PART I
Item 1. BUSINESS.................................................... 1
Item 2. PROPERTIES.................................................. 10
Item 3. LEGAL PROCEEDINGS........................................... 11
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 12
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES.................................................. 12
Item 6. SELECTED FINANCIAL DATA..................................... 13
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 15
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK........................................................ 38
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 39
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................... 89
Item 9A. CONTROLS AND PROCEDURES..................................... 89
Item 9B. OTHER INFORMATION........................................... 90
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 91
Item 11. EXECUTIVE COMPENSATION...................................... 91
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.................. 91
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 91
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...................... 91
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.................. 92
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FORWARD LOOKING STATEMENTS
THIS TRANSITION REPORT ON FORM 10-K/T CONTAINS FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THE FEDERAL SECURITIES LAWS THAT INVOLVE RISKS,
UNCERTAINTIES AND ASSUMPTIONS THAT, IF THEY NEVER MATERIALIZE OR IF THEY PROVE
INCORRECT, COULD CAUSE OUR RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. ALL STATEMENTS OTHER THAN STATEMENTS
OF HISTORICAL FACT ARE STATEMENTS THAT COULD BE DEEMED FORWARD-LOOKING,
INCLUDING STATEMENTS PERTAINING TO: OUR REVENUE, EARNINGS, CASH FLOW AND
LIQUIDITY; OUR STRATEGY RELATING TO SPEECH AND IMAGING 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; OUR CONTRACTUAL COMMITMENTS;
OUR 2005 REVENUE EXPECTATIONS 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 ANNUAL 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 WILL NOT UNDERTAKE AND SPECIFICALLY
DECLINE ANY OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS.
PART I
ITEM 1. BUSINESS
INTRODUCTION
ScanSoft, Inc. ("ScanSoft") offers businesses and consumers market-leading
speech and imaging solutions that facilitate the way people access, share,
manage and use information in business and in daily life. We market and
distribute our products indirectly through a global network of resellers,
comprising system integrators, independent software vendors, value-added
resellers, hardware vendors, telecommunications carriers and distributors; and
directly to businesses and consumers through a dedicated direct sales force and
our e-commerce website (www.scansoft.com). The value of our solutions is best
realized in vertical markets that are information and process intensive, such as
healthcare, telecommunications, financial services, legal and government.
ScanSoft was incorporated in 1992 as Visioneer. In 1999, we changed our
name to ScanSoft, Inc. and ticker symbol to SSFT. Our corporate headquarters and
executive offices are located at 9 Centennial Drive, Peabody, Massachusetts
01960. Our telephone number is 978-977-2000. We have approximately 25 regional
sales and research and development (R&D) offices throughout North America,
Europe and Asia. Our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Proxy Statements relating to our annual meetings of stockholders, Current
Reports on Form 8-K and amendments to these reports are available free of charge
on our website (www.scansoft.com), as well as from the SEC website at
www.sec.gov.
On October 23, 2004, ScanSoft's Board of Directors approved a change in
ScanSoft's fiscal year end from December 31 to September 30, effective beginning
September 30, 2004. All references in this Form 10-K/T to the period ended
September 30, 2004 refer to the nine months ended September 30, 2004. References
to fiscal 2005, refers to the period beginning on October 1, 2004 and ending on
September 30, 2005.
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MARKET OPPORTUNITY
In the past decade, information has become an increasingly important source
of capital for businesses and enterprises, and the speed and sophistication of
information exchange is often a defining characteristic of the most successful
entities worldwide. Many organizations define their strategy, assess their
ability to compete and manage their customer relationships based on the quality,
diversity and availability of their information products, services and
resources. The medium and optimal format for vital business information is wide
and varied, ranging from paper, electronic files and Web content to the spoken
word in multiple languages and in multiple locations.
Confronted by exponentially increasing information through more and more
channels, consumers and business personnel employ a variety of resources for
retrieving information, conducting transactions and performing their jobs. The
Internet and related corporate infrastructure have emerged as a powerful global
communications network and channel for business. These electronic systems have
fundamentally changed the way organizations and consumers obtain information,
communicate, purchase goods and conduct business.
Businesses around the world share a common motivation to improve operating
efficiency and enhance customer service. Customer satisfaction, employee
productivity and company operating results can often be linked to an
organization's ability to effectively manage, utilize and communicate
information.
We believe there is a significant opportunity for our solutions to help
simplify the way people access, share, manage and use information in business
and in daily life. Our strategy is to deliver premier, comprehensive
technologies and services as an independent application (software) or as part of
a larger integrated system in two areas -- speech and imaging. Our speech
technologies enable voice-activated services over a telephone, transform speech
into written word, and permit the control of devices and applications by simply
speaking. Our imaging solutions eliminate the need to manually reproduce
documents, automate the integration of documents into business systems, and
enable the use of electronic documents and forms within XML, Internet, mobile
and other business applications. Our software is delivered as part of a larger
integrated system, such as systems for customer service call centers, or as an
independent application, such as dictation, document conversion or PDF,
navigation systems in automobiles or digital copiers on a network. Our products
and technologies deliver a measurable return on investment to our customers.
BACKGROUND
From our founding in 1992 until December 2001, we focused exclusively on
delivering imaging solutions that simplified converting and managing information
as it moved from paper formats to electronic systems. On March 13, 2000, we
merged with Caere Corporation, a California-based digital imaging software
company, to expand our applications for document and electronic forms
conversion. In December 2001, we entered the speech market through the
acquisition of the Speech & Language Technology Business from Lernout & Hauspie.
We believed speech solutions were a natural complement to our imaging solutions
as they serve similar vertical markets with information intensive requirements.
We continue to execute against our strategy of being the market leader in speech
and imaging through the organic growth of our business as well as through
strategic acquisitions. Since the beginning of 2003, we have completed a number
of acquisitions, including:
- On January 30, 2003, we acquired Royal Philips Electronics Speech
Processing Telephony and Voice Control business units ("Philips") to
expand our solutions for speech in call centers and within automobiles
and mobile devices.
- On August 11, 2003, we acquired SpeechWorks International, Inc.
("SpeechWorks") to broaden our speech applications for
telecommunications, call centers and embedded environments as well as
establish a professional services organization.
- On December 19, 2003, we acquired LocusDialog, Inc. ("LocusDialog") to
expand our speech application portfolio with automated attendant
solutions for business.
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- On June 15, 2004, we acquired Telelogue, Inc. ("Telelogue") to enhance
our automated directory assistance solutions.
- On September 16, 2004, we acquired Brand & Groeber Communications GbR
("B&G") to enhance our embedded speech solutions, which will make mobile
phones accessible to the visually impaired using ScanSoft's
text-to-speech technology.
- On December 6, 2004, we acquired Rhetorical Systems, Inc. ("Rhetorical")
to complement our text-to-speech solutions and add capabilities for
creating custom voices.
Subsequent to September 30, 2004, we also announced agreements to acquire
ART Advanced Recognition Technologies, Inc. ("ART") to expand our portfolio of
embedded speech solutions and Phonetic Systems Ltd. ("Phonetic") to complement
our position in automated directory assistance and enterprise speech
applications. We anticipate closing both of these transactions during the
quarter ended March 31, 2005.
Our focus on providing market leading solutions that enable the capture and
conversion of information and the automation of systems requires a broad set of
technologies and channel capabilities. We have made and expect to continue to
make acquisitions of other companies, businesses and technologies to complement
our internal investments in these areas. We have a team that focuses on
evaluating market needs and potential acquisitions to fulfill them. In addition,
we have a disciplined methodology for integrating acquired companies and
businesses after the transaction is complete.
OUR MARKETS AND SOLUTIONS
We are a leading provider of software and services that allow users to
incorporate speech, images and documents in digital applications, systems and
devices. Our products and technologies automate manual processes and help
enterprises, professionals and consumers increase productivity, reduce costs and
save time. We deliver premier, comprehensive technologies and services in two
markets: speech and imaging.
OVERVIEW OF SPEECH MARKET
ScanSoft delivers field-proven speech solutions that use the human voice to
interact with information systems and devices. Today, thousands of companies and
millions of users depend on ScanSoft solutions to deliver vital business
information and simplify everyday tasks. With our solutions, people can direct
calls, obtain information, conduct transactions and control devices by simply
using their voice.
ScanSoft is working toward our vision of the future where natural
conversations are the preferred way people interact with automated systems and
devices. To achieve this, we are investing in technologies and solutions which
enable conversational, speech-based applications to become more dynamic, sound
more natural and perform tasks on multiple devices that adapt to personal
preferences. We are investing in three speech areas -- network speech, embedded
speech and dictation.
Network Speech. Organizations are looking for ways to improve the quality
of the customer care that they deliver, while reducing the associated costs.
They seek to automate revenue-generating transactions requiring immediate
delivery of goods and services. They also demand solutions that efficiently and
effectively connect a mobile workforce with real-time enterprise information,
including customer data, email and schedules.
Our network speech solutions, comprising automatic speech recognition and
text-to-speech technologies and applications that reside on a company's network
or server-based resources, can be used to implement applications that achieve
these goals. We are a leading provider of software products and professional
services that enable enterprises, telecommunications companies and government
organizations to offer automated, speech-activated services over any telephone.
Our network-based speech solutions allow users to direct their own calls, obtain
information and conduct transactions by simply speaking naturally over any
telephone. Our network-based text-to-speech solutions deliver natural sounding
results by using segments of real human speech, thereby increasing listener
satisfaction especially in the delivery of multiple phrases and sentences.
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Our solutions adhere to global industry standards and we provide speech
technologies and services in more languages than any other vendor.
Our solutions are used within a wide range of applications, across many
customer-service intensive industries including financial services,
telecommunications, utilities, government, travel and entertainment. Our
network-based speech software is used in applications such as call centers,
unified messaging systems, and voice portals that deliver enhanced information
services ranging from advanced call routing, and transaction information (order
placement, status) to customer service information and access to sports scores,
news and stock quotes. In addition, we offer packaged solutions for applications
that are common across a large set of customers and vertical markets. Currently,
we offer packaged applications for directory assistance, corporate voice dialing
and natural language routing for global telecommunication firms. We also offer
applications designed to serve specific verticals, including the healthcare,
utilities and insurance industries.
We license our network speech products to businesses as well as systems
integrators, technology providers and telecommunications companies that in turn
sell an integrated solution to businesses and end-users. We license our
text-to-speech solutions to developers of telephony applications, including
Avaya, Cisco, Genesys, Intervoice and Nortel, which integrate our solutions into
hardware and software platforms.
We complement our technologies and products with a professional services
organization that supports customers and partners with business and systems
consulting project management, user interface design and application development
assistance. Our professional services are designed to shorten time-to-market,
assist clients, reduce implementation risks and improve clients' competitive
position. Our professional services staff is located in Boston, New York and San
Francisco and internationally in Canada, Mexico, the United Kingdom, France,
Germany, Australia, Japan, Korea and Singapore.
Embedded Speech. Automotive, mobile communications, consumer electronics
and computer game manufacturers and their suppliers are accelerating the
development of products that require enhanced voice control capabilities. In
addition, a growing number of independent software and hardware vendors are
incorporating voice control into multimedia applications and devices that allow
users to interact with these systems by speaking.
Our embedded speech solutions add voice control capabilities to
applications integrated on a variety of automobiles and devices, such as mobile
phones, PDAs, consumer electronics and navigation systems. This technology
identifies specific words and phrases at any moment in time, converting spoken
words into instructions that control functions within applications. Our
solutions support dynamic vocabularies and have sophisticated noise management
capabilities that ensure accuracy, even at high vehicle speeds. Our products
scale to meet the size and accuracy requirements for automotive and navigation
systems and offer rapid application development tools, extensive compatibility
with hardware and operating systems and support for up to 18 languages. We
include toolkits with our software that help developers add our technologies to
applications such as navigation systems, hands-free cell phone devices and
voice-activated controls in an automobile.
Our embedded speech solutions are used by tier-one automobile, cell phone,
entertainment and aftermarket system manufacturers, including Bosch-Blaupunkt,
Delphi, Microsoft, Motorola, Nokia, Pioneer and Sony. These technologies are
included as part of a larger system, application or solution that is designed,
manufactured and sold by our customers. These customers include handset and
other device manufacturers and tier-one suppliers, companies whose size and
importance qualifies them to be direct suppliers to the major automotive
manufacturers, and in-dash radio, navigation system and other electronic device
manufacturers, also known as aftermarket systems providers.
Dictation. Organizations demand solutions that increase productivity by
automating repetitive business processes, including the creation of documents,
data entry and completing forms. They also look for ways to maximize the
productivity of their existing workers, including those with disabilities, and
to comply with government requirements relating to workplace safety and
accessibility. Organizations also seek solutions that can reduce the cost
associated with manual transcription of professional documents. Since most
people can
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speak more quickly than they can type, speech is a natural and efficient way to
interact with computers to address these problems.
Our speech recognition and dictation solutions, the Dragon
NaturallySpeaking family of products, increase productivity in the workplace by
using speech to create documents, streamline repetitive and complex tasks, input
data, complete forms and automate manual transcription processes. Our solutions
allow users to automatically convert speech into text at up to 160
words-per-minute, much faster than most people can type. Our software supports a
vocabulary of more than 300,000 words that can be expanded by users to include
specialized words and phrases. Our software is designed to adapt to individual
voice patterns and accents and is highly accurate, able to achieve accuracy
rates of approximately 99%, with the ability to achieve still greater accuracy
with frequent use. Our software supports multiple languages, including Dutch,
French, German, Italian, Japanese, Spanish, Swedish, and U.S./U.K. English.
Our solutions are valuable within enterprises and workgroups for a number
of reasons. Our software can operate within a distributed network environment,
where speaker profiles can be stored on a server and accessed from any networked
computer. Our solutions can also speech-enable existing business systems and
applications, including Microsoft Office, customer service and practice
management applications. Our software allows a user to interact with a computer
completely by voice, increasing the productivity of disabled workers and those
suffering from repetitive stress injury. Our solutions can also help government
agencies address accessibility mandates, such as those described in Section 508
of the U.S. Government Rehabilitation Act. We also deliver versions of our
products that are specialized for the medical and legal markets.
We offer a range of desktop and server solutions, each with features that
match a specific customer target. Our solutions are also used in enterprises and
workgroups, particularly in the medical, legal, government, finance and
education sectors. The Dragon NaturallySpeaking family of products includes our
legal vocabulary and 14 medical vocabularies; supports the creation of custom
vocabularies; and delivers capabilities that allow a user to access the
application from within distributed care provider facilities. A growing number
of healthcare vendors and integrators, including Agfa, Cerner CoPath,
Dictaphone, IDX and SoftMed Systems, have joined with ScanSoft to speech-enable
their healthcare solutions.
Our software is available in eight languages. We utilize a combination of
our global reseller network and direct sales to distribute our speech
recognition and dictation products. We believe we gain a competitive advantage
through our established value-added reseller community, which provide local
sales, integration, training and support services to our professional end-user
customers. We also license our dictation software to companies such as Corel,
Panasonic, and Sony, which bundle our solutions with some of their products.
OVERVIEW OF IMAGING MARKET
The Internet has changed many things, including the way people create and
share information. The ease and popularity of email has reduced people's
dependency on fax machines and postal service, while magazines and newspapers
now deliver as much information through Web-based material as they do in print.
Almost every office worker and many consumers at home use a computer, and a vast
majority of those are connected to the Internet or a network. Despite advances
in technology and networks, businesses are still confronted with productivity
challenges associated with creating, sharing and working with documents
We believe there is a market opportunity for software solutions that
maximize value and efficiency for information and documents processes. Our
imaging solutions simplify the way businesses and consumers create, access and
share documents.
Document and PDF Conversion. Despite the broad use of computing systems in
enterprises, the majority of business information is still maintained in paper
form. The proliferation of PDF as a digital document standard does not resolve
the problem of accessing and utilizing information trapped in a static form. In
addition, manually reproducing static documents in digital form is time
consuming, costly and subject to error, taking valuable resources away from more
productive activities. Enterprises and workgroups seek solutions that integrate
paper and static PDF documents into their business processes, allowing them to
automate the way they store, edit, use and share information.
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Our solutions help businesses save time and money by automatically
converting paper documents and PDF files into editable and usable business
documents. Our Optical Character Recognition ("OCR") software, the OmniPage
product family, delivers highly accurate document and PDF conversion, replacing
the need to manually re-create documents. Our software preserves document
formatting and provides editing capabilities that re-create the complex
components in a typical document, including formatted text, columns, graphics,
tables and spreadsheets. Our products can be used with existing business
applications and enable the distribution and publishing of documents to email,
Internet and mobile applications using standard file formats, including XML,
HTML, PDF and Open eBook.
The proliferation of multifunction devices and digital copiers connected
over a network has increased the number of documents that individuals within an
enterprise are transforming into digital format. Our software solutions create a
more efficient method to process static documents in enterprise content
management and database systems, thereby enhancing the value of their
investments in these systems. All of these documents can then be more easily
archived, edited and combined within the enterprise.
Our solutions are used in professional office settings, particularly in the
government, legal, finance and education sectors. Our software is available in
11 languages. We utilize a combination of our global reseller network and direct
sales to distribute our document and PDF conversion products. We license our
software to companies such as Brother, Dell, HP, Konica and Xerox, which bundle
our solutions with multifunction devices, digital copiers, printers and
scanners. In 2003, we introduced PDF Converter, a new product that converts PDF
files into fully formatted Microsoft Word documents. Developed in collaboration
with Microsoft Corporation, PDF Converter eliminates the need to manually create
PDF content in Microsoft Word, and enables the editing of content in the PDF
format. In 2004, we introduced PDF Create!, which enables users to create PDF
from virtually any Windows based application. By enabling the conversion between
two popular document formats -- PDF and Microsoft Word -- we enhance access to
content within documents and lower the costs associated with converting
documents. Our PDF solutions also provide a cost-effective alternative to those
offered by Adobe Systems.
We also license software development toolkits to independent software
vendors, integrators and in-house developers to add document and PDF conversion
capabilities to their applications. Our independent software vendor customers
include vendors, such as Canon, Captiva, Kofax, Sharp and Verity. Our technology
is also used within high-end enterprise systems from vendors such as Kofax and
Lockheed Martin.
Digital Paper Management. As the volume and complexity of corporate data
continues to multiply, organizations are increasingly challenged in their
efforts to manage all of their paper and digital documents. The wide dispersion
of documents makes finding information even more difficult, time-consuming and
costly. As a result, businesses need solutions that allow individuals,
workgroups or the entire organization to more efficiently organize, find and
share business documents.
Our digital paper management solutions, the PaperPort product family,
convert paper into digital documents that can be easily archived, retrieved and
shared. Our software can be used in conjunction with network scanning devices to
preserve an image of a document exactly as it appears on paper. Our software
automatically indexes the scanned image, so that it can be stored together with
other digital documents on a desktop, over a network or within an enterprise
content management system. In a single search, users can quickly find scanned
documents and existing digital files that match the search criteria.
Within enterprises, workgroups and distributed teams, our solution can also
facilitate the movement of scanned paper and digital documents into email, print
and other business applications. This streamlines the flow of documents between
workers, decreasing the time and costs associated with managing and using paper
documents. Our solution integrates with established file systems to simplify the
transfer of documents between desktop and enterprise content management systems.
Our solutions are used in enterprises and workgroups, especially those
within the legal, healthcare, financial, government, real estate and education
industries. Our software is available in eight languages. We utilize a
combination of our global reseller network and direct sales to distribute our
digital paper management
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products. We also license our software to companies such as Brother,
Hewlett-Packard, and Xerox, which bundle our solutions with multifunction
devices, digital copiers, printers and scanners.
OUR COMPETITIVE STRENGTHS
Core Technology Assets. In recent years, we have developed and acquired
extensive technology assets, intellectual property and industry expertise in
speech and imaging. Our technologies are based on complex mathematical formulas,
which require extensive linguistic and image data, acoustic models and
recognition techniques. A significant investment in capital and time would be
necessary to replicate our current capabilities. We continue to invest in the
advancement of our technologies to maintain our market leading position and to
develop new applications. As of September 30, 2004, we had 309 full-time
employees in research and development, and our technologies were covered by more
than 650 patents and patent applications, expiring on various dates between 2005
and 2020.
Broad Distribution Channels. We maintain an extensive network of resellers
to address the needs of specific markets, such as financial, legal, healthcare
and government. We believe that our extensive channel relationships increase the
difficulty for competitors to develop a similar channel network and make it
difficult for our products to be displaced. In addition, our far-reaching
channel network enables us to introduce new products quickly and effectively
throughout the global marketplace.
Leading Market Share. We have a strong market position in most of our
product categories and are the market leader in document and PDF conversion,
network-based speech recognition and text-to-speech, and dictation.
Organizations tend to look to established market leading vendors when making
product selections. As the established brand in our markets, we believe we can
target and win more partnership arrangements and new customers than our
competition.
International Focus. The broad language coverage within our product
offerings increases the likelihood that vendors selling globally will select our
technology. Our language coverage is difficult for competitors to duplicate, and
our presence in global markets limits the potential entry of new regional
competitors. With nearly one half of our employees located outside of North
America, we are able to efficiently compete on a global basis.
Multiple End Markets. We license to a range of end markets and maintain a
tiered distribution model that provides a diversified revenue stream and broad
market exposure. We are not dependent on any single market segment or set of end
customers and earn revenue from both established and emerging markets.
Specialized Professional Services. We complement our technologies and
products with a professional services organization that supports customers and
partners, particularly in speech, with business and systems consulting, project
management, user interface design and application development assistance. Our
professional services are designed to shorten time-to-market, assist clients,
reduce implementation risks and improve clients' competitive position.
OUR STRATEGY
Pursue High Growth Markets In Speech. We intend to leverage our
technologies and market leadership in speech to expand our opportunities in the
call center, automotive, healthcare, telecommunications and mobile markets. We
also intend to pursue emerging opportunities to use our speech technology within
consumer devices, games and other embedded applications. To expand our position
in speech, we intend to introduce new versions of our products and applications;
complete new license agreements with customers and partners that will resell our
technologies; and continue to make strategic acquisitions that we believe
complement our existing solutions and resources in the telecommunications,
automotive and electronics markets.
Expand PDF and Imaging Solutions. We intend to enhance the value of our
imaging solutions for enterprises to address the proliferation of PDF, the
expanded use of content management systems, and the widespread adoption of
networked multifunction and digital scanning devices. We intend to introduce new
products or new versions of existing products to take advantage of these growth
opportunities. We also plan to
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enhance our software development toolkits so our technologies can be integrated
with more third-party solutions.
Focus on Specific Vertical Markets. We intend to focus our marketing and
sales resources to generate demand and deliver solutions in specific vertical
markets. The value of our solutions is best realized in vertical markets that
are information and process intensive, such as healthcare, telecommunications,
financial services, legal and government. In addition, we intend to offer custom
versions of certain applications and products for specific vertical markets such
as medical, legal and utilities.
Expand Worldwide Channels. We intend to expand our global channel network
and build upon our existing distribution channels, especially in Europe, Asia
and Latin America. In particular, we intend to replicate our successful North
American value-added reseller channel in Europe. Along these lines, we have
added sales employees in different geographic regions and launched programs and
events to help recruit new partners for our channel network.
Pursue Strategic Acquisitions. We have selectively pursued strategic
acquisitions to expand our technology, channel and service resources and to
complement our organic growth. For example, during 2003 we completed the
LocusDialog, SpeechWorks and Philips acquisitions and completed the Telelogue,
B&G and Rhetorical acquisitions in 2004. We intend to continue to pursue
strategic acquisitions as a part of our growth strategy.
SALES, DISTRIBUTION AND FULFILLMENT
We market and distribute our products indirectly through a global network
of resellers, comprising system integrators, independent software vendors,
value-added resellers, hardware vendors, telecommunications carriers and
distributors; and directly through our dedicated direct sales force and through
our e-commerce website (www.scansoft.com). As of September 30, 2004, we have 226
sales and marketing employees worldwide.
We have established relationships with more than 2,000 channel partners,
including leading system vendors, independent software vendors, value-added
resellers and distributors, through which we market and distribute our products
and solutions. In speech, companies such as Avaya, Cisco, Genesys, Dictaphone,
Microsoft and Nortel embed our technologies into telecommunications systems, as
well as automotive, PC or multimedia applications. In imaging, companies such as
Brother, Dell, Hewlett-Packard, Visioneer and Xerox include our technology in
digital copiers, printers and scanners, as well as multifunction devices that
combine these capabilities. In addition, companies such as Corel, Canon,
Captiva, Kofax, Sharp and Verity embed our imaging technology into their
commercial software applications.
We license our applications to enterprises, professionals and consumers
through distribution and fulfillment partners, including 1450, Ingram Micro,
Tech Data and Digital River. These distribution and fulfillment partners provide
our products to computer superstores, consumer electronic stores, eCommerce Web
sites, mail order houses and office superstores, such as Amazon.com, Best Buy,
CDW, MicroWarehouse, Circuit City, CompUSA, Fry's Electronics, Office Depot, PC
Connection and Staples.
The majority of our software products are manufactured, packaged and
shipped by Hewlett-Packard.
PROPRIETARY TECHNOLOGY
We exploit our proprietary technology, trade secrets, know-how, continuing
technological innovations and licensing opportunities to maintain our
competitive position. We rely on patent law, copyright law, trade secret laws,
secrecy, technical measures, licensee agreements and non-disclosure agreements
to protect our technology, trade secrets and other proprietary rights. Our
policy is to file patent applications to protect technology, inventions and
improvements that are important to the development of our business, to maintain
a technological advantage over our competitors and to generate licensing
revenue. In this regard, we have obtained patents that directly relate to our
products. Our speech and imaging technologies are covered by more than 650
patents and patent applications. These patents expire on various dates between
2005 and 2020.
8
To protect our ownership rights in our software products, we license our
products to OEMs and resellers on a non-exclusive basis with contractual
restrictions on reproduction, distribution and transferability. In addition, we
generally license our software in object code form only. We license certain of
our software products to end-users by use of a "shrink-wrap" or "click wrap"
customer license that restricts the end-user to personal use of the product.
We require our employees to execute confidentiality and invention
assignment agreements in order to protect our proprietary technology and other
proprietary rights. We also rely on trade secrets and proprietary know-how to
protect our proprietary rights.
RESEARCH AND DEVELOPMENT
The market for our products and services is characterized by rapid
technological change, frequent new product introductions and enhancements,
evolving industry standards, and rapidly changing client requirements. As a
result, we believe that our future growth is highly dependent on the timely and
efficient introduction of new and updated products and technology. As of
September 30, 2004, we employed 309 people in research and development, slightly
over half of whom are located in international locations. Our employees based in
overseas facilities extend our global focus while often lowering our overall
cost of research and development. To promote efficiency in our research and
development efforts, we have organized the effective use of global development
teams and a comprehensively integrated development process. In addition, we have
developed and refined our time-to-market process, which contributes to
cost-effective resource management while promoting technology sharing across
programs.
Our future success will depend in part on our ability to anticipate
changes, enhance our current products, develop and introduce new products that
keep pace with technological advancements and address the increasingly
sophisticated needs of our clients. Our research and development expenses for
the nine months ending September 30, 2004, and the twelve months ended December
31, 2003 and 2002 were $26.2 million, $33.9 million and $27.6 million,
respectively. We expect that we will continue to commit significant resources to
research and development in the future. To date we have not capitalized any
research and development expenses and all costs have been expensed as incurred.
INTERNATIONAL OPERATIONS
We currently have offices in a number of international locations including:
Australia, Belgium, Canada, Denmark, England, France, Germany, Hong Kong,
Hungary, Italy, Japan, the Netherlands, Poland, Spain, Sweden and Taiwan. The
scope of our international operations includes research and development,
customer support and sales and marketing. Our international research and
development is conducted in Budapest, Hungary; Merelbeke, Belgium; and Aachen,
Germany. Additionally sales and support offices are located throughout the world
to support our current international customers and to expand our international
revenue opportunities.
Geographic revenue classification is based on the country in which the sale
is invoiced. Revenue for the nine months ended September 30, 2004 was 70% North
America and 30% international, versus 72% North America and 28% international
for the year ended December 31, 2003.
Additional financial information relating to foreign and domestic sales and
operations for each of the nine months ended September 30, 2004 and the two
years in the period ended December 31, 2003 is set forth in Note 17, "Segment &
Geographic Information and Significant Customers," of the Notes to Consolidated
Financial Statements.
For a discussion of risks attendant to our foreign operations, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors -- A significant portion of our revenue is derived
from sales in Europe and Asia. Our results could be harmed by economic,
political, regulatory and other risks associated with these and other
international regions."
9
COMPETITION
There are a number of companies that develop or may develop products that
compete in our targeted markets; however, currently there is no one company that
competes with us in all of our product areas. The individual markets in which we
compete are highly competitive, and are subject to rapid technology changes.
Within imaging, we compete directly with ABBYY, Adobe, I.R.I.S. and NewSoft.
Within speech, we compete with AT&T, Fonix, IBM, Microsoft, Nuance and Philips.
In speech, some of our partners such as Avaya, Cisco, Edify, Genesys and Nortel
develop and market products that can be considered substitutes for our
solutions. In addition, a number of smaller companies in both speech and imaging
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.
Some of our competitors or potential competitors in our markets, such as
Adobe, IBM and Microsoft, 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.
EMPLOYEES
As of September 30, 2004, we employed 832 people on a full-time basis, 396
in the United States and 436 internationally. Of the total, 309 were in product
research and development, 226 in sales and marketing, 139 professional service
consultants, 56 in operations and support, and 102 in finance and
administration. Our employees may be subject to collective bargaining agreements
at a company or industry level in those countries where this is part of the
local labor law or practice. We have experienced no work stoppages and believe
that our employee relations are good. We have utilized the services of
consultants, third-party developers, and other vendors in our sales,
development, manufacturing activities and finance and administration functions.
AVAILABLE INFORMATION
Our reports filed with Securities and Exchange Commission, including this
Transition Report on Form 10-K/T, our Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports
filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of
1934, as amended, are available free of charge on our website at
www.scansoft.com, as soon as reasonably practicable after such reports are filed
electronically with the Securities and Exchange Commission.
ITEM 2. PROPERTIES
Our corporate headquarters and administrative, sales, marketing and support
functions for imaging occupy 37,636 square feet of space that we lease in
Peabody, Massachusetts. We also lease 25,233 square feet of space in Waltham,
Massachusetts where our North American speech research and development is
performed. In connection with the acquisition of SpeechWorks, we assumed a lease
for approximately 35,862 square feet of sales, marketing and support office
space for speech, in Boston Massachusetts. These leases expire in July 2006,
September 2006, and September 2006, respectively. We currently anticipate
consolidating our Massachusetts locations in the summer of 2005, which could
require us to incur restructuring expenses, which we have not quantified to
date. Additionally, we lease approximately 21,180 square feet of research and
development space located in Budapest, Hungary and 20,085 square feet in
Merelbeke, Belgium, which houses additional research and development space and
our international headquarters, respectively. These leases expire in December
2006 and April 2008, respectively. In connection with the Philips acquisition,
we assumed a lease for approximately 30,000 square feet of speech research and
development space located in Aachen, Germany. This lease expires in March 2006.
In addition, we assumed two leases for approximately 8,000 square feet and
15,000 square feet, respectively, of speech research and development space
located in Montreal, Canada. These leases expire in January 2005 and March 2013,
10
respectively. Also in connection with the acquisition of SpeechWorks we acquired
26,200 square feet of space in New York, New York that we subleased to another
company. The lease and sublease expire in February, 2016. In connection with the
acquisition of LocusDialog, we assumed a lease for approximately 12,000 square
feet of speech research and development and fulfillment space located in
Montreal, Canada which expires in June, 2006. In connection with the acquisition
of Telelogue we assumed a lease for approximately 5,892 square feet of research
and development space in New Jersey which expires in March, 2006. We also lease
a number of small sales and marketing offices in the United States, Asia and
Europe.
As of September 30, 2004, we were productively utilizing substantially all
of the space in our facilities, except for space that has been subleased or
restructured. We believe that our existing facilities are adequate for our needs
for at least the next twelve months.
ITEM 3. LEGAL PROCEEDINGS
Like many companies in the software industry, the Company has from time to
time been notified of claims that the Company 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 September 9, 2004, BIS Advanced Software Systems, Ltd. ("BIS") filed an
action against us in the United States District Court for the District of
Massachusetts claiming patent infringement. Damages are sought in an unspecified
amount. In the lawsuit, BIS alleges that the Company is infringing United States
Patent No. 6,401,239 entitled "System and Method for Quick Downloading of
Electronic Files." We believe this claim has no merit, and we intend to defend
the action vigorously.
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
claiming patent infringement. Damages are sought in an unspecified amount. In
the lawsuit, Compression Labs alleges that the Company is infringing United
States Patent No. 4,698,672 entitles "Coding System for Reducing Redundancy." We
believe this claim has no merit, and we intend to defend the action vigorously.
On April 23, 2004, Millennium L.P. filed an action against the Company in
the United Sates 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. 5,678,416 entitled "Information
processing Methodology; and No. 6,094,505 entitled "Information Processing
Methodology." The Company filed an Answer on June 17, 2004. 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
11
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 the Company has, both prior to and as a result of the
SpeechWorks acquisition, several products in the speech recognition technology
field, the Company 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.
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.
The Company believes that the final outcome of these matters will not have
a significant adverse effect on its financial position and results of
operations. However, even if its defense is successful, the litigation could
require significant management time and could be costly. Should the Company not
prevail in any such litigation, its operating results, financial position and
cash flows could be adversely impacted.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR COMMON STOCK
Our common stock commenced trading on the Nasdaq National Market on
December 11, 1995 under the symbol "VSNR," and traded under that symbol until
March 3, 1999. Our common stock is now traded on the Nasdaq National Market
under the symbol "SSFT." As of December 31, 2004, there were outstanding
106,249,600 shares of common stock. The following table sets forth for the
periods indicated the high and low sale prices for our common stock as reported
on the Nasdaq National Market.
HIGH LOW
----- -----
FISCAL 2004:
First quarter............................................. $6.36 $4.63
Second quarter............................................ 5.84 4.58
Third quarter............................................. 5.00 3.61
FISCAL 2003:
First quarter............................................. $6.50 $3.81
Second quarter............................................ 6.55 4.45
Third quarter............................................. 5.98 3.32
Fourth quarter............................................ 6.50 4.15
The equity compensation plan information incorporated by reference into
Part III, Item 12 of this Form 10-K/T is hereby incorporated by reference into
this Part II, Item 5.
12
As of December 31, 2004, there were 736 stockholders of record and the last
reported sale price of our common stock on the Nasdaq National Market was $4.19
per share.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
currently expect to retain future earnings, if any, to finance the growth and
development of our business and do not anticipate paying any cash dividends in
the foreseeable future.
Our loan and security agreement with Silicon Valley Bank, as amended on
March 31, 2004, contains a restrictive covenant which prohibits us from paying
or declaring any dividends on our capital stock during the term of the agreement
(except for dividends payable solely in capital stock) without Silicon Valley
Bank's prior written consent. In addition, the zero coupon convertible
subordinated debenture due in 2006 that was issued to Koninklijke Royal Philips
Electronics N.V. in connection with our acquisition of the Speech Processing
Telephony and Voice Control business units of Philips contains a restrictive
covenant which prohibits us from paying or declaring any dividend or
distribution (other than distributions of our equity securities) on our capital
stock while the debenture is outstanding. This restriction terminates if one
half or more of the debenture is converted by Philips into common stock.
ITEM 6. SELECTED FINANCIAL DATA
On October 23, 2004, ScanSoft's Board of Directors approved a change in
ScanSoft's fiscal year end from December 31 to September 30, effective beginning
September 30, 2004. All references in this Form 10-K/T to the period ended
September 30, 2004 refer to the nine months ended September 30, 2004.
The following selected consolidated financial data is not necessarily
indicative of the results of future operations and should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes included
elsewhere in this Annual Report on Form 10-K/T. The interim statement of
operations for the nine months ended September 30, 2003 is unaudited and, in the
opinion of management, reflects all adjustments, consisting
13
of normal recurring adjustments, necessary for a fair presentation of results of
operations for the nine months ended September 30, 2003.
NINE MONTHS
NINE MONTH ENDED
PERIOD ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30,
SEPTEMBER 30, ----------------------------------------- 2003
2004(4) 2003(3) 2002 2001(2) 2000(1) (UNAUDITED)
------------- -------- -------- -------- -------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Total revenue............ $130,907 $135,399 $106,619 $ 62,717 $ 47,961 $ 88,529
-------- -------- -------- -------- -------- --------
Gross margin............. 89,179 98,760 80,730 35,676 23,700 65,405
Income (loss) from
operations............. (7,993) (6,462) 6,603 (16,931) (52,497) (7,033)
Income (loss) before
income taxes........... (8,045) (5,787) 6,587 (17,194) (52,779) (6,375)
Provision for (benefit
from) income taxes..... 1,333 (269) 254 (317) 472 473
-------- -------- -------- -------- -------- --------
Net income (loss)........ $ (9,378) $ (5,518) $ 6,333 $(16,877) $(53,251) $ (6,848)
======== ======== ======== ======== ======== ========
Net income (loss) per
share: basic and
diluted................ $ (0.09) $ (0.07) $ 0.09 $ (0.34) $ (1.26) $ (0.10)
======== ======== ======== ======== ======== ========
Weighted average common
shares outstanding:
Basic.................. 103,780 78,398 67,010 49,693 42,107 71,286
======== ======== ======== ======== ======== ========
Diluted................ 103,780 78,398 72,796 49,693 42,107 71,286
======== ======== ======== ======== ======== ========
AS OF AS OF DECEMBER 31,
SEPTEMBER 30, -----------------------------------------
2004 2003 2002 2001 2000
------------- -------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short and
long-term investments............ $ 47,691 $ 42,584 $ 18,853 $ 14,324 $ 2,633
Working capital (deficit)........... 27,940 44,305 16,842 9,318 (6,484)
Total assets........................ 392,653 401,940 143,690 142,070 109,480
Long-term debt...................... 27,700 27,859 -- 3,273 --
Total stockholders' equity.......... 301,745 303,226 119,378 114,534 87,461
---------------
(1) On March 13, 2000, the Company merged with Caere Corporation, a
California-based digital imaging software company.
(2) On December 12, 2001, the Company acquired the Speech and Language
Technology Business of Lernout & Hauspie Speech Products, N.V.
(3) On January 30, 2003, the Company acquired Royal Philips Electronic Speech
Processing Telephony and Voice Control business units, and related
intellectual property. See Note 19 to Notes to Consolidated Financial
Statements.
On August 11, 2003, the Company acquired SpeechWorks International, Inc.
See Note 19 to Notes to Consolidated Financial Statements.
On December 19, 2003, the Company acquired LocusDialog, Inc. See Note 19 to
Notes to Consolidated Financial Statements.
14
(4) On June 15, 2004, the Company acquired Telelogue, Inc. See Note 19 to Notes
to Consolidated Financial Statements.
On September 16, 2004, the Company acquired Brand & Groeber Communications
Gbr. See Note 19 to Notes to Consolidated Financial Statements.
ITEM 7. 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 INCLUDED ELSEWHERE IN THIS TRANSITION
REPORT ON FORM 10-K/T. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS,
WHICH INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS FOR MANY
REASONS, INCLUDING THE RISKS DESCRIBED IN "RISK FACTORS" STARTING ON PAGE 31 AND
ELSEWHERE IN THIS ANNUAL REPORT.
OVERVIEW OF THE BUSINESS
We offer businesses and consumers market-leading speech and imaging
solutions that facilitate the way people access, share, manage and use
information in business and in daily life. We market and distribute our products
indirectly through a global network of resellers, comprising system integrators,
independent software vendors, value-added resellers, hardware vendors,
telecommunications carriers and distributors; and directly to businesses and
consumers through a dedicated direct sales force and our e-commerce website
(www.scansoft.com). The value of our solutions is best realized in vertical
markets that are information and process intensive, such as healthcare,
telecommunications, financial services, legal and government.
Our strategy is to deliver premier, comprehensive technologies and services
as an independent application or as part of a larger integrated system in two
areas -- speech and imaging. Our speech technologies enable voice-activated
services over a telephone, transform speech into written word, and permit the
control of devices and applications by simply speaking. Our imaging solutions
eliminate the need to manually reproduce documents, automate the integration of
documents into business systems, and enable the use of electronic documents and
forms within XML, Internet, mobile and other business applications. Our software
is delivered as part of a larger integrated system, such as systems for customer
service call centers, or as an independent application, such as dictation,
document conversion or PDF, navigation systems in automobiles or digital copiers
on a network. Our products and technologies deliver a measurable return on
investment to our customers.
Our extensive technology assets, intellectual property and industry
expertise in speech and digital capture create high barriers to entry in markets
where we compete. Our technologies are based on complex mathematical formulas,
which require extensive amounts of linguistic and image data, acoustic models
and recognition techniques. A significant investment in capital and time would
be necessary to replicate our current capabilities, and we continue to build
upon our leadership position. Our speech technology has industry-leading
recognition accuracy, provides recognition for 48 languages and natural sounding
synthesized speech in 22 languages, and supports a broad range of hardware
platforms and operating systems. Our digital capture technology is recognized as
the most accurate in the industry, with rates as high as 99.8%, and supports
more than 100 languages. Our technologies are covered by more than 650 patents
or patent applications.
Our strategy includes pursuing high growth markets in speech, expanding our
PDF and imaging solutions, providing our partners and customers with a
comprehensive portfolio of solutions, promoting the broad adoption of our
technology, focusing and leverage our vertical expertise, building global sales
and channel relationships and pursuing strategic acquisitions that complement
our resources.
ScanSoft was incorporated in 1992 as Visioneer. In 1999, we changed our
name to ScanSoft, Inc. and ticker symbol to SSFT. From our founding until 2001,
we focused exclusively on delivering imaging solutions that simplified
converting and managing information as it moved from paper formats to electronic
systems. On
15
March 13, 2000, we merged with Caere Corporation, a California-based digital
imaging software company, to expand our applications for document and electronic
forms conversion. In December 2001, we entered the speech market through the
acquisition of the Speech & Language Technology Business from Lernout & Hauspie.
We believed speech solutions were a natural complement to our imaging solutions
as both are developed, marketed and delivered through similar resources and
channels. We continue to execute against our strategy of being the market leader
in speech through the organic growth of our business as well as through
strategic acquisitions. Since the beginning of 2003, we have completed a number
of acquisitions, including:
- On January 30, 2003, we acquired Royal Philips Electronics Speech
Processing Telephony and Voice Control business units ("Philips") to
expand our solutions for speech in call centers and within automobiles
and mobile devices.
- On August 11, 2003, we acquired SpeechWorks International, Inc.
("SpeechWorks") to broaden our speech applications for
telecommunications, call centers and embedded environments as well as
establish a professional services organization.
- On December 19, 2003, we acquired LocusDialog, Inc. ("LocusDialog") to
expand our speech application portfolio with automated attendant
solutions for business.
- On June 15, 2004, we acquired Telelogue, Inc. ("Telelogue") to enhance
our automated directory assistance solutions.
- On September 16, 2004, we acquired Brand & Groeber Communications GbR
("B&G") to enhance our embedded speech solutions, which will make mobile
phones accessible to the visually impaired using ScanSoft's
text-to-speech technology.
- On December 6, 2004, we acquired Rhetorical Systems, Inc. ("Rhetorical")
to complement our text-to-speech solutions and add capabilities for
creating custom voices.
Subsequent to September 30, 2004, we also announced agreements to acquire
ART Advanced Recognition Technologies, Inc. ("ART") to expand our portfolio of
embedded speech solutions and Phonetic Systems Ltd. ("Phonetic") to complement
our position in automated directory assistance and enterprise speech
applications. We anticipate closing both of these transactions during the
quarter ended March 31, 2005.
Our focus on providing solutions that enable the capture and conversion of
information and the automation of systems requires a broad set of technologies
and channel capabilities. We have made and expect to continue to make
acquisitions of other companies, businesses and technologies to complement our
internal investments in these areas. We have a team that focuses on evaluating
market needs and potential acquisitions to fulfill them. In addition, we have a
disciplined methodology for integrating acquired companies and businesses after
the transaction is complete.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the dates of the financial statements and the reported amounts of revenue and
expenses during the reporting periods. On an ongoing basis, we evaluate our
estimates and judgments, in particular those related to revenue recognition, the
costs to complete the development of custom software applications and valuation
allowances (specifically sales returns and other allowances); accounting for
patent legal defense costs; the valuation of goodwill, other intangible assets
and tangible long-lived assets; estimates used in the accounting for
acquisitions; assumptions used in valuing stock-based compensation instruments;
evaluating loss contingencies; and valuation allowances for deferred tax assets.
Actual amounts could differ significantly from these estimates. We base our
estimates and judgments on historical experience and various other factors that
are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities and the amounts of revenue and expenses that are not readily
apparent from other sources.
16
We believe the following critical accounting policies most significantly
affect the portrayal of our financial condition and results of operations and
require our most difficult and subjective judgments.
REVENUE RECOGNITION
As a result of SpeechWorks acquisition in August 2003, professional
services became a material component of our business. As a result of this and
the implementation of Oracle, in January 2004, we began to separately track and
disclose professional services revenues and cost of revenue. Prior to 2004, we
did not separately disclose professional services revenue and cost of revenue as
they were immaterial and it is not practical to reclassify these revenues and
associated costs retroactively.
We recognize revenue in accordance with Statement of Position ("SOP") 97-2,
Software Revenue Recognition, as amended by SOP 98-9, "Modification of SOP 97-2
with Respect to Certain Transactions", SOP 81-1 Accounting for Performance of
Construction Type and Certain Performance Type Contracts and the Securities and
Exchange Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition in
Financial Statements" ("SAB 104") and Emerging Issues Task Force ("EITF") 01-09
"Accounting for Consideration Given by a Vendor (Including a Reseller of the
Vendors Products)" and Financial Accounting Standards Board No. 48 ("SFAS 48")
"Revenue Recognition When Right of Return Exists". In general we recognize
revenue when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, collectibility is probable, and
vendor specific objective evidence ("VSOE") exists for any undelivered elements.
We reduce revenue recognized for estimated future returns, price protection and
rebates and certain marketing funds at the time the related revenue is recorded.
Certain distributors and value-added resellers have been granted rights of
return for as long as the distributors or resellers hold the inventory. We have
not aggregated and analyzed historical returns from distributor and resellers to
form a basis in order to estimate the future sales returns by distributor and
resellers. As a result, we recognize revenues from sales to these distributors
and resellers when they have sold products through to retailers and end-users.
Title and risk of loss pass to the distributor or reseller upon shipment, at
which time the transaction is invoiced and payment is due. Based on reports from
distributors and resellers of their inventory balances at the end of each
period, we record an allowance against accounts receivable for the sales price
of all inventories subject to return.
We also make an estimate of sales returns by retailers or end users
directly or through our distributors or resellers based on historical returns
experience. We have aggregated and analyzed historical returns from retailers
and end users which forms the basis of our estimate of future sales returns by
retailers or end users. In accordance with SFAS 48, the provision for these
estimated returns is recorded as a reduction of revenue at the time that the
related revenue is recorded. If actual returns from retailers differ
significantly from our estimates, such differences could have a material impact
on our results of operations for the period in which the actual returns become
known. Our accounts receivable balance, including accounts receivable from a
related party, was $36.5 million and $42.4 million at September 30, 2004 and
December 31, 2003, respectively. These balances are net of sales returns and
other allowances of $8.8 million and $8.8 million and allowances for doubtful
accounts of $2.5 million and $1.4 million as of September 30, 2004 and December
31, 2003, respectively.
Revenue from royalties on sales of our products by OEMs to third parties,
where no services are included, is typically recognized upon delivery to the
third party when such information is available, or when we are notified by the
OEM that such royalties are due as a result of a sale, provided that all other
revenue recognition criteria are met.
When we provide professional services considered essential to the
functionality of the software, such as custom application development for a
fixed fee, we recognize revenue from the fees for such services and any related
software licenses based on the percentage-of-completion method in accordance
with SOP 81-1. We generally determine the percentage of completion by comparing
the labor hours incurred to date to the estimated labor hours required to
complete the project. We consider labor hours to be the most reliable available
measure of progress on these projects. Adjustments to estimates to complete are
made in the periods in which facts resulting in a change become known. When the
estimate indicates a loss, such loss is recorded
17
in the period identified. Significant judgments and estimates are involved in
determining total estimated costs, and therefore the percent complete of each
contract. If our estimates change, the adjustment could have a material effect
on our results of operations in the period of the change.
When we provide services on a time and materials basis, we recognize
revenue as we perform the services based on actual time incurred. Other
professional services not considered essential to the functionality of the
software are limited and primarily include training and feasibility studies,
which are recognized as revenue when the related services are performed.
When we provide software support and maintenance services, we recognize the
revenue ratably over the term of the related contracts, typically one year.
We may sell, under one contract or related contracts, software licenses,
custom software applications and other services considered essential to the
functionality of the software and a maintenance and support arrangement. The
total contract value is attributed first to the maintenance and support
arrangement based upon VSOE of its fair value, equal to its stated list price as
a fixed percentage of the related software product's price and additionally
based upon stated renewal rates. The remainder of the total contract value is
then attributed to the software license and related professional services, which
are typically recognized as revenue using the percentage of completion method.
As a result, discounts inherent in the total contract value are attributed to
the software license and related professional services. We may sell, under one
contract or related contracts, software licenses, a maintenance and support
arrangement and professional services not considered essential to the
functionality of the software. In those arrangements, the total contract value
is attributed first to the undelivered elements of maintenance and support and
professional services based on VSOE of their respective fair values, as
described above. The remainder of the contract value is attributed to the
software licenses, which are typically recognized as revenue upon delivery,
provided all other revenue recognition criteria are met. As a result, discounts
inherent in the total contract value are attributed to the software licenses.
We follow the guidance of EITF 01-09 in determining whether consideration
given to a customer should be recorded as an operating expense or a reduction of
revenue recognized from that same customer. Consideration given to a customer is
recorded as a reduction of revenue unless both of the following conditions are
met:
- We receive an identifiable benefit in exchange for the consideration, and
the identified benefit is sufficiently separable from the customer's
purchase of our products and services such that we could have purchased
the products from a third party, and
- We can reasonably estimate the fair value of the benefit received.
Consideration, including that in the form of our equity instruments (if
applicable), is recorded as a reduction of revenue, to the extent we have
recorded cumulative revenue from the customer or reseller. As a result of this
policy, we have recorded a $0.3 million, $0.2 million and $0.3 million reduction
in total revenue for the nine months ended September 30, 2004 and the years
ended December 31, 2003 and 2002, respectively.
We follow the guidance of EITF Issue No. 01-14, Income Statement
Characterization of Reimbursements for "Out-of-Pocket" Expenses Incurred, and
record reimbursements received for out-of-pocket expenses as revenue, with
offsetting costs recorded as cost of revenue. Out-of-pocket expenses generally
include, but are not limited to, expenses related to airfare, hotel stays and
out-of-town meals.
ACCOUNTING FOR PATENT LEGAL DEFENSE COSTS
We have capitalized external legal costs incurred in the defense of our
patents where we believe that the future economic benefit of the patent will be
increased. We monitor the legal costs incurred and the anticipated outcome of
the legal action and, if changes in the anticipated outcome occur, write off
capitalized costs, if any, in the period the change is determined.
18
VALUATION OF LONG-LIVED TANGIBLE AND INTANGIBLE ASSETS AND GOODWILL
We have significant long-lived tangible and intangible assets and goodwill,
which are susceptible to valuation adjustments as a result of changes in various
factors or conditions. The most significant long-lived tangible and intangible
assets are fixed assets, patents and core technology, completed technology and
trademarks which are typically amortized using the straight-line method over
their estimated useful lives. The values of intangible assets, with the
exception of goodwill, were initially determined by a risk-adjusted, discounted
cash flow approach. We assess the potential impairment of identifiable
intangible assets and fixed assets whenever events or changes in circumstances
indicate that the carrying value may not be recoverable and at least annually.
Factors we consider important, which could trigger an impairment of such assets,
include the following:
- Significant underperformance relative to historical or projected future
operating results;
- Significant changes in the manner of or use of the acquired assets or the
strategy for our overall business;
- Significant negative industry or economic trends;
- Significant decline in our stock price for a sustained period; and
- A decline in our market capitalization below net book value.
Future adverse changes in these or other unforeseeable factors could result
in an impairment charge that would materially impact future results of
operations and financial position in the reporting period identified.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 142
requires, among other things, the discontinuance of goodwill amortization. The
standard also includes provisions for the assessment of the useful lives of
existing recognized intangible assets and the identification of reporting units
for purposes of assessing potential future impairments of goodwill. We have
assessed the useful lives of our existing intangible assets, other than
goodwill, and believe that estimated useful lives remain appropriate. In
addition, we have determined that we operate in one reporting unit. As a result,
we use the market value approach on the enterprise level basis to determine fair
value of the Company in the initial step of our goodwill impairment testing.
Based on this, we performed the annual assessment during the last quarter of
fiscal 2004 and determined that these intangible assets were not impaired. We
complete goodwill impairment analyses at least annually, or more frequently when
events and circumstances occur indicating that the recorded goodwill might be
impaired.
Significant judgments and estimates are involved in determining the useful
lives of our intangible assets, determining what reporting units exist and
assessing when events or circumstances would require an interim impairment
analysis of goodwill or other long-lived assets to be performed. Changes in our
organization or our management reporting structure, as well as other events and
circumstances, including but not limited to technological advances, increased
competition and changing economic or market conditions, could result in (a)
shorter estimated useful lives, (b) additional reporting units, which may
require alternative methods of estimating fair values or greater disaggregation
or aggregation in our analysis by reporting unit, and/or (c) other changes in
previous assumptions or estimates. In turn, this could have a significant impact
on our consolidated financial statements through accelerated amortization and/or
impairment charges.
ACCOUNTING FOR ACQUISITIONS
We have completed multiple significant business and other asset
acquisitions over the preceding five years which have resulted in significant
goodwill and other intangible asset balances. Our future business strategy
contemplates that we may continue to pursue additional acquisitions in the
future. We completed the acquisition of Rhetorical in December 2004 and have
announced our agreements to acquire ART and Phonetic. Our accounting for
acquisitions involves significant judgments and estimates primarily, but not
limited to: the fair value of certain forms of consideration, the fair value of
acquired intangible assets, which involve projections of future revenues and
cash flows, the fair value of other acquired assets and assumed liabilities,
including potential contingencies, and the useful lives and, as applicable, the
reporting unit, of the
19
assets. The impact of prior or future acquisitions on our financial position or
results of operations may be materially impacted by the change in or initial
selection of assumptions and estimates. Additionally, under SFAS 142, we
determine the fair value of the reporting unit, for purposes of the first step
in our annual goodwill impairment test, based on our market value. If prior or
future acquisitions are not accretive to our results of operations as expected,
our market value declines dramatically, or we determine we have more than one
reporting unit, we may be required to complete the second step which requires
significant judgments and estimates and which may result in material impairment
charges in the period in which they are determined.
ACCOUNTING FOR STOCK-BASED COMPENSATION INSTRUMENTS
We apply the principles of FASB Statement No. 123 "Accounting for
Stock-based Compensation" to value any grants of equity instruments to
non-employees as well as to calculate pro forma information relative to our
employee awards for disclosure purposes. Application of this principle
inherently includes a number of estimates and assumptions including stock price
volatility factors. We based our estimates and assumptions on the best
information available at the time of valuation, however, changes in these
estimates and assumptions including stock price volatility factors could have a
material effect on the valuation of the underlying instruments.
LOSS CONTINGENCIES
We are subject to legal proceedings, lawsuits and other claims relating to
labor, service and other matters arising in the ordinary course of business.
Quarterly, we review the status of each significant matter and assess our
potential financial exposure. If the potential loss from any claim or legal
proceeding is considered probable and the amount can be reasonably estimated, we
accrue a liability for the estimated loss. Significant judgment is required in
both the determination of probability and the determination as to whether an
exposure is reasonably estimable. Because of uncertainties related to these
matters, accruals are based only on the best information available at the time.
As additional information becomes available, we reassess the potential liability
related to our pending claims and litigation and may revise our estimates. Such
revisions in the estimates of the potential liabilities could have a material
impact on our results of operations and financial position.
ACCOUNTING FOR INCOME TAXES
As part of the process of preparing our consolidated financial statements,
we are required to calculate our income tax expense based on taxable income by
jurisdiction. There are many transactions and calculations where the ultimate
tax outcome is uncertain. Some of these uncertainties arise as a consequence of
revenue-sharing and cost-reimbursement arrangements among related entities and
the differing tax treatment of revenue and cost items across various
jurisdictions.
Additionally, we monitor the realization of our deferred tax assets based
on changes in circumstances, for example, recurring periods of income for tax
purposes following historical periods of cumulative losses or changes in tax
laws or regulations. Our income tax provisions and our assessment of the
realizability of our deferred tax assets involve significant judgments and
estimates. If we continue to generate taxable income through profitable
operations in future years we may be required to recognize these deferred tax
assets through the reduction of the valuation allowance which would result in a
material benefit to our results of operations in the period in which the benefit
is determined, excluding the recognition of the portion of the valuation
allowance which relates to net deferred tax assets acquired in a business
combination and stock compensation.
20
OVERVIEW OF RESULTS OF OPERATIONS
On October 23, 2004, ScanSoft's Board of Directors approved a change in
ScanSoft's fiscal year end from December 31 to September 30, effective beginning
September 30, 2004. All references in this Form 10-K/T to the period ended
September 30, 2004 refer to the nine months ended September 30, 2004. References
to fiscal 2005, refers to the period beginning on October 1, 2004 and ending on
September 30, 2005.
The following table presents, as a percentage of total revenue, certain
selected financial data for the nine months ended September 30, 2004 and
September 30, 2003 and for the two years ended December 31, 2003 and 2002. The
interim statement of operations for the nine months ended September 30, 2003 is
unaudited and, in the opinion of management, reflects all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
results of operations for the nine months ended September 30, 2003.
NINE MONTH YEAR ENDED NINE MONTHS
PERIOD ENDED DECEMBER 31, ENDED
SEPTEMBER 30, ------------- SEPTEMBER 30,
2004 2003 2002 2003
------------- ----- ----- -------------
(UNAUDITED)
Revenue:
Revenue.................................... 74.6% 100% 100% 100%
Professional services...................... 25.4 -- -- --
----- ----- ----- -----
Total revenue......................... 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of revenue............................ 7.9 19.3 15.4 17.7
Cost of professional services.............. 17.5 -- -- --
Cost of revenue from amortization of
intangible assets....................... 6.5 7.8 8.9 8.4
----- ----- ----- -----
Gross Margin................................. 68.1 72.9 75.7 73.9
Research and development................... 20.0 25.1 25.9 28.3
Sales and marketing........................ 37.5 36.0 30.9 35.3
General and administrative................. 13.6 12.0 10.1 13.0
Amortization of other intangible
assets(1)............................... 1.5 1.7 1.6 1.6
Stock based compensation expense........... 1.0 0.2 0.1 0.2
Restructuring and other charges, net(2).... 0.6 2.7 0.9 3.4
----- ----- ----- -----
Total costs and expenses.............. 106.1 104.8 93.8 107.9
----- ----- ----- -----
Income (loss) from operations................ (6.1) (4.8) 6.2 (7.9)
Other income (expense), net.................. (0.1) 0.5 0.0 0.7
----- ----- ----- -----
Income (loss) before income taxes............ (6.2) (4.3) 6.2 (7.2)
Provision for (benefit from) income taxes.... 1.0 (0.2) 0.2 0.5
----- ----- ----- -----
Net income (loss)............................ (7.2)% (4.1)% 6.0% (7.7)%
===== ===== ===== =====
---------------
(1) See Note 5 of Notes to Consolidated Financial Statements.
(2) See Note 8 of Notes to Consolidated Financial Statements.
21
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THE YEAR ENDED DECEMBER 31,
2003 AND TO THE YEAR ENDED DECEMBER 31, 2002
We derive our revenue from licensing 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 by simply speaking. Our imaging solutions
eliminate the need to manually reproduce documents, automate the integration of
documents into business systems, and enable the use of electronic documents and
forms within XML, Internet, mobile and other business applications.
Total Revenue
Total revenue for the nine month transition period ended September 30, 2004
decreased by $4.5 million, or 3.3%, compared to the twelve months ended December
31, 2003. The decrease in revenue is attributable to a shorter fiscal period due
to our changing our fiscal year end from December 31 to September 30, the
omission of the period October through December from the transition period as
this three month period is historically the strongest revenue quarter of the
calendar year, offset by the inclusion of nine months of SpeechWorks revenue in
the nine month transition period compared to approximately four months in the
twelve months ended December 31, 2003 and organic growth in the nine month
period over the comparable period in 2003.
As a result of SpeechWorks acquisition in August 2003, professional
services became a material component of our business. As a result of this and
the implementation of Oracle, in January 2004, we began to separately track and
disclose professional services revenues and cost of revenue. Prior to 2004, we
did not separately disclose professional services revenue and cost of revenue as
they were immaterial and it is not practical to reclassify these revenues and
associated costs retroactively.
Our speech revenues increased to 66.1% of total revenues in the nine months
ended September 30, 2004, up from 57.6% in the twelve months ended December 31,
2003 due to the increased SpeechWorks revenue described above. Revenue from our
speech products was $86.6 million for the nine months ended September 30, 2004,
an $8.7 million increase over the twelve months ended December 31, 2003. Within
speech, network revenues increased to 38.4% of total revenues from 25.9% in the
twelve months ended December 31, 2003 due to full period results for SpeechWorks
revenue, embedded revenue rose to 10.6% of total revenues from 7.5% in the
twelve months ended December 31, 2003 due to increased professional services
from current period design wins and net increase in royalties, while dictation
revenues declined to 17.1% of total revenues in 2004 from 24.1% in the twelve
months ended December 31, 2003 due to a disproportionate increase in network and
embedded revenues described above. Imaging revenue declined to 33.9% of total
revenues for the nine months ended September 30, 2004 from 42.4% of total
revenues in the twelve months ended December 31, 2003 due to the
disproportionate increase in speech revenues described above. Revenue for our
imaging products was $44.3 million for the nine months ended September 30, 2004,
a $13.2 million decline from the twelve months ended December 31, 2003 as a
result of our change in fiscal year end from December to September. Our imaging
products showed 14.0% growth for the nine months ended September 30, 2004 when
compared to the nine months ended September 30, 2003.
Total revenue for the twelve months ended December 31, 2003 increased by
$28.8 million or 27% compared to the twelve months ended December 31, 2002. The
growth in revenue is attributed to a $33.8 million growth in our speech
revenues, offset by an overall decrease of $5.0 million in our imaging revenues
from 2002. Revenue from our speech products was $77.9 million and $44.2 million
for 2003 and 2002, respectively. The increase in our speech revenues is
primarily related to a $24.7 million increase in our networked speech
technologies, a $4.9 million increase in our embedded speech technologies, as
well as a
22
$4.2 million increase in our dictation product lines, from the year 2002. The
$5.0 million overall decrease in our Imaging products can be attributed to a
$10.0 million decrease in revenues recognized from our OCR products. This
overall decrease is due, in part, to the fact that OmniPage Pro 12 was launched
earlier in 2002 than OmniPage Pro 14 was launched in 2003, as well as the
recognition in 2002 of revenue previously deferred. The decrease in the OCR
revenues was offset to some extent by an overall strengthening of our other
Imaging product lines, in particular, PaperPort and the revenues derived from
the launch of our new product, PDF Converter, during the fourth quarter of 2003.
Related-party revenue declined in 2004 because Xerox ceased to be a related
party as of June 30, 2004. Related-party revenue increased $1.6 million for the
twelve months ended December 31, 2003, or 32%, compared to the twelve months
ended December 31, 2002. This increase was related to the inclusion of our
products in expanded product offerings of our related parties, primarily Xerox.
The geographic revenue split for the nine months ended September 30, 2004
was 70% North America and 30% international versus 72% North America and 28%
international for the twelve months ended December 31, 2003 and 73% North
America and 27% international for the twelve months ended December 31, 2002.
Geographic revenue classification is based on the country, in which the sale is
invoiced.
For the twelve months ended September 30, 2005 (fiscal year 2005), we
expect revenue growth of 15% to 20% in speech revenues and 5% to 10% in imaging
revenues, annualized, from the nine month fiscal 2004 total.
Cost of Revenue
As a result of the SpeechWorks acquisition in August 2003, professional
services became a material component of our business. As a result of this and
the implementation of Oracle in January 2004, we began to separately track and
disclose professional services revenue and cost of revenue. Prior to 2004, we
did not separately disclose professional services revenue and associated cost of
revenue as they were immaterial and it is not practical to reclassify these
revenues and associated costs retroactively.
Cost of revenue as a percentage of related and third party revenue for the
nine months ended September 30, 2004 was 10.6% compared to 19.3% for the twelve
months ended December 31, 2003 and 15.4% for the twelve months ended December
31, 2002. For the nine month period ended September 30, 2004, cost of revenue
consists primarily of material and fulfillment costs and third-party royalties,
excluding cost of professional services. Cost of revenue for the nine months
ended September 30, 2003 and the years ended December 31, 2003 and 2002,
consists of material and fulfillment costs, third-party royalties, and
professional services costs including salaries for product support personnel,
and engineering costs associated with certain contracts which were accounted for
under percentage-of-completion method of accounting.
Cost of professional services revenue for the nine months ended September
30, 2004 was 69.2% of professional services revenue. Cost of professional
services revenue consists primarily of salaries for professional consulting
staff, salaries for product support personnel, and engineering costs associated
with certain contracts which were accounted for under percentage-of-completion
method of accounting.
During fiscal 2005, we expect cost of revenue as a percentage of related
and third party revenue to be consistent with results for the nine months ended
September 30, 2004.
During fiscal 2005, we expect cost of professional services revenues to
decline as a percentage of professional services revenue relative to results for
the nine months ended September 30, 2004 as a result of higher utilization of
our new services personnel and anticipated increases in revenue.
23
Cost of Revenue from Amortization of Intangible Assets
Cost of revenue from amortization of intangible assets consists of the
amortization of acquired patents and core and completed technology.
Cost of revenue from amortization of intangible assets was 6.4% of total
revenue for the nine months ended September 30, 2004, compared to 7.8% of
revenue for the twelve months ended December 31, 2003 and 8.9% for the twelve
months ended December 31, 2002. In absolute dollars, increases in amortization
of intangible assets results from the inclusion of a full nine months of
amortization from the SpeechWorks and LocusDialog acquisitions versus only four
months and one month of amortization in the prior year given the acquisitions
closed in August of 2003 and December 2003, respectively. During fiscal 2005, we
anticipate cost of revenue from amortization of other intangible assets to be
approximately $7.6 million, based on the current intangible assets at September
30, 2004 and their remaining useful lives.
The increase in cost of revenue from amortization of intangible assets in
absolute dollars for the twelve months ended December 31, 2003, compared to the
twelve months ended December 31, 2002, is attributable to $1.7 million of
amortization related to the exclusive worldwide license of certain desktop
dictation products and technologies, $0.7 million related to the Philips
acquisition which was closed on January 30, 2003 and $0.2 million related to the
SpeechWorks acquisition which was closed on August 11, 2003, partially offset by
$1.6 million of intangible assets that became fully amortized during the twelve
months ended December 31, 2002.
Gross Margin
Gross margin was 68.1% of revenues for the nine months ended September 30,
2004 as compared to 72.9% for the twelve months ended December 31, 2003 and
75.7% for the twelve months ended December 31, 2002. The decrease is directly
attributable to the increase in professional services revenue, which increased
to 25.4% of total revenue for the nine months ended September 30, 2004 from 8.6%
for the twelve months ended December 31, 2003 and from 3.8% the twelve months
ended December 31, 2002. The increase in professional services revenue, which
has a lower gross margin, was directly attributed to the acquisitions of
SpeechWorks and Phillips.
Research and Development Expense
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.
Research and development expense for the nine months ended September 30,
2004 was 20.0% of total revenue, compared to 25.1% and 25.9% of total revenue
for the twelve months ended December 31, 2003 and 2002, respectively. In
absolute dollars, research and development expenses in 2004 increased by 4.4%
over the comparable nine months ended September 30, 2003, significantly less
than related sales growth of 47.9%. Research and development expenses for the
twelve months ended December 31, 2003 increased in absolute dollars over the
twelve months ended December 31, 2002 due to increased speech and language
development efforts resulting from both the Philips and SpeechWorks
acquisitions. While we will continue to invest significantly in research and
development, in fiscal 2005, we expect research and development expense to
decline as a percentage of revenue due to growth in total revenue.
Sales and Marketing Expense
Sales and marketing expenses include salaries, commissions, advertising,
direct mail, public relations, trade shows, travel and other related sales and
marketing expenses.
Sales and marketing expense was 37.5% of total revenue for the nine months
ended September 30, 2004, compared to 36.0% and 30.9% for the twelve months
ended December 31, 2003 and 2002, respectively. The
24
increase in sales and marketing expenses in absolute dollars and as a percentage
of total revenue in 2004 was the result of increased compensation costs
resulting primarily from the investment in additional of sales and marketing
personnel added as part of the SpeechWorks and LocusDialog acquisitions
completed late in 2003. The increase for the twelve months ended December 31,
2003 compared to 2002 was primarily due to the Philips and SpeechWorks
acquisitions. We expect sales and marketing expenses to decrease as a percentage
of revenue in fiscal 2005 as a result of increased revenues.
General and Administrative Expense
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.
General and administrative expenses were 13.6% of total revenue for the
nine months ended September 30, 2004, compared to 12.0% and 10.0% for the twelve
months ended December 31, 2003 and 2002, respectively. The proportionate
increase in general and administrative expenses in 2004 is due primarily to
increased professional fees of approximately $1.4 million related to the
restatement of certain historical financial statements of SpeechWorks and
approximately $1.0 million of professional fees related to compliance with
Sarbanes Oxley regulatory requirements. The increase for the twelve months ended
December 31, 2003 compared to 2002 was primarily due to the Phillips and
SpeechWorks acquisitions. We expect general and administrative expenses in
absolute dollars to increase but to decrease as a percentage of revenues in
fiscal 2005 because of growth in total revenues. We attempt to control general
and administrative expense; however, if revenue continues to grow, we expect
general and administrative expenses to increase to support our growing
operations. In addition, we may increase general and administrative expenses in
advance of revenue to support expected future revenue growth in specific product
lines or geographic regions.
Amortization of Other Intangible Assets
Amortization of other intangible assets includes amortization of acquired
customer and contractual relationships, non-compete agreements and acquired
trade names and trademarks.
Amortization of other intangible assets was 1.5% of total revenue for the
nine months ended September 30, 2004, compared to 1.7% and 1.6% for the twelve
months ended December 31, 2003 and 2002, respectively. The decrease in
amortization for the nine months ended September 30, 2004 compared to the twelve
months ended December 31, 2003 was directly related to the nine month transition
period versus a twelve month period in the prior year. The increase in
amortization for the twelve months ended December 31, 2003 compared to 2002 was
primarily related to the Philips and SpeechWorks acquisitions, partially offset
by certain intangible assets that became fully amortized in 2002. During fiscal
2005, we expect amortization of other intangible assets to be approximately $1.8
million, based on the current intangible assets and their remaining useful lives
at September 30, 2004.
Stock-Based Compensation
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.
Stock-based compensation expense was 1.0% of total revenue for the nine
months ended September 30, 2004, as compared to 0.2% and 0.1% for the twelve
months ended December 31, 2003 and 2002 respectively. The absolute dollar
increase of $1.1 million is directly attributed to increased non-cash
compensation expense associated with the granting of approximately 1.0 million
shares of restricted stock (or restricted stock purchase rights) during the nine
months ended September 30, 2004. We expect stock-based compensation expense to
increase significantly in fiscal 2005 due to the adoption of Financial
Accounting Standards Board Statement No. 123 "Accounting for Stock-Based
Compensation" which will be effective for our fourth quarter beginning July 1,
2005.
25
Restructuring and Other Charges, Net
Restructuring and other charges, net were 0.6% of total revenue for the
nine months ended September 30, 2004, as compared to 2.7% and 0.9% for the
twelve months ended December 31, 2003 and 2002 respectively. For the nine months
ended September 30, 2004, we recorded a charge of $0.8 million related to
separation agreements with two former members of our senior management team.
Restructuring and other charges for the twelve months ended December 31, 2003
were $3.7 million compared to $1.0 million for the twelve months ended December
31, 2002. The 2003 charges reflect $2.4 million related to the termination of
106 employees as a result of the Philips and SpeechWorks acquisitions and $0.8
million and $0.4 million of employee and facility related costs, respectively,
associated with the restructuring of various corporate activities during 2003.
Income (Loss) from Operations
As a result of the factors described above, loss from operations was (6.1)%
of revenue for the nine months ended September 30, 2004 compared to a loss of
(4.8)% for the twelve months ended December 31, 2003, and income of 6.2% for the
twelve months ended December 31, 2002.
Other Income (Expense), Net
Other income (expense), net was (0.1)% of revenue for the nine months ended
September 30, 2004, compared to 0.5% of revenue for the twelve months ended
December 31, 2003 and 0.0% for the twelve months ended December 31, 2002. Other
income (expense), net in the twelve months ended December 31, 2003, included
foreign exchange gains of $1.2 million, which more than offset net interest
expense and other expenses of $0.2 million.
Income (Loss) Before Income Taxes
Loss before income taxes was (6.2)% of revenue for the nine months ended
September 30, 2004, compared with a loss of (4.3)% of revenue for the twelve
months ended December 31, 2003 and income of 6.2% of revenue for the twelve
months ended December 31, 2002.
Income Taxes
The provision for income taxes of 1.0% of revenues for the nine months
ended September 30, 2004, compared with a benefit of 0.2% of revenues for the
twelve months ended December 31, 2003 and a provision of 0.2% of revenues for
the twelve months ended December 31, 2002.
In 2004, the Company's effective tax rate was a provision of 16.6% versus a
benefit of 4.6% in 2003. The variance from the federal statutory rate for 2004
was primarily due to state, federal and foreign credits for research and
development, offset by increases in the valuation allowance.
In 2003, the Company's effective tax rate was a benefit of 4.6% versus a
provision of 3.9% in 2002. The variance from the statutory rate for 2003 was due
primarily to a federal refund received relating to Caere Corporation for taxes
paid prior to its acquisition by ScanSoft, offset by increases in the valuation
allowance.
In 2002, the Company's effective tax rate was a provision of 3.9%. The
variance from the statutory rate for 2002 was primarily due to foreign and state
provisions offset, in part, by the federal tax benefit related to a refund of
taxes paid by Caere Corporation prior to its acquisition by ScanSoft.
At September 30, 2004, ScanSoft had net deferred tax assets of
approximately $78 million which were subject to consideration of a valuation
allowance. A full valuation allowance has been provided against the net deferred
tax assets in the United States due to the uncertainty of their realization as a
result of cumulative historical losses. In the future, a period of sustained
profitability will cause us to reassess the need for the valuation allowance. We
may be required to recognize these deferred tax assets through the reduction of
the valuation allowance which would result in a material benefit to our results
of operations and adjustments to recorded goodwill and shareholder equity in the
period in which the benefit is determined.
26
Net Income (Loss)
As a result of the factors described above, net loss totaled (7.2)% of
revenues for the nine months ended September 30, 2004, compared with a loss of
(4.1)% of revenue for the twelve months ended December 31, 2003 and income of
6.0% of revenue for the twelve months ended December 31, 2002.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2004, we had cash and cash equivalents of $23.0
million, marketable securities of $7.4 million, long term marketable securities
of $17.4 million and working capital of $27.9 million as compared to $42.6
million in cash and cash equivalents and working capital of $44.3 million at
December 31, 2003. During 2004, we adopted a formal investment policy in order
to achieve a higher yield on our cash position by investing in short and
long-term marketable securities.
We have reported a net loss of $(9.4) million for the nine months ended
September 30, 2004, a net loss of $(5.5) million and net income of $6.3 million
for the years ended December 31, 2003 and 2002, respectively. We had an
accumulated deficit of $161.8 million at September 30, 2004.
Net cash provided by operating activities for the nine months ended
September 30, 2004 was $6.3 million as compared to $5.2 million for the twelve
months ended December 31, 2003. Cash provided by operations in the 2004 period
came primarily from income from operations, after adjustments for non-cash
amortization, depreciation and stock compensation, and lower accounts receivable
balances; this was offset primarily by lower deferred revenues.
Net cash used in investing activities for the nine months ended September
30, 2004 was $28.7 million compared to cash provided by investing activities of
$24.1 million for the twelve months ended December 31, 2003. Net cash used in
investing activities in 2004 consisted of $25.0 million invested in marketable
securities, $3.3 million in capital expenditures and $0.7 million in net cash
paid for acquisitions. Net cash provided by investing activities for the twelve
months ended December 31, 2003 consisted of $40.0 million acquired in the
SpeechWorks acquisition, $1.1 million received from Philips in accordance with
provisions in the purchase agreement and $0.6 million due to the maturity of
marketable securities, partially offset by $2.9 million in capital expenditures,
$8.5 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 nine months ended
September 30, 2004 was $2.7 million compared to net cash used in financing
activities of $5.1 million for the twelve months ended December 31, 2003. Net
cash provided in 2004 consisted of $6.1 million in proceeds from issuance of
common stock under employee stock compensation plans and $0.6 million in
proceeds from the issuance of common stock warrants. This was partially offset
by a $2.8 million payment associated with a licensing agreement, a $0.7 million
payment of note payable and deferred acquisition payments and a $0.4 million
payment to the former Caere president and CEO in connection with the settlement
of a non-competition and consulting agreement.
Net cash used in financing activities for the twelve months ended December
31, 2003 consisted of the payment of $6.9 million (6.0 million euros) related to
the 5.0 million euro note payable and 1.0 million euro deferred payment due in
connection with the Philips acquisition, the payment of the $3.3 million note
related to the acquisition of certain Lernout & Hauspie assets during 2001, a
$1.6 million payment to the former Caere President and CEO in connection with
the settlement of a non-competition and consulting agreement, $2.9 million of
payments to repurchase outstanding common shares and the payment of $0.3 million
related to outstanding equipment lines of credit. This was partially offset by
proceeds of $5.5 million from an underwritten offering of our common stock in
the first quarter of 2003 and proceeds of $4.4 million from the issuance of
common stock in connection with employee stock compensation plans.
On October 31, 2002, we 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"). We amended
this Loan and Security Agreement, as of March 31, 2004, through March 31, 2006.
Under this amendment, we must comply with both a minimum adjusted quick ratio
and minimum
27
tangible net worth calculation, as defined in the Loan Agreement. Depending on
our adjusted quick ratio, borrowings under the Credit Facility bear interest at
the Bank's prime rate plus 0.0% or 0.75% (4.75% at September 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 of 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 term loan. 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 September 30, 2004, we were
in compliance with all covenants.
As of September 30, 2004, no amounts were outstanding under the Credit
Facility and $9.1 million was available for borrowing in addition to
approximately $1.9 million previously committed under this line of credit for
outstanding Letters of Credit. We can make no guarantees as to our ability to
satisfy our future financial covenant calculations.
For the nine months ended September 30, 2004, we paid a total of $1.6
million in severance payments, of which $0.3 million relates to the 2004
restructuring, $1.1 million relates to the March 2002 restructuring and $0.2
million relates to severance paid to the former Caere President and CEO,
pursuant to a 2000 restructuring charge.
At September 30, 2004, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.6 million. The balance is
comprised of $0.2 million of lease exit costs and $0.4 million of
employee-related severance costs, of which $0.1 million are for severance to the
former Caere President and CEO, and $0.3 million is for severance costs related
to actions taken during 2003 and 2004.
The lease exit costs and severance due to the former Caere President and
CEO will be paid through March 2005. Severance costs related to restructuring
actions undertaken during 2003 and 2004 will be paid through March 2009.
As part of the underwritten offering completed for L&H in February 2003, we
sold 1,000,000 shares and raised approximately $3.8 million in gross proceeds.
After considering offering costs, the estimated net proceeds equaled
approximately $2.1 million. On March 11, 2003, the Company received
approximately $3.8 million of net proceeds from the exercise of the
over-allotment option of 1,072,500 shares granted to the underwriters as part of
the underwritten offering.
Although we generated $6.3 million of cash from operations for 2004 and
ended the year with a cash balance of $23.0 million, a market- able securities
balance of $7.4 million and long-term marketable securities of $17.4 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.
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. Additionally, in connection with the
SpeechWorks acquisition we acquired certain long-term lease obligations that
begin to come due in the next 12-24 months. In connection with the ART
acquisition, we agreed to pay approximately $10.0 million at closing, expected
in January 2005, and $16.5 million in December 2005. In connection with the
pending Phonetic acquisition, we agreed to (i) pay $17.5 million at closing,
expected in February 2005, and $17.5 million 24 months after closing, (ii) make
contingent payments of up to an additional $35.0 million in cash, in 2006
through 2008 if at all, upon the achievement of certain performance targets, and
(iii) issue unvested warrants to purchase 750,000 shares of our common stock
that will vest, if at all, upon the achievement of certain performance targets.
The cash consideration for these acquisitions is expected to be provided by
existing cash, marketable securities, cash generated from operations, or debt or
equity offerings. In connection with the Rhetorical acquisition, we paid
approximately $4.9 million in cash on December 6, 2004.
28
We believe that cash flows from future operations in addition to cash and
marketable securities on hand will be sufficient to meet our working capital,
investing, financing and contractual obligations, including the debt obligation
issued in connection with the Philips acquisition, lease obligations assumed in
the SpeechWorks acquisition, and cash obligations related to acquisitions
completed subsequent to year end, as they become due for the foreseeable future.
We also believe that in the event future operating results are not as planned,
that we could take actions, including restructuring actions and other cost
reduction initiatives, to reduce operating expenses to levels which, in
combination with expected future revenues, will continue to generate sufficient
operating cash flow. In the event that these actions are not effective in
generating operating cash flows we may be required to issue equity or debt
securities on less than favorable terms.
CONTRACTUAL OBLIGATIONS
The following table outlines our contractual payment obligations as of
September 30, 2004:
PAYMENTS DUE BY PERIOD
------------------------------------------------------
CONTRACTUAL LESS THAN 2-3 4-5 MORE THAN
OBLIGATIONS(1) TOTAL 1 YEAR YEARS YEARS 5 YEARS
-------------- ------- --------- ------- ------ ---------
(IN THOUSANDS)
Philips Convertible debenture... $27,524 -- $27,524 -- $ --
Deferred payments for technology
license....................... 2,714 2,714 -- -- --
Operating leases................ 34,071 5,445 7,622 5,260 15,744
Equipment line of credit........ 488 403 85 -- --
Standby letters of credit....... 1,458 344 46 44 1,024
Royalty commitments............. 833 485 245 33 70
Purchase commitments............ 1,124 1,124 -- -- --
Imputed interest................ 86 86 -- -- --
------- ------- ------- ------ -------
Total contractual cash
obligations................... $68,298 $10,601 $35,522 $5,337 $16,838
---------------
(1) Excludes the impact of the Art Advanced Recognition Technologies, Inc.
("ART"), Phonetic Systems Ltd. ("Phonetic") and Rhetorical Systems Ltd.
("Rhetorical") acquisitions. In connection with the ART acquisition, we
agreed to pay approximately $10.0 million at closing (expected in the
quarter ending March 31, 2005) and $16.5 million in December 2005. In
connection with the Phonetic acquisition, we agreed to (i) pay $17.5 million
at closing (expected in the quarter ended March 31, 2005) and $17.5 million
24 months after closing, (ii) make a contingent payment of up to an
additional $35.0 million, if at all, upon the achievement of certain
performance targets, and (iii) issue unvested warrants to purchase 750,000
shares of our common stock that will vest, if at all, upon the achievement
of certain performance targets. The cash consideration for these
acquisitions is expected to be provided by existing cash, marketable
securities, cash generated from operations, or debt or equity offerings. In
connection with the Rhetorical acquisition, we paid approximately $4.9
million in cash on December 6, 2004.
At September 30, 2004, the Company has sub-leased certain office space to
third parties. Total sub-lease income under contractual terms of $11.0 million,
or approximately $1.0 million annually, which has not been reflected in the
above operating lease contractual obligations, will be received through February
2016.
OFF-BALANCE SHEET ARRANGEMENTS
Through September 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
29
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 to the United States. The contract has a
one year term that expired on November 1, 2004. On November 1, 2004 we renewed
this forward hedge contract the renewed contract has a one year term expiring on
November 1, 2005; however it is cancelable at our discretion.
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 to the United States. The
original contract expired on January 30, 2004. This contract was renewed on
three month terms through October 29, 2004.
As of September 30, 2004, we have a $0.6 million liability related to these
contracts.
With our increased international presence in a number of geographic
locations and with international revenues projected to increase in 2005, 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.
RECENTLY ISSUED 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, Earnings 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. The adoption if EITF No. 03-06 did not have a material effect on
our financial position or results of operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS 150 was originally effective for financial instruments entered
into or modified after May 31, 2003, and otherwise effective at the beginning of
the first interim period beginning after June 15, 2003, however certain elements
of SFAS No. 150 have been deferred. The adoption of the provisions of SFAS No.
150, not deferred, did not have a material impact on our financial position or
results of operations and we do not expect the adoption of the deferred elements
of SFAS No. 150 to have a material impact on our financial position or results
of operations.
On December 16, 2004, the FASB issued FASB SFAS No. 123 (revised 2004),
Share-Based Payment, which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of
Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the
approach described in SFAS No. 123. However, SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative. The new standard will be effective, upon
us, beginning July 1,
30
2005. We have not yet completed our evaluation but we expect the adoption to
have a material effect on our consolidated financial statements.
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 could 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 PURCHASING DECISIONS IN ANTICIPATION OF NEW
VERSIONS OF PRODUCTS;
- CUSTOMERS DELAYING, CANCELING OR LIMITING THEIR PURCHASES AS A RESULT OF
THE THREAT OR RESULTS OF TERRORISM;
- INTRODUCTION OF NEW PRODUCTS BY US OR OUR COMPETITORS;
- SEASONALITY IN PURCHASING PATTERNS OF OUR CUSTOMERS, WHERE PURCHASES TEND
TO SLOW IN THE FOURTH 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;
- 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
31
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 GROWN, AND MAY CONTINUE TO GROW, THROUGH ACQUISITIONS, WHICH COULD
DILUTE OUR EXISTING SHAREHOLDERS AND COULD INVOLVE SUBSTANTIAL INTEGRATION
RISKS. As part of our business strategy, we have in the past acquired, and
expect to continue to acquire, other businesses and technologies. 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. We may also incur debt
in connection with future acquisitions, which, if available at all, may place
additional restrictions on our ability to operate our business. Furthermore, 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
acquisitions of Telelogue, Inc. and Rhetorical Systems Ltd. and our pending
acquisitions of ART Advanced Recognition Technologies, Inc. and Phonetic
Systems, Ltd. 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.
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 $(9.4) million and $(5.5)
million for the nine month period ended September 30, 2004 and the twelve months
ended December 31, 2003, respectively. We had an accumulated deficit of $161.8
million at September 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.
PURCHASE ACCOUNTING TREATMENT OF OUR 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. Under accounting principles generally
accepted in the United States of America, we have accounted for our acquisitions
using
32
the purchase method of accounting. Under 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.
SALES OF OUR DOCUMENT AND PDF CONVERSION PRODUCTS AND OUR DIGITAL PAPER
MANAGEMENT PRODUCTS REPRESENTED APPROXIMATELY 40% AND 31%, OF OUR REVENUE FOR
THE YEAR ENDED DECEMBER 31, 2003 AND FOR THE NINE MONTHS ENDED SEPTEMBER 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 nine months ended September 30, 2004, our document
and PDF conversion products represented approximately 19% 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 AND, INGRAM MICRO, 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 and Ingram Micro to serve
this network of channel partners. For the nine months ended September 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 WOULD 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 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 September 30, 2004, Ingram Micro, Tech Data and Digital River
represented 4%, 2% and 3%, 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
33
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 imaging, we compete directly with ABBYY, Adobe,
I.R.I.S. and NewSoft. Within speech, we compete with AT&T, Fonix, IBM,
Microsoft, Nuance and Philips. In speech, some of our partners such as Avaya,
Cisco, Edify, Genesys and Nortel develop and market products that can be
considered substitutes for our solutions. In addition, a number of smaller
companies in both speech and imaging 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 license or the prices we can
charge. Some of our current or potential competitors, such as Adobe, IBM and
Microsoft, 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 IBM and 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 2004 YEAR-END AUDIT COULD HARM OUR BUSINESS. In connection with their
audit of our 2004 consolidated financial statements, BDO Seidman, LLP, our
independent registered public accounting firm advised management and our Audit
Committee of the following significant deficiencies which do not individually or
in the aggregate raise to the level of material weakness: The Company lacks the
necessary corporate accounting resources to ensure consistently complete and
accurate reporting of financial information which, when combined with the
Company's need to realign and cross-train current finance and accounting
personnel, has led to a dependence on key personnel in the organization, the
loss of whom could impair the Company's ability to ensure consistently complete
and accurate financial reporting. In certain circumstances the Company's
accounting transactions, including related judgments and estimates, were not
always supported in a timely manner by a sufficiently formal processes or
sufficiently comprehensive documentation.
In the third quarter of 2003, we commenced our Section 404 of the
Sarbanes-Oxley Act compliance efforts. During 2004, we deployed Oracle 11i to
process and report all of our general accounting functions in our three major
locations (Peabody, Massachusetts, Belgium and Hungary). In 2005, we will
implement
34
additional modules to continue to enhance the functionality of our Oracle
implementation. We are also currently in the process of augmenting current
processes, repositioning current finance and accounting personnel and recruiting
additional personnel to ensure consistently complete and accurate reporting of
financial information and to reduce our dependence on key personnel in our
finance and accounting organization. We currently expect these efforts to extend
into the second half of fiscal 2005. While we believe that these actions will
address the conditions raised by BDO, we have been and will continue to be
required to devote substantial resources to these activities during 2005.
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, particularly given the added requirements associated with the
integration of our recently completed acquisitions of Telelogue, Inc. and
Rhetorical Systems Ltd. and our pending acquisitions of ART Advanced Recognition
Technologies, Inc. and Phonetic Systems Ltd., further accelerated filing
deadlines mandated by the SEC and the requirements of Section 404 of the
Sarbanes-Oxley Act.
A SIGNIFICANT PORTION OF OUR REVENUE IS DERIVED FROM SALES IN EUROPE AND
ASIA. OUR RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH THESE AND OTHER INTERNATIONAL REGIONS. Since we license
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 nine months
ended September 30, 2004 represented 28% and 30% of our consolidated revenue for
those periods, respectively. Most of these international revenues are generated
by sales in Europe and Asia. 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 imaging research and development is conducted in
Hungary. In connection with the Philips acquisition, we added an additional
research and development location in Germany, and in connection with the
acquisition of Locus Dialog, we 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 ECONOMIC CONDITIONS;
- GEOPOLITICAL TURMOIL, INCLUDING TERRORISM AND WAR;
- 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 exposure. With our
increased international presence in a number of geographic locations and with
international revenues
35
projected to increase in fiscal 2005, 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 September 9, 2004, BIS Advanced Software Systems, Ltd. ("BIS") filed an
action against us in the United States District Court for the District of
Massachusetts claiming patent infringement. Damages are sought in an unspecified
amount. In the lawsuit, BIS alleges that the Company is infringing United States
Patent No. 6,401,239 entitled "System and Method for Quick Downloading of
Electronic Files." We believe this claim has no merit, and we intend to defend
the action vigorously.
On August 5, 2004, Compression Labs, Inc. filed an action against us in the
United States District Court for the Eastern District of Texas claiming patent
infringement. Damages are sought in an unspecified amount. In the lawsuit,
Compression Labs alleges that we are infringing United States Patent No.
4,698,672 entitled
36
"Coding System for Reducing Redundancy." We believe this claim has no merit, and
we intend to defend the action vigorously.
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 filed an Answer on June 17, 2004. 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 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. In the lawsuit, AllVoice alleges that we are infringing
United States Patent No. 5,799,273 entitled "Automated Proofreading Using
Interface Linking Recognized Words to their Audio Data While Text is Being
Changed" (the "273 Patent"). The "273 Patent generally discloses techniques for
manipulating audio data associated with text generated by a speech recognition
engine. Although we has several products in the speech recognition technology
field, we believe that our 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. 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, ORGANIZATION AND 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 September
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 September 30,
2004. Because of their large holdings of our capital stock relative to other
37
stockholders, Warburg Pincus 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:
- 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
EXCHANGE RATE SENSITIVITY
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.
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
38
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.
In connection with the Philips acquisition on January 30, 2003, we entered
into a forward hedge in the amount of $5.3 million to cover our obligation to
pay the 5.0 million euro promissory note (Philips Note) issued as part of the
acquisition. On August 26, 2003, we entered into a forward exchange contract to
hedge the foreign currency exposure of our 1.0 million euro note payable to
Philips. As both the 5.0 million euro promissory note and 1.0 million euro note
payable to Philips were paid prior to December 31, 2003, the related forward
hedge and forward exchange contract were terminated.
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 had a
one-year term that expired on November 1, 2004. On November 1, 2004, we renewed
this forward hedge contract. The renewed contract has a one year term expiring
on November 1, 2005; however it is cancelable at our discretion.
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 original contract expired on January 30, 2004. This contract was renewed on
three month terms through October 29, 2004.
As of September 30, 2004, we have a $0.6 million liability related to these
contracts.
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, but could have an adverse impact on liquidity.
INTEREST RATE SENSITIVITY
We are exposed to interest rate risk as a result of our significant cash
and cash equivalent and short and long-term marketable securities holdings. The
rate of return that we may be able to obtain on investment securities will
depend on market conditions at the time we make these investments and may differ
from the rates we have secured in the past.
At September 30, 2004, we held $23.0 million of cash and cash equivalents,
$7.4 million of short-term marketable securities and $17.4 million of long-term
marketable securities. Our cash and cash equivalents consist primarily of cash
and money-market funds and our short-term and long-term marketable securities
consist primarily of government agency and corporate securities. Due to the low
current market yields and relatively short -term nature of our investments, a
hypothetical increase in market rates is not expected to have a material effect
on the fair value of our portfolio or results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
39
SCANSOFT, INC.
CONSOLIDATED FINANCIAL STATEMENTS
40
SCANSOFT, INC.
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Reports of Independent Registered Public Accounting Firms... 42
Consolidated Balance Sheets............................... 44
Consolidated Statements of Operations..................... 45
Consolidated Statements of Stockholders' Equity........... 46
Consolidated Statements of Cash Flows..................... 47
Notes to Consolidated Financial Statements................ 48
41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of ScanSoft, Inc.:
We have audited the accompanying consolidated balance sheet of ScanSoft,
Inc. and subsidiaries as of September 30, 2004 and the related consolidated
statements of operations, stockholders' equity and comprehensive income (loss),
and cash flows for the nine months then ended. These financial statements are
the responsibility of management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of ScanSoft,
Inc. and subsidiaries at September 30, 2004, and the results of their operations
and their cash flows for the nine months then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ BDO Seidman, LLP
Boston, Massachusetts
January 5, 2005
42
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of ScanSoft, Inc.:
In our opinion, the consolidated balance sheet as of December 31, 2003 and
the related consolidated statements of operations, of stockholders' equity and
of cash flows for each of the two years in the period ended December 31, 2003
(appearing on pages 44 through 47 of the ScanSoft, Inc. Annual Report on Form
10-K/T) present fairly, in all material respects, the financial position,
results of operations and cash flows of ScanSoft, Inc. and its subsidiaries at
December 31, 2003 and for each of the two years in the period ended December 31,
2003, in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, MA
February 26, 2004
43
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 22,963 $ 42,584
Marketable securities (Note 4)............................ 7,373 --
Accounts receivable, less allowances of $11,308 and
$10,200, respectively (Note 3)......................... 36,523 40,271
Receivables from related parties (Note 21)................ -- 2,133
Inventory................................................. 373 427
Prepaid expenses and other current assets................. 6,256 9,264
--------- ---------
Total current assets................................... 73,488 94,679
Long-term marketable securities (Note 4).................. 17,355 --
Goodwill.................................................. 246,424 243,266
Other intangible assets, net.............................. 43,898 54,286
Property and equipment, net............................... 7,985 6,977
Other assets.............................................. 3,503 2,732
--------- ---------
Total assets........................................... $ 392,653 $ 401,940
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 8,018 $ 7,244
Accrued compensation...................................... 7,407 7,871
Accrued expenses (Note 7)................................. 12,710 13,481
Deferred revenue.......................................... 10,529 13,672
Note payable (Note 9)..................................... 457 904
Deferred payment obligation for technology license........ 2,760 2,754
Other current liabilities................................. 3,667 4,448
--------- ---------
Total current liabilities.............................. 45,548 50,374
Deferred revenue............................................ 147 490
Long-term notes payable, net of current portion............. 27,700 27,859
Deferred tax liability...................................... 2,123 1,264
Other liabilities (Notes 5 and 10).......................... 15,390 18,727
--------- ---------
Total liabilities...................................... 90,908 98,714
--------- ---------
Commitments and contingencies (Notes 9, 11, 14, 18, 19 and
22)
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; 108,604,686 and 105,327,485 shares issued
and 105,833,179 and 102,592,019 shares outstanding,
respectively........................................... 109 105
Additional paid-in capital................................ 476,206 464,350
Treasury stock, at cost (2,771,507 and 2,735,466 shares,
respectively).......................................... (11,071) (10,925)
Deferred compensation..................................... (5,465) (1,743)
Accumulated other comprehensive loss...................... (843) (748)
Accumulated deficit....................................... (161,822) (152,444)
--------- ---------
Total stockholders' equity............................. 301,745 303,226
--------- ---------
Total liabilities and stockholders' equity............. $ 392,653 $ 401,940
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
44
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------------------- -----------------------
2004 2003 2003 2002
------------- ------------- ---------- ----------
(UNAUDITED)
REVENUES:
Revenue, third parties........................ $ 95,765 $84,214 $128,681 $101,524
Revenue, related parties (Note 24)............ 1,955 4,315 6,718 5,095
Professional services......................... 33,187 -- -- --
-------- ------- -------- --------
Total revenue............................ 130,907 88,529 135,399 106,619
-------- ------- -------- --------
COSTS AND EXPENSES:
Cost of revenue:
Cost of revenue............................. 10,348 15,643 26,123 16,419
Cost of professional services(1)............ 22,949 -- -- --
Cost of revenue from amortization of
intangible assets........................ 8,431 7,481 10,516 9,470
-------- ------- -------- --------
Total cost of revenue.................... 41,728 23,124 36,639 25,889
-------- ------- -------- --------
Gross Margin.................................. 89,179 65,405 98,760 80,730
Operating expenses:
Research and development(1)................. 26,162 25,070 33,938 27,633
Sales and marketing(1)...................... 49,134 31,221 48,706 32,990
General and administrative(1)............... 17,807 11,481 16,258 10,678
Amortization of other intangible assets..... 1,967 1,446 2,297 1,682
Stock-based compensation expense(1)......... 1,301 155 330 103
Restructuring and other charges, net(1)..... 801 3,065 3,693 1,041
-------- ------- -------- --------
Total operating expenses................. 97,172 72,438 105,222 74,127
-------- ------- -------- --------
Income (loss) from operations................. (7,993) (7,033) (6,462) 6,603
Other income (expense):
Interest income............................. 429 288 465 354
Interest expense............................ (340) (421) (793) (369)
Other (expense) income, net................. (141) 791 1,003 (1)
-------- ------- -------- --------
Income (loss) before income taxes............. (8,045) (6,375) (5,787) 6,587
Provision for (benefit from) income taxes..... 1,333 473 (269) 254
-------- ------- -------- --------
Net income (loss)............................. $ (9,378) $(6,848) $ (5,518) $ 6,333
======== ======= ======== ========
Net income (loss) per share, basic and
diluted..................................... $ (0.09) $ (0.10) $ (0.07) $ 0.09
======== ======= ======== ========
Weighted average common shares outstanding.... 103,780 71,286 78,398 67,010
======== ======= ======== ========
Weighted average common shares outstanding.... 103,780 71,286 78,398 72,796
======== ======= ======== ========
---------------
(1) Includes stock-based compensation expense as follows:
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
-------------------- -------------
2004 2003 2003 2002
------ ----------- ----- -----
(UNAUDITED)
Cost of revenue................................... -- 4 11 --
Cost of professional services..................... 66 -- -- --
Research and development.......................... 228 4 15 --
Selling and marketing............................. 420 59 116 --
General and administrative........................ 587 88 188 103
Restructuring and other charges, net.............. 231 -- -- --
------ ---- ---- ----
$1,532 $155 $330 $103
====== ==== ==== ====
The accompanying notes are an integral part of these consolidated financial
statements.
45
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME/(LOSS)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------ -------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- ------ ----------- ------ ----------
Balance at December 31, 2001................................ 3,562,238 4,631 62,754,211 63 264,893
Issuance of common stock under employee stock-based
compensation plans......................................... 1,449,484 1 2,682
Issuance of common stock in connection with AudioMining
acquisition................................................ 121,359 638
Issuance of common stock in private placement............... 1,000,000 1 5,592
Issuance of common stock issued to L&H in connection with
registration rights as amended............................. 150,000 1 (1)
Issuance of common stock in connection with settlement of
note payable............................................... 65,100 336
Compensation expense associated with restricted stock.......
Recognition of liability in connection with the settlement
of a stock price guarantee................................. (4,282)
Repurchase of common stock at cost..........................
Comprehensive income:
Net income.................................................
Foreign currency translation adjustment....................
Comprehensive income.......................................
--------- ------ ----------- ---- --------
Balance at December 31, 2002................................ 3,562,238 4,631 65,540,154 66 269,858
Issuance of common stock under employee stock-based
compensation plans......................................... 2,856,251 2 4,432
Issuance of common stock in public offering, net of offering
costs of $2,375............................................ 2,072,500 2 5,493
Issuance of common stock, restricted common, and warrants in
connection with SpeechWorks acquisition.................... 32,499,942 33 170,904
Issuance of restricted stock................................ 300,000 -- 1,176
Issuance of warrants in connection with acquisition of
intellectual property assets............................... 120
Issuance of common stock in connection with LocusDialog
Acquisition................................................ 2,328,638 2 12,367
Compensation expense associated with restricted stock.......
Repurchase of common stock at cost..........................
Comprehensive loss:
Net loss...................................................
Foreign currency translation adjustment....................
Comprehensive loss.........................................
--------- ------ ----------- ---- --------
Balance at December 31, 2003................................ 3,562,238 $4,631 105,327,485 $105 $464,350
========= ====== =========== ==== ========
Issuance of common stock under employee stock-based
compensation plans......................................... 2,570,697 3 6,221
Issuance of restricted stock................................ 706,504 1 5,253
Issuance of warrant......................................... 382
Compensation expense associated with restricted stock.......
Repurchase of common stock at cost..........................
Comprehensive loss:
Net loss...................................................
Unrealized loss on marketable securities...................
Foreign currency translation adjustment....................
Comprehensive loss.........................................
--------- ------ ----------- ---- --------
Balance at September 30, 2004............................... 3,562,238 $4,631 108,604,686 $109 $476,206
========= ====== =========== ==== ========
ACCUMULATED
TREASURY STOCK OTHER
-------------------- DEFERRED COMPREHENSIVE ACCUMULATED
SHARES DOLLARS COMPENSATION LOSS DEFICIT
--------- -------- ------------ ------------- -----------
Balance at December 31, 2001................................ 656,000 (1,031) (276) (487) $(153,259)
Issuance of common stock under employee stock-based
compensation plans.........................................
Issuance of common stock in connection with AudioMining
acquisition................................................
Issuance of common stock in private placement...............
Issuance of common stock issued to L&H in connection with
registration rights as amended.............................
Issuance of common stock in connection with settlement of
note payable...............................................
Compensation expense associated with restricted stock....... 103
Recognition of liability in connection with the settlement
of a stock price guarantee.................................
Repurchase of common stock at cost.......................... 1,461,378 (7,000)
Comprehensive income:
Net income................................................. 6,333
Foreign currency translation adjustment.................... 440
Comprehensive income.......................................
--------- -------- ------- ----- ---------
Balance at December 31, 2002................................ 2,117,378 (8,031) (173) (47) (146,926)
Issuance of common stock under employee stock-based
compensation plans.........................................
Issuance of common stock in public offering, net of offering
costs of $2,375............................................
Issuance of common stock, restricted common, and warrants in
connection with SpeechWorks acquisition.................... (724)
Issuance of restricted stock................................ (1,176)
Issuance of warrants in connection with acquisition of
intellectual property assets...............................
Issuance of common stock in connection with LocusDialog
Acquisition................................................
Compensation expense associated with restricted stock....... 330
Repurchase of common stock at cost.......................... 618,088 (2,894)
Comprehensive loss:
Net loss................................................... (5,518)
Foreign currency translation adjustment.................... (701)
Comprehensive loss.........................................
--------- -------- ------- ----- ---------
Balance at December 31, 2003................................ 2,735,466 $(10,925) $(1,743) $(748) $(152,444)
========= ======== ======= ===== =========
Issuance of common stock under employee stock-based
compensation plans.........................................
Issuance of restricted stock................................ 4,000 (5,254)
Issuance of warrant.........................................
Compensation expense associated with restricted stock....... 1,532
Repurchase of common stock at cost.......................... 32,041 (146)
Comprehensive loss:
Net loss................................................... (9,378)
Unrealized loss on marketable securities................... (140)
Foreign currency translation adjustment.................... 45
Comprehensive loss.........................................
--------- -------- ------- ----- ---------
Balance at September 30, 2004............................... 2,771,507 $(11,071) $(5,465) $(843) $(161,822)
========= ======== ======= ===== =========
TOTAL COMPREHENSIVE
STOCKHOLDERS' INCOME
EQUITY (LOSS)
------------- -------------
Balance at December 31, 2001................................ 114,534
Issuance of common stock under employee stock-based
compensation plans......................................... 2,683
Issuance of common stock in connection with AudioMining
acquisition................................................ 638
Issuance of common stock in private placement............... 5,593
Issuance of common stock issued to L&H in connection with
registration rights as amended.............................
Issuance of common stock in connection with settlement of
note payable............................................... 336
Compensation expense associated with restricted stock....... 103
Recognition of liability in connection with the settlement
of a stock price guarantee................................. (4,282)
Repurchase of common stock at cost.......................... (7,000)
Comprehensive income:
Net income................................................. 6,333 6,333
Foreign currency translation adjustment.................... 440 440
-------
Comprehensive income....................................... 6,773
-------- =======
Balance at December 31, 2002................................ 119,378
Issuance of common stock under employee stock-based
compensation plans......................................... 4,434
Issuance of common stock in public offering, net of offering
costs of $2,375............................................ 5,495
Issuance of common stock, restricted common, and warrants in
connection with SpeechWorks acquisition.................... 170,213
Issuance of restricted stock................................ --
Issuance of warrants in connection with acquisition of
intellectual property assets............................... 120
Issuance of common stock in connection with LocusDialog
Acquisition................................................ 12,369
Compensation expense associated with restricted stock....... 330
Repurchase of common stock at cost.......................... (2,894)
Comprehensive loss:
Net loss................................................... (5,518) (5,518)
Foreign currency translation adjustment.................... (701) (701)
-------
Comprehensive loss......................................... $(6,219)
-------- =======
Balance at December 31, 2003................................ $303,226
========
Issuance of common stock under employee stock-based
compensation plans......................................... 6,224
Issuance of restricted stock................................
Issuance of warrant......................................... 382
Compensation expense associated with restricted stock....... 1,532
Repurchase of common stock at cost.......................... (146)
Comprehensive loss:
Net loss................................................... (9,378) (9,378)
Unrealized loss on marketable securities................... (140) (140)
Foreign currency translation adjustment.................... 45 45
-------
Comprehensive loss......................................... $(9,473)
-------- =======
Balance at September 30, 2004............................... $301,745
========
The accompanying notes are an integral part of these consolidated financial
statements.
46
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS NINE MONTHS
ENDED ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30, SEPTEMBER 30, -----------------------
2004 2003 2003 2002
------------- ------------- -------- ------------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)..................................... $ (9,378) $(6,848) $ (5,518) $ 6,333
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation...................................... 2,919 1,549 2,443 2,007
Amortization of other intangible assets........... 10,399 8,927 12,813 11,152
Accounts receivable allowances.................... 1,285 540 898 370
Gain on disposal or sale of property and
equipment....................................... -- -- -- (30)
Non-cash portion of restructuring charges......... 395 69 89 113
Stock-based compensation.......................... 1,301 155 330 103
Foreign exchange gain (loss)...................... 113 (71) (959) --
Non-cash interest expense......................... 199 168 146 --
Deferred tax provision............................ 859 1,441 1,264 --
Changes in operating assets and liabilities, net
of effects from acquisitions:
Accounts receivable............................... 4,990 (1,151) (10,193) (2,921)
Inventory......................................... 57 1,010 1,503 (456)
Prepaid expenses and other current assets......... (229) (917) 737 (1,372)
Other assets...................................... (738) (371) 878 (2,738)
Accounts payable.................................. 553 (2,720) (1,799) 532
Accrued expenses.................................. (2,147) 810 (2,166) 1,166
Other liabilities................................. (1,563) (143) 168 --
Deferred revenue.................................. (2,757) 536 4,561 (1,916)
-------- ------- -------- -------
Net cash provided by operating activities....... 6,258 2,984 5,195 12,343
-------- ------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment..... (3,281) (1,441) (2,898) (2,410)
Proceeds from sale of property and equipment........ -- -- -- 42
Cash received (paid) for acquisitions, including
transaction costs................................. (734) 31,347 32,568 (3,606)
Cash expenditures for licensing agreements.......... -- (6,113) (6,113) --
Maturities of marketable securities................. 260 -- 553 --
Purchases of marketable securities.................. (24,960) -- -- --
-------- ------- -------- -------
Net cash provided by (used in) investing
activities...................................... (28,715) 23,793 24,110 (5,974)
-------- ------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of capital lease obligation................ -- -- -- (320)
Payments associated with licensing agreements....... (2,800) -- -- --
Payment of note payable and deferred acquisition
payments.......................................... (721) (3,273) (10,514) (641)
Purchase of treasury stock.......................... (146) (1,832) (2,894) (7,000)
Payments under deferred payment agreement........... (410) (1,230) (1,640) (2,233)
Proceeds from issuance of common stock warrants..... 625 -- -- --
Proceeds from issuance of common stock, net of
issuance costs.................................... -- 6,767 5,495 5,593
Proceeds from issuance of common stock under
employee stock-based compensation plans........... 6,146 2,053 4,434 2,683
-------- ------- -------- -------
Net cash provided by (used in) financing
activities.................................... 2,694 2,485 (5,119) (1,918)
-------- ------- -------- -------
Effects of exchange rate changes on cash and cash
equivalents......................................... 142 (630) (455) 78
-------- ------- -------- -------
Net (decrease) increase in cash and cash
equivalents......................................... (19,621) 28,632 23,731 4,529
Cash and cash equivalents at beginning of period...... 42,584 18,853 18,853 14,324
-------- ------- -------- -------
Cash and cash equivalents at end of period............ $ 22,963 $47,485 $ 42,584 $18,853
======== ======= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
47
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PRESENTATION
ScanSoft, Inc. was incorporated as Visioneer, Inc. in 1992. In 1999, the
Company changed its name to ScanSoft, Inc. and ticker symbol to SSFT. On
December 12, 2001, the Company acquired the speech and language technologies
operations of Lernout & Hauspie Speech Products, N.V. (L&H). On January 30,
2003, the Company acquired Royal Philips Electronics Speech Processing Telephony
and Voice Control business units, and related intellectual property ("Philips").
On August 11, 2003, the Company acquired SpeechWorks International, Inc.
("SpeechWorks"). On December 19, 2003, the Company acquired LocusDialog, Inc.
("LocusDialog"). On June 15, 2004, the Company acquired Telelogue, Inc.
("Telelogue"). The acquisitions of L&H, Philips, SpeechWorks, LocusDialog,
Telelogue and Brand & Groeber Communcations Gbr ("B&G") were accounted for under
the purchase method of accounting and, accordingly, the results of operations
from the acquired businesses have been included in the Company's financial
statements as of the acquisition dates.
When we refer to "we" or "ScanSoft" or "the Company" in these financial
statements. Such terms are meant to indicate ScanSoft, Inc., including all of
its consolidated subsidiaries.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Change in Fiscal Year
On October 23, 2004 the Company's Board of Directors approved a change in
the Company's fiscal year end from December 31 to September 30, effective
beginning September 30, 2004. All references in the consolidated financial
statements to the period ended September 30, 2004 refer to the nine months ended
September 30, 2004, whereas the years ended December 31, 2003 and 2002 are
referred to as fiscal 2003 and 2002, respectively. The interim statement of
operations for the nine months ended September 30, 2003 is unaudited and, in the
opinion of management, reflects all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of results of operations for the
nine months ended September 30, 2003.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the dates of the financial statements and the reported amounts of revenue and
expenses during the reporting periods. On an ongoing basis, ScanSoft evaluates
its estimates and judgments, including those related to revenue recognition, the
costs to complete the development of custom software applications and valuation
allowances (specifically sales returns and other allowances); accounting for
patent legal defense costs; the valuation of goodwill, other intangible assets
and tangible long-lived assets, estimates used in accounting for acquisitions;
assumptions used in valuing stock-based compensation instrument, evaluation loss
contingencies; and valuation allowances for deferred tax assets. Actual amounts
could differ significantly from these estimates. ScanSoft bases its estimates
and judgments on historical experience and various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
and the amounts of revenue and expenses that are not readily apparent from other
sources.
Basis of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. Intercompany transactions and balances have
been eliminated.
48
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 (expense), a net foreign
currency transaction loss and other translation loss of $0.3 million for the
nine months ended September 20, 2004 and a $1.2 million gain for the year ended
2003. Foreign currency translation and transaction gains and losses were
insignificant in 2002.
Foreign Currency Risk Management
In certain circumstances, the Company enters into forward exchange
contracts to hedge against foreign currency fluctuations. These contracts are
used to reduce the Company's risk associated with exchange rate movements, as
the gains or losses on these contracts are intended to offset the exchange rate
losses or gains on the underlying exposures. The Company does not engage in
foreign currency speculation. Hedges of underlying exposures are designated and
documented at the inception of the hedge and are evaluated for effectiveness
monthly. Forward exchange contracts representing cash flow hedges qualify for
hedge accounting when they are designated as a hedge of the foreign currency
exposure and they are effective in minimizing such exposure. Gains and losses on
forward exchange contracts that qualify for hedge accounting are recognized as
other comprehensive income (loss) in stockholders' equity, along with the
associated losses and gains on the hedged item. As the terms of the forward
exchange contract and underlying exposure are matched generally at inception,
hedging effectiveness is calculated by comparing the change in fair value of the
contract to the change in fair value of the underlying exposure. To date the
Company has not incurred any significant gains or losses associated with hedge
ineffectiveness.
On January 30, 2003, the Company entered into a forward exchange contract
to hedge the foreign currency exposure of its 5.0 million euro note payable to
Philips (Note 19). The contract and the note payable each had a term that
expired on December 31, 2003. On August 26, 2003, the Company entered into a
forward exchange contract to hedge the foreign currency exposure of its 1.0
million euro payable to Philips. The contract and the payable each had a term
that expired on December 31, 2003. Prior to December 31, 2003, the Company made
payments to Philips in satisfaction of these obligations and the related forward
hedges were also terminated.
Revenue Recognition
As a result of SpeechWorks acquisition in August 2003, professional
services became a material component of our business. As a result of this and
the implementation of Oracle, in January 2004, we began to separately track and
disclose professional services revenues and cost of revenue. Prior to 2004, we
did not separately disclose professional services revenue and cost of revenue as
they were immaterial and it is not practical to reclassify these revenues and
associated costs retroactively.
The Company recognizes revenue in accordance with Statement of Position
("SOP") 97-2, Software Revenue Recognition, as amended by SOP 98-9,
"Modification of SOP 97-2 with Respect to Certain Transactions", SOP 81-1
Accounting for Performance of Construction Type and Certain Performance Type
Contracts and the Securities and Exchange Commission's Staff Accounting Bulletin
No. 104, "Revenue Recognition in Financial Statements" ("SAB 104") and Emerging
Issues Task Force (EITF) Issue No. 01-09, "Accounting for Consideration Given by
a Vendor (Including a Reseller of the Vendors
49
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Products)" and FASB 48 ("FAS 48"), "Revenue Recognition when Right of Return
Exists". In general we recognize revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable,
collectibility is probable, and vendor specific objective evidence ("VSOE")
exists for any undelivered elements. We reduce revenue recognized for estimated
future returns, price protection and rebates, and certain marketing funds at the
time the related revenue is recorded.
Certain distributors and value-added resellers have been granted rights of
return for as long as the distributors or resellers hold the inventory. The
Company has not aggregated and analyzed historical returns from distributor and
resellers to form a basis in order to estimate the future sales returns by
distributor and resellers. As a result, the Company recognizes revenue from
sales to these distributors and resellers when the distributor and reseller has
sold products through to retailers and end-users. Title and risk of loss pass to
the distributor or reseller upon shipment, at which time the transaction is
invoiced and payment is due. Based on reports from distributors and resellers of
their inventory balances at the end of each period, the Company records an
allowance against accounts receivable for the sales price of all inventories
subject to return.
The Company also makes an estimate of sales returns by retailers or end
users directly or through its distributors or resellers based on historical
returns experience. The Company has aggregated and analyzed historical returns
from retailers and end users which forms the basis of its estimate of future
sales returns by retailers or end users. In accordance with FAS 48, the
provision for these estimated returns is recorded as a reduction of revenue at
the time that the related revenue is recorded. If actual returns differ
significantly from its estimates, such differences could have a material impact
on the Company's results of operations for the period in which the actual
returns become known.
Revenue from royalties on sales of the Company's products by OEMs to third
parties, where no services are included, is typically recognized upon delivery
to the third party when such information is available, or when the Company is
notified by the OEM that such royalties are due as a result of a sale, provided
that all other revenue recognition criteria are met.
When the Company provides professional services considered essential to the
functionality of the software, such as custom application development for a
fixed fee, it recognizes revenue from the fees for such services and any related
software licenses based on the percentage-of-completion method in accordance
with SOP 81-1. The Company generally determines the percentage-of-completion by
comparing the labor hours incurred to date to the estimated total labor hours
required to complete the project. The Company considers labor hours to be the
most reliable, available measure of progress on these projects. Adjustments to
estimates to complete are made in the periods in which facts resulting in a
change become known. When the estimate indicates that a loss will be incurred,
such loss is recorded in the period identified. Significant judgments and
estimates are involved in determining the percent complete of each contract.
Different assumptions could yield materially different results.
When the Company provides services on a time and materials basis, it
recognizes revenue as it performs the services based on actual time incurred.
Other professional services not considered essential to the functionality
of the software are limited and primarily include training and feasibility
studies, which are recognized as revenue when the related services are
performed. When the Company provides software support and maintenance services,
it recognizes the revenue ratably over the term of the related contracts,
typically one year.
The Company may sell, under one contract or related contracts, software
licenses, custom software applications and other services considered essential
to the functionality of the software and a maintenance and support arrangement.
The total contract value is attributed first to the maintenance and support
arrangement based on VSOE of its fair value and additionally based upon stated
renewal rates. The remainder of the total contract value is then attributed to
the software license and related professional services, which are typically
recognized as revenue using the percentage-of-completion method. As a result,
discounts inherent in the total
50
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contract value are attributed to the software license and related professional
services. The Company may sell, under one contract or related contracts,
software licenses, a maintenance and support arrangement and professional
services not considered essential to the functionality of the software. In those
arrangements, the total contract value is attributed first to the undelivered
elements of maintenance and support and professional services based on VSOE of
their fair values. The remainder of the contract value is attributed to the
software licenses, which are typically recognized as revenue upon delivery,
provided all other revenue recognition criteria are met. As a result, discounts
inherent in the total contract value are attributed to the software licenses.
The Company follows the guidance of EITF No. 01-09, in determining whether
consideration given to a customer should be recorded as an operating expense or
a reduction of revenue recognized from that same customer. Consideration given
to a customer is recorded as a reduction of revenue unless both of the following
conditions are met:
- The Company receives an identifiable benefit in exchange for the
consideration, and the identified benefit is sufficiently separable from
the customer's purchase of the Company's products and services such that
the Company could have purchased the products from a third party, and
- The Company can reasonably estimate the fair value of the benefit
received.
Consideration, including that in the form of the Company's equity
instruments (if applicable), is recorded as a reduction of revenue, to the
extent the Company has recorded cumulative revenue from the customer or reseller
has resulted in a $0.3 million, $0.2 million and $0.3 million reduction in total
revenue for the nine months ended September 30, 2004 and for the years ended
2003 and 2002, respectively.
The Company follows the guidance of EITF Issue No. 01-14, Income Statement
Characterization of Reimbursements for "Out-of-Pocket" Expenses Incurred, and
records reimbursements received for out-of-pocket expenses as revenue, with
offsetting costs recorded as cost of revenue. Out-of-pocket expenses generally
include, but are not limited to, expenses related to airfare, hotel stays and
out-of-town meals.
Cost of Revenue
As a result of SpeechWorks acquisition in August 2003, professional
services became a material component of our business. As a result of this and
the implementation of Oracle, in January 2004, the company began to separately
track and disclose professional services revenues and cost of revenue. Prior to
2004, it did not separately disclose professional services revenue and cost of
revenue as they were immaterial and it is not practical to reclassify these
revenues and associated costs retrospectively.
For the nine month period ended September 30, 2004, cost or revenue
consists primarily of material and fulfillment costs and third-party royalties.
Cost of professional services revenue consists primarily of salaries for
professional consulting staff, salaries for product support personnel, and
engineering costs associated with certain contracts which were accounted for
under percentage-of-completion method of accounting.
Cost of revenue for the nine months ended September 30, 2003 and the years
ended December 31, 2003 and 2002, consists of material and fulfillment costs,
third-party royalties, salaries for product support personnel, and engineering
costs associated with certain contracts which were accounted for under
percentage-of-completion method of accounting.
Costs of Revenue from Amortization of Intangible Assets
Cost of revenue from amortization of intangible assets includes the
amortization of acquired patents and core and completed technology.
51
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock-based Compensation
Stock-based compensation expenses result from non-cash charges for common
shares, including restricted common shares of stock, issued with exercise or
purchase prices that are less than the fair market value of the common stock on
the date of grant.
Cash Equivalents
Cash equivalents are short-term, highly liquid instruments with original
maturities of 90 days or less at the date of acquisition. The Company invests
primarily in commercial paper and money market funds.
During the nine months ended September 30, 2004, the Company escrowed
approximately $0.4 million of cash as a result of a dispute with one of its
vendors. The Company is working to resolve this dispute at which time the escrow
will be returned to the Company or released from escrow.
Accounts Receivable
The Company establishes reserves against its accounts receivable for
potential credit losses when it determines receivables are at risk for
collection based upon the length of time the receivables are outstanding as well
as various other criteria. Receivables are written off against these reserves in
the period they are determined to be uncollectible.
Inventory
Inventory consists of finished goods, primarily of software media and user
manuals, and is stated at the lower of cost (determined on a first-in, first-out
basis) or market value.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the term of the related lease or the useful
life, if shorter. The cost and related accumulated depreciation of sold or
retired assets are removed from the accounts and any gain or loss is included in
operations. Repairs and maintenance costs are expensed as incurred.
Long-lived Tangible and Intangible Assets and Goodwill
The Company has significant long-lived tangible and intangible assets,
including goodwill, which are susceptible to valuation adjustments as a result
of changes in various factors or conditions. The most significant long-lived
tangible and intangible assets are fixed assets, patents and core technology,
completed technology and trademarks which are amortized using the straight-line
method over their estimated useful lives. The values of intangible assets, with
the exception of goodwill, were initially determined by a risk-adjusted,
discounted cash flow approach. The Company assesses the potential impairment of
identifiable intangible assets and fixed assets whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
it considers important, which could trigger an impairment of such assets,
include the following:
- Significant underperformance relative to historical or projected future
operating results;
- Significant changes in the manner of or use of the acquired assets or the
strategy for the Company's overall business;
- Significant negative industry or economic trends;
- Significant decline in the Company's stock price for a sustained period;
and
52
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- A decline in the Company's market capitalization below net book value.
Future adverse changes in these or other unforeseeable factors could result
in an impairment charge that would impact future results of operations and
financial position in the reporting period identified.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets or SFAS 142.
SFAS 142 requires, among other things, the discontinuance of goodwill
amortization. The standard also includes provisions for the assessment of the
useful lives of existing recognized intangible assets and the identification of
reporting units for purposes of assessing potential future impairments of
goodwill. The Company has assessed the useful lives of its existing intangible
assets, other than goodwill, and believes that estimated useful lives remain
appropriate. In addition, the Company has determined that it operates in one
reporting unit. As a result, the fair value of the reporting unit was determined
using the Company's market capitalization as of July 1, 2004 and November 1,
2003. As the fair value of the reporting unit as of these dates was in excess of
the carrying amount of the net assets, the Company concluded that its goodwill
was not impaired. No further analysis was required under SFAS 142.
The Company uses the market value approach on an enterprise level basis to
determine fair value in the initial step of its goodwill impairment test. Based
on this, the Company performed the annual assessment during the last quarter of
fiscal 2004 and determined that these intangible assets were not impaired. The
Company completes goodwill impairment analyses at least annually, or more
frequently when events and circumstances occur indicating that the recorded
goodwill might be impaired.
Significant judgments and estimates are involved in determining the useful
lives of intangible assets, determining what reporting units exist and assessing
when events or circumstances would require an interim impairment analysis of
goodwill or other long-lived assets to be performed. Changes in the organization
or the Company's management reporting structure, as well as other events and
circumstances, including but not limited to technological advances, increased
competition and changing economic or market conditions, could result in (a)
shorter estimated useful lives, (b) additional reporting units, which may
require alternative methods of estimating fair values or greater disaggregation
or aggregation in our analysis by reporting unit, and/or (c) other changes in
previous assumptions or estimates. In turn, this could have a significant impact
on the consolidated financial statements through accelerated amortization and/or
impairment charges. (See Notes 6 and 7).
Research and Development Costs
Costs incurred in the research and development of new software products and
enhancements to existing products, other than certain software development costs
that qualify for capitalization, are expensed as incurred. Software development
costs incurred subsequent to the establishment of technological feasibility, but
prior to the general release of the product, are capitalized and amortized to
cost of revenue over the estimated useful life of the related products. In the
nine months ended September 30, 2004 and the years ended December 31, 2003 and
2002, costs eligible for capitalization were not material.
Legal Expenses Incurred to Defend Patents
The Company capitalizes external legal costs incurred in the defense of its
patents if the Company believes that the future economic benefit of the patent
will be increased. The Company monitors the legal costs incurred and the
anticipated outcome of the legal action and, if changes in the anticipated
outcome occur, writes off capitalized costs, if any, in the period the change is
determined. As of September 30, 2004, December 31, 2003 and December 31, 2002
capitalized patent defense costs totaled $0.5 million, $0.2 million and $0.0
million, respectively.
53
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Capitalization of Internal Use Software Costs
The Company capitalizes development costs of software for internal use
pursuant to Statement of Position No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. As of September 30, 2004, the
Company had capitalized costs of $0.4 million related to internal financial
systems of which a portion of the cost for modules not yet deployed have been
included in construction in process.
Income Taxes
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect in the years in which the differences are expected
to reverse. A valuation allowance against deferred tax assets is recorded if,
based on the weight of available evidence, it is more likely than not that some
or all of the deferred tax assets will not be realized. The Company does not
provide for U.S. income taxes on the undistributed earnings of its foreign
subsidiaries, which the Company considers to be permanent investments.
The Company monitors the realization of its deferred tax assets based on
changes in circumstances, for example, recurring periods of income for tax
purposes following historical periods of cumulative losses or changes in tax
laws or regulations. The Company's income tax provisions and its assessment of
the realizability of its deferred tax assets involve significant judgments and
estimates. If the Company continued to generate taxable income through
profitable operations in future years it may be required to recognize these
deferred tax assets through the reduction of the valuation allowance which would
result in a material benefit to its results of operations in the period in which
the benefit is determined, excluding the recognition of the portion of the
valuation allowance which relates to net deferred tax assets acquired in a
business combination and stock compensation.
Comprehensive Income (Loss)
Total comprehensive income (loss), net of taxes, was ($9.5) million, ($6.2)
million and $6.8 million for the nine months ended September 30, 2004 and for
the years ended December 31, 2003 and 2002, respectively. Comprehensive income
(loss) consists of net income (loss) and other comprehensive income (loss),
which includes current period foreign currency translation adjustments and gains
related to derivatives reported as cash flow hedges and gains or losses on
marketable securities. For the purposes of comprehensive loss disclosures, the
Company does not record tax provisions or benefits for the net changes in the
foreign currency translation adjustment, as the Company intends to permanently
reinvest undistributed earnings in its foreign subsidiaries.
Concentration of Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents, and
trade accounts receivable. The Company places its cash and cash equivalents with
financial institutions with high credit ratings. The Company performs ongoing
credit evaluations of its customers' financial condition and does not require
collateral, since management does not anticipate nonperformance of payment. The
Company also maintains reserves for potential credit losses and such losses have
been within management's expectations. At September 30, 2004 and December 31,
2003, no customer represented greater than 10% of the Company's net accounts
receivable balance.
54
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value Disclosures of Financial Instruments
Financial instruments include cash equivalents, marketable securities,
accounts receivable, and long-term notes payable and are carried in the
financial statements at amounts that approximate their fair value as of
September 30, 2004 and December 31, 2003.
Advertising Costs
Advertising costs are expensed as incurred and are classified as sales and
marketing expenses. The Company incurred advertising costs of $1.8 million, $2.3
million and $3.0 million for the nine months ended September 30, 2004 and the
years ended December 31, 2003 and 2002, respectively.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Basic net income per share for the year ended
December 31, 2002 includes the assumed conversion of the Series B Preferred
Stock, which participates in dividends with common stock when and if declared.
Diluted net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted-average number of common shares
outstanding for the period plus potential dilutive common equivalent shares,
which include, when dilutive, outstanding stock options, warrants, unvested
shares of restricted stock using the treasury stock method and the convertible
debenture using the as converted method. All potential dilutive common shares
are excluded from the computation of net loss per share for the nine months
ended September 30, 2004 and for the year ended December 31, 2003 because they
are antidilutive.
55
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a reconciliation of the shares used in the computation of
basic and diluted net income (loss) per share (in thousands, except per share
amounts):
NINE MONTHS
ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30, ------------------------
2004 2003 2002
------------- -------- -------------
Net income (loss)................................. $ (9,378) $(5,518) $ 6,333
Basic:
Weighted average common shares outstanding...... 103,780 78,398 63,448
Assumed conversion of Series B Preferred
Stock........................................ -- -- 3,562
-------- ------- -------
Weighted average common shares:
basic............................................. 103,780 78,398 67,010
======== ======= =======
Net income (loss) per share:
basic............................................. $ (0.09) $ (0.07) $ 0.09
======== ======= =======
Effect of dilutive common equivalent shares:
Stock options................................ -- -- 5,223
Convertible debenture........................ -- -- --
Warrants..................................... -- -- 468
Unvested restricted stock.................... -- -- 95
-------- ------- -------
Weighted average common shares:
diluted........................................... 103,780 78,398 72,796
======== ======= =======
Net income (loss) per share:
diluted........................................... $ (0.09) $ (0.07) $ 0.09
======== ======= =======
Stock options to purchase 3,957,794 and 6,070,164 shares of common stock
were not included in the calculation of diluted net loss per share for the nine
months ended September 30, 2004 and for the year ended December 31, 2003,
respectively, because they were antidilutive. For the year ended December 31,
2002 stock options to purchase 1,039,955 shares of common stock were outstanding
but were excluded from the calculation of diluted net income per share because
the options' exercise prices were greater than the average market price of the
Company's common stock for the year.
Potential weighted-average common shares, including stock options, unvested
restricted stock, unvested stock purchase units, preferred shares, convertible
debt and warrants at September 30, 2004 and December 31, 2003 were 12,807,361
and 14,463,449, respectively. 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.
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". 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
56
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 employee 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
income (loss) and net income (loss) and pro forma net income (loss) per share
would have been as follows (in thousands, except per share amounts):
NINE MONTHS YEAR ENDED
ENDED DECEMBER 31,
SEPTEMBER 30, ------------------
2004 2003 2002
------------- -------- -------
Net income (loss) -- as reported.................... $ (9,378) $ (5,518) $ 6333
Add back: Stock-based compensation included in net
income (loss), as reported........................ 1,301 330 103
Deduct: Stock-based employee compensation expense
determined under the fair value-based-method...... (9,157) (10,299) (9,320)
-------- -------- -------
Net loss -- pro forma............................... $(17,234) $(15,487) $(2,884)
======== ======== =======
Net income (loss) per share -- as reported: basic
and diluted....................................... $ (0.09) $ (0.07) $ 0.09
Net loss per share -- pro forma: basic and
Diluted........................................... $ (0.17) $ (0.20) $ (0.04)
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
expected volatility of 74% for 2004 and 80% for 2003 and 2002, risk-free
interest rate of 2.21% to 3.44% for options granted in 2004, 1.59% to 3.68% for
options granted in 2003, and 2.26% to 4.33% for options granted in 2002, and a
weighted average expected option term of 3.5 years for each period. The Company
has not paid dividends to date and assumed no dividend yield.
The weighted average grant date fair value per share of options granted was
$2.63, $2.58 and $3.12 for the nine months ended September 30, 2004 and for the
years ended December 31, 2003 and 2002, respectively.
For the Company's Employee Stock Purchase Plan, the fair value of each
purchase right was estimated at the beginning of the offering period using the
Black-Scholes option-pricing model with the following assumptions used in 2004,
2003 and 2021: expected volatility of 60% for 2004 and 80% for 2003 and 2002;
risk-free interest rate of 1.00% to 1.77% for 2004, 1.05% to 1.65% for 2003,
1.65% to 3.36% for 2002, respectively; and expected lives of six months for all
three years. The Company has not paid dividends and assumed no dividend yield.
The weighted-average fair value of all purchase rights granted in 2004, 2003 and
2002, were $1.51, $1.72 and $1.49.
Recently Issued Accounting Standards
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, Earnings 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. The adoption if EITF No. 03-06 did not have a material effect on
the Company's financial position or results of operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting
for Certain Financial Instruments with
57
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Characteristics of both Liabilities and Equity." SFAS 150 establishes standards
for how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS 150 was originally
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise effective at the beginning of the first interim period beginning
after June 15, 2003, however certain elements of SFAS No. 150 have been
deferred. The adoption of the provisions of SFAS No. 150, not deferred, did not
have a material impact on the Company's financial position or results of
operations and the Company does not expect the adoption of the deferred elements
of SFAS No. 150 to have a material impact on the Company's financial position or
results of operations.
In December 2004, the FASB issued FASB SFAS No. 123 (revised 2004),
Share-Based Payment, which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of
Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the
approach described in SFAS No. 123. However, SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative. The new standard will be effective for
the Company in the quarter beginning July 1, 2005. The Company has not yet
completed its evaluation but expects the adoption to have a material effect on
its consolidated financial statements.
Reclassifications
Certain prior year financial statement amounts have been reclassified to
conform with the current year presentation. As a result of SpeechWorks
acquisition in August 2003, professional services became a material component of
our business. As a result of this and the implementation of Oracle, in January
2004, we began to separately track and disclose professional services revenues
and cost of revenue. Prior to 2004, we did not separately disclose professional
services revenue and cost of revenue as they were immaterial and it is not
practical to reclassify these revenues and associated costs retroactively.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(IN THOUSANDS)
Accounts receivable......................................... $38,265 $41,066
Unbilled accounts receivable................................ 9,566 9,405
------- -------
47,831 50,471
Less -- allowances.......................................... (11,308) (10,200)
------- -------
$36,523 $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 percentage of
completion contracts that have not yet been billed based on the terms of the
specific arrangement.
58
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Allowance for Doubtful Accounts and Sales Returns:
2004 2003 2002
------- ------- ------
Balance at beginning of period........................... $10,200 $ 5,903 $6,273
Additions charged to costs and expenses.................. 1,286 898 200
Additions (reductions) made to other accounts............ 65(a) 3,309(a) (73)(a)
Net additions (deductions and write-offs)................ (243) 90 (497)
------- ------- ------
Balance at end of period................................. $11,308 $10,200 $5,903
======= ======= ======
---------------
(a) Net increase (decrease) in amounts recorded against revenue as of September
30, 2004 and December 31, 2003 and 2002, respectively.
4. MARKETABLE SECURITIES
All short-term and long-term marketable securities have been classified as
available-for-sale securities as follows:
NET
UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
------- ---------- ----------
BALANCE AT SEPTEMBER 30, 2004 (IN THOUSANDS)
-----------------------------
Classified as current assets:
U.S. government agencies............................ $ 4,419 $ (4) $ 4,415
Corporate notes..................................... 2,967 (9) 2,958
------- ----- -------
Short-term marketable securities................. 7,386 (13) 7,373
------- ----- -------
Classified as long-term assets:
U.S. government agencies............................ 2,055 (15) 2,040
Corporate bonds..................................... 15,427 (112) 15,315
------- ----- -------
Long-term marketable securities.................. 17,482 (127) 17,355
------- ----- -------
Total................................................. $24,868 $(140) $24,728
======= ===== =======
The Company accounts for its marketable equity securities in accordance
with SFAS 115 "Accounting for Certain Investments in Debt and Equity
Securities." Beginning in April 2004, the Company began investing in short and
long-term marketable securities to improve the yield on its investment
portfolio. At September 30, 2004, the stated maturities of the Company's
investments are $7.4 million within one year and $17.4 million within one to
five years. These investments are classified as available-for-sale and are
recorded on the balance sheet at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income, net
of tax. Realized gains and losses on sales of short-term and long-term
investments have not been material.
59
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- ------------ ------------
SEPTEMBER 30, 2004
Patents and core technology.................... $ 53,998 $32,753 $21,245
Completed technology........................... 13,511 3,966 9,545
Tradenames and trademarks...................... 5,871 2,407 3,464
Non-competition agreement...................... 4,058 4,058 --
Acquired favorable lease....................... 553 553 --
Customer relationships......................... 12,324 2,680 9,644
Other.......................................... 200 200 --
-------- ------- -------
$ 90,515 $46,617 $43,898
======== ======= =======
DECEMBER 31, 2003
Patents and core technology.................... $ 55,607 $28,652 $26,955
Completed technology........................... 30,681 18,528 12,153
Tradenames and trademarks...................... 6,471 2,474 3,997
Non-competition agreement...................... 4,058 4,052 6
Acquired favorable lease....................... 553 553 --
Customer relationships......................... 13,538 2,363 11,175
Other.......................................... 200 200 --
-------- ------- -------
$111,108 $56,822 $54,286
======== ======= =======
On March 31, 2003, the Company entered into an agreement that grants an
exclusive license to the Company to resell, in certain geographies worldwide,
certain productivity applications. The period of exclusivity expires after seven
years, unless terminated earlier as permitted under the agreement. Total
consideration to be paid by the Company for the license was $13.0 million. On
June 30, 2003, the terms and conditions of the agreement were amended, resulting
in a $1.2 million reduction in the license fee. The initial payment of $6.4
million due on or before June 30, 2003 was paid in accordance with the terms of
the license agreement and the first installment payment of $2.8 million due
March 31, 2004 was paid on that date. The remaining payment of $2.8 million
including interest of $0.2 million will be paid on March 31, 2005.
Based on the net present value of the deferred payments due in 2004 and
2005, using an interest rate of 7.0%, the Company recorded $11.4 million as
completed technology, which 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. As of September 30, 2004, the payment
due on or before March 31, 2005, has been classified as deferred payment for
technology license and other liabilities.
On March 31, 2003, the Company acquired certain intellectual property
assets related to multimodal speech technology, in exchange for $0.1 million in
cash and the issuance of a warrant for common stock valued at $0.1 million (Note
11). The purchase price was recorded as completed technology and is being
amortized over three years.
60
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Aggregate amortization expense was $10.4 million, $12.8 million and $11.2
million ($8.4, $10.5 and $9.5 million included in cost of revenue, respectively)
for the nine months ended September 30, 2004, and the twelve months ended
December 31, 2003 and 2002, respectively. Estimated amortization expense for
each of the five succeeding years as of September 30, 2004 is as follows (in
thousands):
SELLING,
COST OF GENERAL AND
YEAR ENDING REVENUE ADMINISTRATIVE TOTAL
----------- ------- -------------- -------
2005................................................. $ 7,627 $ 1,834 $ 9,461
2006................................................. 5,323 2,515 7,838
2007................................................. 5,284 2,248 7,532
2008................................................. 4,072 1,982 6,054
2009................................................. 2,641 1,783 4,424
Thereafter........................................... 5,843 2,746 8,589
------- ------- -------
Total................................................ $30,790 $13,108 $43,898
======= ======= =======
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
USEFUL LIFE SEPTEMBER 30, DECEMBER 31,
(IN YEARS) 2004 2003
----------- ------------- ------------
Computers, software and equipment................ 3 $ 14,182 $10,346
Leasehold improvements........................... 2-4 2,846 2,693
Furniture and fixtures........................... 3 2,499 2,095
Construction in process.......................... -- 391 857
-------- -------
19,918 15,991
Accumulated depreciation......................... (11,933) (9,014)
-------- -------
$ 7,985 $ 6,977
======== =======
Depreciation expense, associated with property and equipment, for the nine
months ended September 30, 2004 and the years ended December 31, 2003 and 2002
was $2.9 million, $2.4 million and $2.0 million, respectively. Construction in
progress is related to the capitalization of internal costs associated with
financial systems.
In January 2002, the Company entered into a one-year capital lease
agreement for certain equipment. Total payments during the year were $0.3
million. No further obligation existed as of December 31, 2002.
61
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Accrued sales and marketing incentives...................... $ 3,533 $ 2,540
Accrued restructuring and other charges..................... 574 1,861
Accrued royalties........................................... 513 510
Accrued professional fees................................... 2,673 1,735
Accrued acquisition liabilities............................. 32 143
Accrued transaction costs................................... 362 834
Accrued other............................................... 5,023 5,858
------- -------
$12,710 $13,481
======= =======
8. RESTRUCTURING AND OTHER CHARGES
In January 2002, the Company announced, and in March 2002 completed, a
restructuring plan to consolidate facilities, worldwide sales organizations,
research and development teams and other personnel following the December 12,
2001 L&H acquisition. As a result, the Company exited facilities in both North
America and Europe, eliminating 21 employee positions, including 12 in research
and development and 9 in selling, general and administrative functions. In the
first quarter of 2002, the Company recorded a restructuring charge in the amount
of $0.6 million for severance payments to these employees, and a restructuring
charge of $0.4 million for certain termination fees to be incurred as a result
of exiting the facilities, including the write-off of previously recorded
assembled workforce of $0.1 million.
In connection with the Philips acquisition (Note 19), the Company
eliminated 25 ScanSoft personnel across all functional areas, resulting in a
charge of approximately $0.5 million in severance-related restructuring costs in
the three month period ended March 31, 2003.
During the three months ended June 30, 2003, the Company committed to a
plan to transfer certain research and development activities currently located
at its corporate headquarters to Budapest resulting in the elimination of 21
employees. The Company recorded a restructuring charge in the amount of $0.4
million for severance payments to these employees. In addition, the Company
recorded a charge in the amount of $0.4 million for severance payments to a
former member of the senior management team.
During the three months ended September 30, 2003, the Company eliminated 81
ScanSoft employees as a result of the SpeechWorks acquisition across all
functional areas, resulting in charges of $1.9 million for severance costs,
representing the ratable recognition of expenses through the period ended
December 31, 2003. Certain of these employees had termination dates after
December 31, 2003 and, as required by SFAS 112, the Company recorded severance
expense ratably from the date the plan was announced through the termination
date. Also during 2003, the Company accrued $0.2 million and $0.2 million,
respectively, related to certain facility restructuring efforts taken at our
corporate headquarters and the closing of certain ScanSoft offices as a result
of the SpeechWorks acquisition and related expenses.
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 its
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.
62
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the nine months ended September 30, 2004, the Company paid a total of
$1.6 million in severance payments, of which $0.3 million relates to 2004
activities, $1.1 million relates to 2003 activities and $0.2 million relates to
severance paid to the former Caere President and CEO, pursuant to a 2000
restructuring charge.
At September 30, 2004, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $0.6 million. This amount is
comprised of $0.2 million of lease exit costs and $0.4 million of
employee-related severance costs, of which $0.1 million are for severance to the
former Caere President and CEO, and $0.3 million are for severance costs related
to actions taken during 2003 and 2004.
The severance due to the former Caere President and CEO will be paid
through March 2005. Certain other severance costs related to restructuring
actions undertaken during 2003 will be paid through March 2009. Severance costs
related to the March 2004 separation agreements will be paid through December
31, 2004.
The following table sets forth the 2004, 2003 and 2002 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, 2001................... $ 634 $ -- $ -- $ 634
Restructuring and other charges for March 2002
restructuring................................ 576 465 -- 1,041
Non-cash write-off............................. (113) -- (113)
Cash payments.................................. (764) (133) (897)
------- ----- ----- -------
Balance at December 31, 2002................... 446 219 -- 665
Restructuring and other charges................ 3,267 337 89 3,693
Non-cash write-off............................. -- -- (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 write-off............................. (348) -- -- (348)
Cash Payments.................................. (1,599) (141) -- (1,740)
------- ----- ----- -------
Balance at September 30, 2004.................. $ 406 $ 168 $ -- $ 574
======= ===== ===== =======
9. 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, extending the term to 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 adjusted quick ratio, borrowings under the Credit Facility bear interest at
the Bank's prime rate plus 0.0% or 0.75% (4.75% at September 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 of 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
63
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 term loan.
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 September 30, 2004, the Company was in
compliance with all covenants. There were no borrowings outstanding under the
Loan Agreement as of September 30, 2004 or December 31, 2003.
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 September 30,
2004, a balance of $0.6 million remains outstanding. Borrowings under this line
are collateralized by the fixed assets purchased and bear interest at the bank's
prime rate (4.75% at September 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 September 30, 2004, principal payments of $0.5
million are due during the year ending September 30, 2005, and $0.1 million are
due during the year ending September 30, 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 September 30, 2004.
Notes Payable
In connection with the L&H acquisition, the Company issued a $3.5 million
promissory note (the "Note") to Lernout & Hauspie Speech Products, N.V. The Note
had a stated maturity date of December 15, 2004 and bore interest at 9% per
annum. Payments of principal and interest in the amount of $133,000 were due
quarterly commencing on March 15, 2002, for a total of eleven payments. During
the year ended December 31, 2002, four quarterly payments were made in
accordance with the terms of the promissory note. In connection with an
agreement entered into by the Company in September 2002 to repurchase 1,461,378
shares of common stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech
Products N.V. (collectively, "L&H") and to register in an underwritten offering
the remaining shares held by L&H, the terms of the Note were amended to provide
for the acceleration of the maturity date of the outstanding principal and
interest to January 1, 2003 if consummation of the underwritten public offering
did not occur by January 1, 2003. The Company did not complete the offering by
January 1, 2003 and, accordingly, the debt became immediately due and payable.
To fulfill this obligation, on January 3, 2003, the Company paid $3.3 million in
full settlement of all outstanding principal and accrued interest under the
Note.
In connection with the Philips acquisition on January 30, 2003, the Company
issued a 5.0 million euro promissory note (the "Philips Note") to Philips. The
unsecured Philips Note matured on December 31, 2003 and bore interest at 5% per
annum. Payments of principal and accrued interest were due at maturity. In
connection with the issuance of the Philips Note, the Company entered into a
forward foreign currency exchange contract on January 31, 2003 to hedge the
foreign exchange exposure on the Philips Note. Prior to December 31, 2003, the
Company made payments to Philips in satisfaction of these obligations and the
related forward hedges were also terminated.
Convertible Debenture
On January 30, 2003, the Company issued a $27.5 million three-year,
zero-interest convertible subordinated debenture due January 2006 (the
"Convertible Note") to Philips in connection with the Philips acquisition (Note
19). The Convertible Note is convertible into shares of the Company's common
stock at $6.00 per share at any time until maturity at Philips' option. The
conversion rate may be subject to adjustments from time to time as provided in
the Convertible Note. The Convertible Note contains a provision in which all
amounts unpaid at maturity will bear interest at a rate of 3% per quarter until
paid.
64
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 (Note 19) did not result in a Change in Control.
10. OTHER LIABILITIES
Other liabilities consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Facilities lease obligations................................ $14,300 $15,820
Deferred payments for technology license (Note 5)........... -- 2,585
Other....................................................... 1,090 322
------- -------
$15,390 $18,727
======= =======
The facility lease obligations assumed by the Company in connection with
the SpeechWorks acquisition include leases extending through September 2004
related to the former corporate offices of SpeechWorks, leases related to two
office locations vacated during 2003 which extend through 2010 and 2016,
respectively, and a lease associated with office space which will become
available beginning in January 2005.
11. 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 of ScanSoft (see Note 1), 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 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.
65
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 this warrant, for approximately $80 million. In
connection with this transaction, Warburg Pincus acquired new warrants to
purchase 2.5 million additional shares of the Company's common stock from the
Company for total consideration of $0.6 million. The warrants have a six year
life and an 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 (Note 5),
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 (Note 19), 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
In September of 2002, the Company repurchased 1,461,378 shares of common
stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech Products N.V.
(collectively, L&H) and certain other parties at $4.79 per share for a total
consideration of $7.0 million. The price per share was based on the greater of
$4.79 or the twenty day trading average beginning August 14, 2002, which was
$4.67. These shares represented a portion of the common shares that were issued
to L&H in connection with the December 12, 2001 acquisition of certain of L&H's
speech and language technology operations and the March 21, 2002 acquisition of
the AudioMining assets of L&H Holdings USA, Inc.
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. From August 6, 2003 through December 31, 2003, the Company
repurchased 618,088 common shares at a purchase price of $2.9 million; the
Company records treasury stock at cost.
66
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of September 30, 2004 the Company had repurchased a total of 2,771,507
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.
Acquisition of SpeechWorks International, Inc.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks (Note 19). In connection with the acquisition of SpeechWorks, the
Company exchanged 0.860 of a share of its common stock for each outstanding
share of SpeechWorks stock. This transaction resulted in the issuance of
approximately 32.5 million shares of common stock, representing approximately
33% of the outstanding common stock of the Company after the completion of the
acquisition.
Acquisition of LocusDialog, Inc.
On December 19, 2003, the Company acquired all of the outstanding shares of
LocusDialog, Inc (Note 19). In connection with the acquisition of LocusDialog,
the Company issued approximately 2.3 million shares of its common stock.
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.
Other
On April 12, 2002, the Company completed a private placement of 1.0 million
shares of common stock at a purchase price of $6.00 per share with SF Capital
Partners Ltd. ("SF Capital"), resulting in proceeds, net of issuance costs, of
$5.6 million. In purchasing these shares, SF Capital was provided with certain
registration rights which required that the shares be registered no later than
August 10, 2002. The shares held by SF Capital were registered on February 14,
2003, however no penalty for late registration was enforced.
In connection with the agreement to repurchase 1,461,378 shares of common
stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech Products N.V.
(collectively, L&H) entered into by the Company in September 2002, the Company
agreed to issue an additional 150,000 shares of its common stock to L&H if it
did not complete an underwritten public offering of the shares held by L&H by
December 15, 2002. The Company further agreed to issue an additional 150,000
shares of its common stock to L&H if it did not complete an underwritten public
offering by February 15, 2003. The Company also agreed to issue an additional
100,000 shares of its common stock to L&H if, by February 15, 2003, it failed to
file a registration statement to register the shares remaining unsold. The value
ascribed to the potential right to acquire additional shares of the Company's
common stock was valued at $0.3 million using a probability-weighted,
Black-Scholes valuation model and recorded as a credit to additional paid-in
capital, with a corresponding reduction in additional paid-in capital because
the Company has an accumulated deficit. Accordingly, the right had no net effect
on the Company's financial position or results of operations. The Company
completed the public offering on February 14, 2003. Because the offering was not
completed by December 15, 2002, the Company issued L&H 150,000 shares of common
stock on December 18, 2002.
67
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. RESTRICTED COMMON STOCK
During 2004, the Company awarded net 387,009 restricted stock purchase
rights and 605,259 shares of restricted common stock to certain senior
executives and employees of the Company. Unvested stock purchase rights and
restricted shares may not be sold, transferred or assigned. The restricted stock
purchase rights and shares of restricted stock vest no later than September 30,
2007 with opportunities for acceleration for achievement of defined goals.
Except as otherwise specified in the agreements, in the event that the
employees' employment with the Company terminates, any unvested share shall be
forfeited and revert to the Company. The purchase price of the restricted shares
equaled the par value of the shares. The purchase price of the restricted stock
purchase rights, payable at time of issuance of shares, equaled the par value of
the shares. The difference between the purchase price and the fair value of the
Company's common stock on the date of issuance based on the listed exchange
price of $5.3 million, net, has been recorded as deferred compensation and
additional paid-in-capital. The deferred compensation expense is being
recognized as compensation expense ratably over the vesting period.
On August 11, 2003, the Company issued 300,000 shares of restricted common
stock to the Company's Chief Executive Officer. Unvested restricted shares may
not be sold, transferred or assigned. Of these restricted common shares, 100,000
vest on each of August 31, 2004, 2005 and 2006. Except as otherwise specified in
the restricted stock agreement, in the event that the executive's employment
with the Company terminates, any unvested shares of the restricted stock shall
be forfeited and revert to the Company. The purchase price of the shares equaled
the par value of the shares. 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 approximately $1.2 million has been recorded as
deferred compensation and additional paid-in-capital.
In connection with the SpeechWorks acquisition (Note 19), the Company
issued 184,850 shares of restricted common stock in replacement of previously
outstanding SpeechWorks unvested restricted common stock. 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
restricted common stock vests no later than March 25, 2007. Deferred
compensation of $0.7 million was recorded associated with the issuance of these
restricted shares which is equal to the closing price of ScanSoft common stock
on the acquisition date.
During 2001, the Company awarded 133,824 shares of restricted common stock
to senior executives at a weighted average fair value of the Company's common
stock at the grant date of $2.72 resulting in deferred compensation of $291,000.
Restrictions lapse over a period of 2 to 4 years depending on the grant. The
restricted stock awards entitle the participant to full dividend and voting
rights. Unvested shares are restricted as to disposition and subject to
forfeiture under certain circumstances. Deferred compensation expense is
amortized to compensation expense over the period that the restrictions lapse.
The deferred compensation expense from the aforementioned awards is being
recognized ratably over the vesting periods, resulting in $1.3 million of stock
compensation expense during the nine months ended September 30, 2004 and $0.3
and $0.1 million in the twelve months ended December 31, 2003 and 2002,
respectively.
13. STOCK-BASED COMPENSATION PLANS
Stock Option and Award Plans
The Company has several stock-based compensation plans under which
employees, officers, directors and consultants may be granted stock awards or
options to purchase the Company's common stock generally at the fair market
value on the date of grant. Plans do not allow for options to be granted at
below fair market value nor can they be re-priced at anytime. Options become
exercisable over various periods, typically two to four years and have a maximum
term of 10 years. At September 30, 2004, 21,417,977 shares were authorized for
grant under the Company's stock-based compensation plans, of which 4,623,039
were available for future
68
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
grant. To date, all stock options have been granted with exercise prices equal
to or greater than the fair market value of the Company's common stock on the
date of grant.
The following table summarizes activity under all stock option and award
plans and for options granted outside the plans:
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
---------- --------------
Balance at December 31, 2001................................ 13,217,169 $2.33
Options granted............................................. 4,965,913 $5.43
Options exercised........................................... (1,362,299) $1.83
Options canceled............................................ (1,675,076) $4.03
----------
Balance at December 31, 2002................................ 15,145,707 $3.20
Options granted............................................. 6,122,250 $4.57
Options exercised........................................... (2,422,484) $1.61
Options canceled............................................ (999,841) $4.34
----------
Balance at December 31, 2003................................ 17,845,632 $3.82
Options granted............................................. 3,489,750 $4.89
Options exercised........................................... (2,238,588) $2.22
Options canceled............................................ (2,301,856) $4.70
----------
Balance at September 30, 2004............................... 16,794,938 $4.14
==========
Stock options to purchase 10,018,921, 9,600,859 and 8,389,293 shares of
common stock were exercisable as of September 30, 2004 and December 31, 2003 and
2002, respectively.
The following table summarizes information about stock options outstanding
under the Company's stock compensation plans at September 30, 2004:
OPTIONS OUTSTANDING
-------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED ----------------------------
NUMBER OF AVERAGE WEIGHTED NUMBER OF WEIGHTED
EXERCISE SHARES REMAINING AVERAGE SHARES AVERAGE
PRICE RANGE OUTSTANDING LIFE IN YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
----------- ----------- ------------- -------------- ----------- --------------
$0.41 -- $1.28 768,574 6.22 $1.05 733,381 $1.06
$1.31 -- $1.34 2,029,003 5.88 $1.34 2,028,194 $1.34
$1.41 -- $3.92 2,064,646 6.27 $3.09 1,702,020 $3.02
$4.00 -- $4.18 2,260,605 6.97 $4.09 1,082,687 $4.11
$4.20 -- $4.31 2,601,389 7.98 $4.30 1,048,747 $4.30
$4.38 -- $5.06 2,015,266 6.87 $4.81 501,586 $4.81
$5.08 -- $5.36 1,743,927 7.70 $5.31 1,316,276 $5.34
$5.38 -- $5.80 1,952,774 7.79 $5.65 650,770 $5.68
$5.81 -- $7.50 1,355,754 6.96 $6.75 953,510 $6.80
$8.74 -- $8.74 3,000 7.67 $8.74 1,750 $8.74
---------- ----------
$0.41 -- $8.74 16,794,938 7.03 $4.14 10,018,921 $3.72
========== ==========
69
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1995 Employee Stock Purchase Plan
The Company's 1995 Employee Stock Purchase Plan ("The Plan"), as amended
and restated on August 11, 2003, authorizes the issuance of a maximum of
1,500,000 shares of common stock in semi-annual offerings to employees at a
price equal to the lower of 85% of the closing price on the applicable offering
commencement date or 85% of the closing price on the applicable offering
termination date. The Plan currently meets all regulatory requirements to be
considered a non-compensatory plan. The Company issued 332,119, 163,837 and
87,185 shares of common stock under this plan during the nine months ended
September 30, 2004 and the years ended December 31, 2003 and 2002, respectively.
14. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has various operating leases for office space around the world.
In connection with the acquisition of SpeechWorks, ScanSoft assumed all of
SpeechWorks' lease obligations. Among these obligations are lease payments
related to two office locations vacated during 2003 by SpeechWorks and one
associated with office space which will become available beginning in January
2005. Gross lease payments associated with these office locations amounting to
$10.5 million and $13.6 million, respectively, have been included in the table
below. These obligations extend through 2016. The following table outlines the
Company's future minimum payments under non-cancelable operating leases as of
September 30, 2004 (in thousands):
YEAR ENDING
SEPTEMBER 30,
-------------
2005........................................................ $ 5,445
2006........................................................ 4,673
2007........................................................ 2,949
2008........................................................ 2,706
2009........................................................ 2,554
Thereafter.................................................. 15,744
-------
Total....................................................... $34,071
=======
At September 30, 2004, the Company has sub-leased certain office space to
third parties. Total sub-lease income under contractual terms is $11.0 million,
or approximately $1.0 million annually, which has not been reflected in the
above operating lease contractual obligations, will be received through February
2016.
Total rent expense under operating leases for the nine months ended
September 30, 2004 and for the years ended December 31, 2003 and 2002 was $4.0
million and $4.0 million and $1.8 million, respectively.
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
70
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 September 9, 2004, BIS Advanced Software Systems, Ltd. ("BIS") filed an
action against the Company in the United States District Court for the District
of Massachusetts claiming patent infringement. Damages are sought in an
unspecified amount. In the lawsuit, BIS alleges that the Company is infringing
United States Patent No. 6,401,239 entitled "System and Method for Quick
Downloading of Electronic files." The Company believes this claim has no merit,
and it intends to defend the action vigorously.
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
claiming patent infringement. Damages are sought in an unspecified amount. In
the lawsuit, Compression Labs alleges that the Company is infringing United
States Patent No. 4,698,672 entitles "Coding System for Reducing Redundancy."
The Company believes this claim has no merit, and intends to defend the action
vigorously.
On April 23, 2004, Millennium L.P. filed an action against the Company in
the United States in the United Sates 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
Sates 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. 5,678,416 entitled "Information
processing Methodology; and No. 6,094,505 entitled "Information Processing
Methodology." The Company filed an Answer on June 17, 2004. The Company believes
this claim has no merit, and it intends 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.
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 "feet273 Patent"). The feet273 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 feet273 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.
71
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
The Company has entered into agreements to indemnify its directors and
officers to the fullest extent authorized or permitted under applicable law.
These agreements, among other things, provide for the indemnification of its
directors and officers for expenses, judgments, fines, penalties and settlement
amounts incurred by any such person in his or her capacity as a director or
officer of the company, whether or not such person is acting or serving in any
such capacity at the time any liability or expense is incurred for which
indemnification can be provided under the agreements. 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 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 nine months ended September 30, 2004
and for the year ended December 31, 2003 (in thousands):
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Balance at beginning of period.............................. $ 4,056 $ 1,396
Additions due to acquisitions............................... -- 2,459
Additions due to new billings during the period............. 5,262 5,485
Maintenance revenue recognized during the period............ (5,188) (5,284)
------- -------
Balance at end of period.................................... $ 4,130 $ 4,056
======= =======
72
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. 401(k) SAVINGS PLAN
The Company has established a retirement savings plan under Section 401(k)
of the Internal Revenue Code (the "401(k) Plan"). The 401(k) Plan covers
substantially all employees of the Company who meet minimum age and service
requirements, and allows participants to defer a portion of their annual
compensation on a pre-tax basis. Through October 15, 2002, the Company matched
an employee's contributions dollar for dollar up to 4%. During the period from
October 16, 2002 through June 30, 2003, this match was discontinued. Effective
July 1, 2003, Company match of employee's contributions was reinstated, dollar
for dollar up to 2%. Employees who were hired prior to April 1, 2004 are 100%
vested into the plan as soon as they start to contribute to the plan. Employees
hired April 1, 2004 and thereafter, vest 1/3 of the contribution annually over a
three year period. The Company's contributions to the 401(k) Plan totaled $0.5
million, $0.2 million and $0.6 million for the nine months ended September 30,
2004 and for the years ended December 31, 2003 and 2002, respectively.
16. SUPPLEMENTAL CASH FLOW INFORMATION
During the nine months ended September 30, 2004 and the years ended
December 31, 2003 and 2002, the Company made cash payments for interest totaling
$0.2 million, $0.4 million and $0.3 million, respectively.
During nine months ended September 30, 2004 and the years ended December
2003 and 2002, the Company made cash payments for income taxes totaling $0.6
million, $1.0 million and $0.6 million, respectively.
During December 2003, the Company issued 2,328,638 shares of the Company's
common stock valued at $12.4 million in connection with the acquisition of
LocusDialog.
During August 2003, in connection with the SpeechWorks acquisition (Note
22), the Company issued a warrant to its investment banker for the purchase of
150,000 shares of ScanSoft common stock valued at $0.2 million.
During March 2003, in connection with the acquisition of certain
intellectual property assets related to multimodal speech technology (Note 6),
the Company issued a warrant for the purchase of 78,000 shares of ScanSoft
common stock valued at $0.1 million.
During January 2003, the Company issued a $27.5 million three-year,
zero-interest convertible subordinated debenture due January 2006 (the
"Convertible Note") to Philips in connection with the Philips acquisition (Note
23) valued a $27.5 million.
During December 2002, the Company issued 150,000 shares of common stock
valued at $0.3 million in connection with the agreement to repurchase 1,461,378
shares of common stock from L&H (Note 25).
During March 2002, the Company issued 121,359 shares of the Company's
common stock valued at $0.6 million in connection with a purchase agreement
associated with the Audiomining assets of L&H. In addition, the Company issued a
9% promissory note in the principal amount of $0.4 million.
During January 2002, the Company issued 65,100 shares of its common stock
in partial settlement of a $1.0 million liability incurred as part of the Caere
acquisition. The common stock was valued at $0.3 million based on the fair value
of the common stock on December 21, 2001, the date the agreement was reached.
During January 2002, the Company acquired $0.3 million of equipment through
a one-year capital lease arrangement.
73
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. SEGMENT AND GEOGRAPHIC INFORMATION AND SIGNIFICANT CUSTOMERS
The Company operates in a single segment. The following table presents
total revenue information by geographic area and principal product line (in
thousands):
DECEMBER 31,
SEPTEMBER 30, -------------------
2004 2003 2002
------------- -------- --------
United States of America........................... $ 89,176 $ 96,657 $ 77,540
Canada............................................. 2,427 251 --
Other foreign countries............................ 39,304 38,491 29,079
-------- -------- --------
Total............................................ $130,907 $135,399 $106,619
======== ======== ========
No single country within other foreign countries had revenues greater than
10% of total revenues.
Revenue classification above is based on the country in which the sale
originates. Revenue in other countries predominately relates to sales to
customers in Europe and Asia. Inter-company sales are insignificant as products
sold in other countries are sourced within Europe or the United States.
NINE MONTHS
ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30, -----------------------
2004 2003 2002
------------- ---------- ----------
Speech............................................. $ 86,594 $ 77,928 $ 44,165
Imaging............................................ 44,313 57,471 62,454
-------- -------- --------
Total............................................ $130,907 $135,399 $106,619
======== ======== ========
Two distribution and fulfillment partners, Ingram Micro and Digital River,
accounted for 14% and 8%, 16% and 13% and 25% and 12% of the Company's
consolidated revenue for the nine months ended September 30, 2004 and for the
years ended 2003 and 2002, respectively.
The following table summarizes the Company's long-lived assets, including
intangible assets and goodwill, by geographic location (in thousands):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
United States of America.................................... $278,950 $267,295
Canada...................................................... 12,814 13,538
Other foreign countries..................................... 27,401 26,428
-------- --------
Total..................................................... $319,165 $307,261
======== ========
74
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. INCOME TAXES
The components of the income tax provision (benefit) are as follows (in
thousands):
NINE MONTHS YEAR ENDED
ENDED DECEMBER 31,
SEPTEMBER 30, ---------------
2004 2003 2002
------------- ------- -----
Current
Federal............................................. $ -- $(1,534) $(900)
Foreign............................................. 451 (49) 907
State............................................... 23 50 247
------ ------- -----
$ 474 $(1,533) $ 254
====== ======= =====
Deferred
Federal............................................. $ 705 $ 1,083 $ --
Foreign............................................. 24 (20) --
State............................................... 130 201 --
------ ------- -----
$ 859 $ 1,264 $ 0
------ ------- -----
Provision (benefit) for income taxes.................. $1,333 $ (269) $ 254
====== ======= =====
The benefits for federal income taxes in 2003 and 2002 relate to refunds
related to Caere Corporation.
The deferred income tax provision in 2004 and 2003 includes a $0.9 million
and $1.2 million provision to increase the deferred tax valuation allowance,
respectively. A portion of the deferred tax liabilities are created by taxable
temporary differences related to certain goodwill for which the period the
differences will reverse is indefinite. Following the adoption of SFAS No. 142,
taxable temporary differences creating deferred tax liabilities as a result of
different treatment of goodwill for book and tax purposes cannot offset
deductible temporary differences that create deferred tax assets in determining
the valuation allowance. As a result, a deferred tax provision is required to
increase the Company's valuation allowance. The deferred tax provision in 2003
includes $0.4 million related to 2002.
For financial reporting purposes, income (loss) before income taxes
includes the following components (in thousands):
NINE MONTHS YEAR ENDED
ENDED DECEMBER 31,
SEPTEMBER 30, ----------------
2004 2003 2002
------------- ------- ------
North America......................................... $(10,413) $(6,781) $4,585
Foreign............................................... 2,368 994 2,002
-------- ------- ------
Total............................................... $ (8,045) $(5,787) $6,587
======== ======= ======
The cumulative amount of undistributed earnings of foreign subsidiaries,
which is intended to be permanently reinvested and for which U.S. income taxes
have not been provided, totaled approximately $6.9 million at September 30,
2004. An estimate of the tax consequences from the repatriation of these
earnings is not practicable at this time due to conditions and limitations
applicable to the utilization of foreign tax credits and other tax assets.
75
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets (liabilities) consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Deferred tax assets
Net operating loss carryforwards.......................... $ 55,647 $ 68,157
Federal and state credit carryforwards.................... 7,867 7,740
Capitalized start-up and development costs................ 7,056 5,743
Accrued expense and other reserves........................ 10,395 7,044
Deferred revenue.......................................... 2,220 3,534
Deferred compensation..................................... 439 3,640
Depreciation.............................................. 767 2,759
Other..................................................... 397 155
-------- --------
Gross deferred tax assets................................. 84,788 98,772
Deferred tax liabilities
Acquired intangibles...................................... (8,547) (3,050)
Valuation allowance....................................... (78,364) (96,986)
-------- --------
Net deferred tax liabilities.............................. $ (2,123) $ (1,264)
======== ========
The decrease in ScanSoft's net deferred tax assets before valuation
allowance to $78 million from $97 million as of September 30, 2004 compared to
December 31, 2003, primarily relates to the expiration of state net operating
loss and tax credit carryforwards and the adjustment of tax liabilities related
to the acquisition of SpeechWorks.
At September 30, 2004 and December 31, 2003, the Company provided a full
valuation allowance for its net deferred tax assets in the United States due to
the uncertainty of realization of those assets as a result of the recurring and
cumulative losses from operations.
The Company monitors the realization of its deferred tax assets based on
changes in circumstances, for example, recurring periods of income for tax
purposes following historical periods of cumulative losses or changes in tax
laws or regulations. The Company's income tax provisions and its assessment of
the realizability of its deferred tax assets involve significant judgments and
estimates. If the Company generates taxable income through profitable operations
in future years it may be required to recognize these deferred tax assets
through the reduction of the valuation allowance which would result in a
material benefit to its results of operations in the period in which the benefit
is determined, excluding the recognition of the portion of the valuation
allowance which relates to net deferred tax assets acquired in a business
combination and stock compensation.
76
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the Company's effective tax rate to the statutory
federal rate is as follows:
NINE MONTHS YEAR ENDED
ENDED DECEMBER 31,
SEPTEMBER -------------
2004 2003 2002
----------- ----- -----
Federal statutory tax rate................................ (35.0)% (35.0)% 34.0%
Foreign taxes............................................. (6.0)% (4.9)% 6.6%
State tax, net of federal benefit......................... (7.7)% (5.6)% 3.1%
Other..................................................... 2.7% 0.3% (2.2)%
Change in valuation allowance............................. 70.1% 77.6% (17.4)%
Federal research and development credits.................. (7.5)% (10.5)% (6.5)%
Federal benefit -- refundable taxes....................... -- (26.5)% (13.7)%
----- ----- -----
16.6% (4.6)% 3.9%
===== ===== =====
At September 30, 2004 and December 31, 2003, the Company had federal net
operating loss carryforwards of approximately $160.7 million and $168.3 million,
respectively, of which approximately $27.2 million and $18.2 million,
respectively, relate to tax deductions from stock compensation. The tax benefit
related to the stock compensation, when realized, will be accounted for as
additional paid-in capital rather than as a reduction of the provision for
income tax. At September 30, 2004 the Company had federal and state research and
development credit carryforwards of approximately $6.5 million and $1.4 million
respectively. At December 31, 2003 the Company had federal and state research
and development credit carryforwards of approximately $5.5 million and $3.4
million, respectively. The net operating loss and credit carryforwards will
expire at various dates through 2024, if not utilized.
Utilization of the net operating losses and credits are subject to an
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation will result in the expiration of certain net operating losses and
credits before utilization.
19. ACQUISITIONS
ACQUISITION OF BRAND & GROEBER COMMUNICATIONS GBR ("B&G")
On September 16, 2004, the Company acquired B&G, including all the
intellectual property relating to embedded speech synthesis technology. B&G's
embedded speech application makes mobile phones accessible to the visually
impaired. Many of the application's standard features, like email reading, have
broad applicability for all types of users where "eyes-free" use of mobile
devices is important, like in the automobile. The initial purchase price
allocation of approximately $0.2 million is preliminary and has been allocated
to goodwill. The Company agreed to make four contingent installment payments of
up to approximately E5.8 million through 2007, if at all, based upon the
achievement of certain performance targets, as defined in the acquisition
agreement.
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 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.
77
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 performance
of certain 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 assumed............................... (685)
Long term liabilities....................................... (503)
------
$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:
AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------
Core technology............................................. $220 7
Completed technology........................................ 90 3
Trade names and trademarks.................................. 240 4
----
$550
====
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 the new acquisition. The Company believes that these identified
intangible assets have no residual value. The excess of the purchase price over
the tangible and identifiable 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.
78
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ACQUISITION OF LOCUSDIALOG, INC.
On December 19, 2003, the Company acquired all of the outstanding shares of
LocusDialog, a leader in speech-enabled, auto-attendant applications, based in
Montreal, Canada. LocusDialog's call routing and auto-attendant solutions are
used by nearly 1,000 installations worldwide, handling approximately 500 million
calls annually.
The acquisition of LocusDialog enhances the Company's competitive position
in key markets, specifically the auto-attendant market. In addition, it enhances
the distribution channel adding new reference accounts for both customer
relationships and technology partners. These incremental intangible benefits
attributed to excess purchase consideration resulting in goodwill.
The results of operations of the acquired business have been included in
the financial statements of the Company since the date of acquisition.
Consideration for the transaction comprised 2,328,638 shares of 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.
The purchase price allocation is as follows (in thousands):
Total purchase consideration:
Common stock issued....................................... $12,370
Transaction costs......................................... 660
-------
Total purchase consideration.............................. $13,030
=======
Allocation of the purchase consideration:
Current assets............................................ $ 2,417
Property and equipment.................................... 420
Identifiable intangible assets............................ 2,850
Goodwill.................................................. 9,357
-------
Total assets acquired..................................... 15,044
-------
Accounts payable.......................................... (157)
Accrued liabilities....................................... (1,338)
Deferred revenue.......................................... (519)
-------
Total liabilities assumed:................................ (2,014)
-------
$13,030
=======
Current assets acquired primarily relate to cash and accounts receivable.
Current liabilities assumed primarily relate to accounts payable, accrued
expenses and deferred revenue. Current assets include approximately $0.8 million
in research and development tax credits receivable from the Canadian government.
Under the purchase agreement up to $1.0 million of research and development tax
credits expected to be received by the Company will be repaid to the former
shareholders of Locus. Any amounts in excess of $1.0 million will be retained by
the Company, and be treated as a reduction of goodwill. The estimated fair value
of the receivable at the date of acquisition of $0.8 million is included in
current assets with a corresponding liability in accrued liabilities.
79
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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)
-------------- ------------
Patents and core technology................................ $ 220 5
Completed technology....................................... 300 10
Customer relationships..................................... 2,330 5
------
$2,850 5.5
======
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 $9.4 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. All goodwill and other identifiable intangible
assets are not deductible for tax purposes.
ACQUISITION OF SPEECHWORKS INTERNATIONAL, INC.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone.
The acquisition of SpeechWorks enhances the ability of the Company to
promote its products and comprehensively address the needs of the system
integrators in telephony markets. The addition of SpeechWorks' professional
services organization will enable the Company to support major accounts, channel
partners and telecommunications firms, as well as provide the ability to deliver
complete solutions. In addition, the acquisition enhances the Company's
strengths in key vertical markets, including multiple deployments in
travel/hospitality, financial services and government, thereby expanding the
Company's market share in these key markets and expertise in developing
applications and solutions for these industries. These incremental intangible
benefits, which are reflected in the purchase consideration, resulted in
goodwill.
The results of operations of the acquired business have been included in
the financial statements of the Company since the date of acquisition.
In connection with the acquisition of SpeechWorks, ScanSoft exchanged 0.860
of a share of its common stock for each outstanding share of SpeechWorks stock.
This transaction resulted in the issuance of approximately 32.5 million shares
of ScanSoft common stock, representing approximately 33% of the outstanding
common stock of ScanSoft after the completion of the acquisition. The
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 ScanSoft's common stock (Note 13). In
addition, the purchase price also includes the value of 184,850 shares of
restricted ScanSoft common stock issued by ScanSoft, in replacement of
previously outstanding SpeechWorks unvested restricted common stock, of $0.7
million based on the closing price of ScanSoft common stock on the acquisition
date. The value of the unvested restricted common stock has been recorded as
deferred compensation (Note 14).
80
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The final purchase price allocation is as follows (in thousands):
Total purchase consideration:
Common stock and restricted stock issued.................. $170,950
Transaction costs......................................... 4,500
--------
Total purchase consideration.............................. $175,450
========
Allocation of the purchase consideration:
Assets acquired:
Cash...................................................... $ 39,711
Marketable securities..................................... 553
Accounts receivable....................................... 9,952
Other current assets...................................... 1,230
Property and equipment.................................... 2,840
Other long term assets.................................... 808
Identifiable intangible assets............................ 13,310
Goodwill.................................................. 141,961
--------
Total assets acquired..................................... 210,365
--------
Deferred compensation for unvested restricted common
stock.................................................. 724
Liabilities assumed:
Accounts payable.......................................... (1,610)
Accrued expenses.......................................... (9,817)
Deferred revenue.......................................... (6,135)
Other long term liabilities............................... (16,537)
Note payable.............................................. (1,540)
--------
Total liabilities assumed:................................ (34,915)
--------
$175,450
========
In December 2002, SpeechWorks committed to a restructuring plan to vacate
two office locations during 2003. In connection with this restructuring plan,
SpeechWorks recorded a charge of $5.9 million. As of the acquisition date, the
balance of this accrual was $5.4 million, which has been included in other
long-term liabilities. The Company reduced the recorded accrual by $1.0 million
to record such obligation at its net present value, using a discount rate of 3%.
The $1.0 million difference between the lease obligations and the recorded
accrual will be recognized as incremental rent expense over the remaining life
of the lease. These assumed leases extend through 2010 and 2016, respectively,
unless the Company is able to negotiate earlier termination dates. The Company
anticipates that the facilities-related accrual will be expended equally over
the remaining life of the leases.
In connection with the acquisition of SpeechWorks, the Company assumed all
its lease obligations. Among these obligations are liabilities associated with
office space which will become available beginning in January 2005. During the
quarter ended December 31, 2003, the Company completed its review of all of the
assumed leases. Based on the provisions of the lease agreements and management's
expectations for post-acquisition operations, the Company determined that the
total fair value of the assumed liabilities related to leases for which there
will be no future benefit amounted to $12.9 million, which resulted in an
adjustment to accrued liabilities and other long term liabilities assumed in the
acquisition of $0.9 million and $12.0 million, respectively. A corresponding
adjustment to goodwill of $12.9 million has been reflected in the table above.
81
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of the future lease obligations includes an estimate of
expected future sublease income in accordance with the provisions of EITF Issue
95-3 Recognition of Liabilities in Connection with a Purchase Business
Combination. In accordance with EITF 95-3, if the actual lease obligations is
less than the estimated lease obligation, due to the amount or timing of actual
lease payments or sublease rental receipts, the difference will be recorded as
an adjustment to the purchase price, resulting in an adjustment to goodwill. If
the actual lease obligation exceeds the estimated lease obligation recorded and
such amount is determined beyond one year after the acquisition date, the
difference will be recorded as an adjustment to net income (loss).
During the quarter ended September 30, 2004, the Company negotiated a
sublease for a portion of the assumed SpeechWorks lease obligations. The terms
of the sublease will result in approximately $0.8 million of additional sublease
income to the Company. Therefore, the lease obligation and goodwill were reduced
by approximately $0.8 million. Additionally, during the quarter the Company
finalized its analysis of certain litigation assumed in the acquisition. The
analysis resulted in the Company increasing the acquired liabilities by
approximately $0.8 million
At September 30, 2004, the purchase price allocation is final.
In connection with the SpeechWorks acquisition, the Company eliminated 54
former employees of SpeechWorks. In connection with this action, a liability of
$1.3 million, representing severance and related benefits, has been included in
the purchase price allocation. All of the restructuring accrual related to
SpeechWorks acquisition had been paid as of September 30, 2004.
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)
-------------- ------------
Patents and core technology................................ $ 1,300 10
Completed technology....................................... 2,200 5
Customer relationships..................................... 9,000 6
Trade names and trademarks................................. 800 5
Non-compete agreements..................................... 10 1
-------
$13,310 6.5
=======
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 $142.0 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. All goodwill and other identifiable intangible
assets are not deductible for tax purposes.
ACQUISITION OF PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL BUSINESS
On January 30, 2003, the Company completed the acquisition of the Philips
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property. The Telephony
business unit offers speech-enabled services including directory assistance,
interactive voice response and voice portal applications for enterprise
customers, telephony vendors and carriers. The Voice Control business unit
offers a product portfolio including small footprint speech recognition engines
for embedded applications such as voice-controlled climate, navigation and
entertainment features in automotive vehicles, as well as voice dialing for
mobile phones.
82
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The acquisition of the Philips Speech Processing Telephony and Voice
Control business enhances the Company's market share in key markets and gives
the Company additional competitive momentum in its target markets, specifically
the telephony, automotive and embedded markets. In addition, it enhances the
distribution channel adding new reference accounts for both customer
relationships and technology partners. These incremental intangible benefits
attributed to excess purchase consideration resulting in goodwill.
The results of operations of the acquired business have been included in
the financial statements of the Company since the date of acquisition.
Consideration for the acquisition, before any purchase price adjustment
determined by the parties as described below, totaled $39.5 million, including
transaction costs of $2.1 million. The consideration consisted of 3.1 million
euros ($3.4 million) in cash paid at closing, subject to adjustment in
accordance with the provisions of the purchase agreement, as amended; a deferred
payment of 1.0 million euros in cash due no later than December 31, 2003, a 5.0
million euro note due December 31, 2003; bearing 5.0% interest per annum; and a
$27.5 million three-year, zero-interest subordinated debenture, convertible at
any time at Philips' option into shares of common stock at $6.00 per share. The
fair value of the convertible debenture was determined to be $27.5 million based
on the present value of the expected cash outflows using an incremental
borrowing rate of 12% and the fair value of the conversion feature based on the
Black-Scholes option pricing model using the following assumptions: the fair
value of the Company's common stock of $3.62 per share, the closing price of the
Company's common stock on the day the parties entered into the acquisition
agreement; volatility of 100%; risk-free interest rate of 2.16%; no dividends
and an expected term of 3 years.
The purchase price was subject to adjustment based on calculations set
forth in the purchase agreement, as amended, which required agreement by the
parties. In accordance with the provisions of the agreement, the Company and
Philips agreed during the fourth quarter of 2003 to a final purchase price,
adjustment of approximately $4.1 million, resulting in a corresponding reduction
in goodwill. The Company received $1.1 million of the purchase price adjustment
prior to December 31, 2003. The remaining $3.0 million (2.5 million euros),
recorded in other current assets at December 31, 2003, was received on January
5, 2004.
The final purchase price allocation reflecting the above noted adjustments
is as follows (in thousands):
Total purchase consideration:
Cash...................................................... $ (760)
Other current liability (1.0 million euro payable)........ 1,080
Note payable.............................................. 5,410
Convertible debenture..................................... 27,520
Transaction costs......................................... 2,100
-------
Total purchase consideration........................... $35,350
=======
Allocation of the purchase consideration:
Current assets............................................ $ 3,930
Property and equipment.................................... 310
Identifiable intangible assets............................ 5,650
Goodwill.................................................. 28,846
-------
Total assets acquired.................................. 38,736
-------
Current liabilities assumed............................... (3,386)
-------
$35,350
=======
83
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Current assets acquired primarily relate to accounts receivable, and
current liabilities assumed primarily relate to accounts payable and assumed
contractual liabilities related to development work with customers which were
agreed to prior to the acquisition date.
The 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)
-------------- ------------
Patents and core technology................................ $3,990 10
Completed technology....................................... 460 5.5
Customer relationships..................................... 1,030 1.8
Trade names and trademarks................................. 170 5
------
$5,650 9.3
======
The 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 $28.8 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. All goodwill and other identifiable intangible
assets are deductible for tax purposes.
ACQUISITION OF AUDIOMINING
On February 22, 2002, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and intellectual
property from L&H Holdings USA, Inc. The transaction was completed on March 21,
2002. Pursuant to the Purchase Agreement, the Company acquired patents and core
technology associated with the Audiomining assets of the speech and language
technology assets of L&H and paid $1.5 million in total consideration to L&H as
follows: $0.5 million in cash, 121,359 shares of the Company's common stock
valued at $0.6 million (based on the average of the closing share price of the
Company's stock five days before and after the date the transaction was
completed) and a 9% promissory note in the principal amount of $0.4 million (the
"Note"), with principal and interest to be repaid in full on July 31, 2002. The
Company incurred $0.2 million of acquisition related costs. The purchase price
including acquisition costs of $1.7 million was allocated to core technology.
On July 31, 2002, the Company repaid all amounts due under the Note, which
included principal and interest of $0.4 million.
The following table identifies the intangible assets acquired in connection
with Audiomining and their respective lives:
AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------
Core technology............................................. $1,674 3.5
ACQUISITION OF LERNOUT & HAUSPIE (L&H) SPEECH PRODUCTS N.V. ASSETS:
On December 7, 2001, the Company entered into a definitive asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and intellectual
property relating to the former L&H entities that were in bankruptcy under the
jurisdiction of both the U.S. Bankruptcy Court for the District of Delaware and
the Commercial Court of Ieper, Belgium. The Company purchased these assets in a
closed auction proceeding
84
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
administered by the creditors committee of the former entities and approved by
both the U.S. and Belgium courts on December 11, 2001. The transaction was
completed on December 12, 2001 and the Company's results from operations include
L&H activities since that date. The acquisition was accounted for as the
acquisition of a business.
Pursuant to the Purchase Agreement, the Company acquired patents,
trademarks, tradenames, product and customer contracts associated with certain
of the speech and language technology assets of L&H. In addition, the Company
obtained rights to accounts receivable related to the customer contracts
acquired and fixed assets. The Company also hired 223 employees from L&H. The
Company paid $41.3 million in total consideration to the creditors as follows:
$10.0 million in cash, 7.4 million shares of the Company's common stock valued
at $27.8 million (based on the average of the closing share price of our stock 3
days before and after the proposed acquisition was announced) and a 9%
promissory note in the principal amount of $3.5 million, to be repaid in
installments of $0.1 million of principal and interest quarterly commencing on
March 15, 2002, for a total of eleven payments. All remaining principal and
interest would become due on December 15, 2004 (Note 11). The Company incurred
approximately $1.0 million of acquisition related costs.
The purchase price was allocated to the tangible and intangible assets
acquired (patents and core technology and trade names and trademarks) and
liabilities assumed based on their respective fair market values. The total
identifiable tangible assets amounted to $21.0 million. The excess of the
purchase price over the fair value of the identifiable intangible assets and net
liabilities assumed amounted to $23.0 million and was allocated to goodwill. The
Company believes that the acquisition resulted in an excess of the purchase
price over the fair value of the net assets acquired because the Company
purchased, in an auction as a result of L&H's bankruptcy status, a substantial
portfolio of patents and core technology in speech and language technology which
were internally developed or acquired by L&H over the course of several years.
Furthermore, the acquisition enabled the Company to enter the speech and
language market immediately upon completion of the acquisition. All goodwill and
other identifiable intangible assets are deductible for tax purposes. The
purchase price including acquisition costs was allocated as follows (in
thousands):
Identified intangible assets................................ $20,970
Goodwill.................................................... 23,031
Net current liabilities assumed............................. (1,701)
-------
$42,300
=======
Net current liabilities assumed primarily relate to accounts receivable and
assumed liabilities for products which were sold prior to the acquisition date
and which were expected to be upgraded with newer versions in 2002 and
liabilities for development contracts with customers. During 2002, the Company
entered into favorable settlement agreements related to these liabilities
resulting in a reduction of $2.2 million of the assumed liabilities recorded at
the date of acquisition with a corresponding reduction recorded to the carrying
value of goodwill.
The following table identifies the intangible assets acquired and their
respective lives over which the assets will be amortized on a straight-line
basis:
AMOUNT LIFE
(IN THOUSANDS) (IN YEARS)
-------------- ----------
Patents and core technology................................. $17,870 10
Trade names and trademarks.................................. 3,100 12
-------
$20,970
=======
OEM contracts and customer relationships, as well as completed technology,
were determined to have de minimus values and, accordingly, no amount of the
purchase price was allocated to these intangible assets.
85
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
20. PRO FORMA RESULTS (UNAUDITED)
The following table reflects unaudited pro forma results of operations of
the Company assuming that the Philips, SpeechWorks, Locus Dialogue, Telelogue
and B&G acquisitions had occurred on January 1, 2003 (in thousands, except per
share data):
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Revenues.................................................... $131,748 $164,325
Net loss.................................................... $(11,257) $(42,251)
Net loss per basic and diluted share........................ $ (0.11) $ (0.42)
The unaudited pro forma results of operations in this note 20 include the
restated financial results of SpeechWorks for the first six months of fiscal
2003 as previously reported on the Company's current report on Form 8-K/A as
filed with the Securities and Exchange Commission on August 27, 2004. The
unaudited pro forma results of operations are not necessarily indicative of the
actual results that would have occurred had the transactions actually taken
place at the beginning of these periods.
21. 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 11).
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's related party revenue accounted for 1%, 5%
and 5% of total net revenues during each of the nine months ended September 30,
2004 and the years ended December 31, 2003 and 2002, respectively. As of
December 31, 2003, Xerox owed the Company $1.9 million, pursuant to these
agreements, which are included in receivables from related parties.
In connection with the Caere acquisition in the first quarter of 2000 and
pursuant to a concurrent non-competition and consulting agreement, the Company
agreed to pay in cash to the former Caere President and CEO, a current member of
the Board of Directors of the Company, on the second anniversary of the merger,
March 13, 2002, the difference between $13.50 and the closing price per share of
ScanSoft common stock at that time, multiplied by 486,548. On March 5, 2002, the
Company negotiated a deferred payment agreement with the former Caere President
and CEO to terminate this agreement. Under the terms of the deferred payment
agreement, the Company paid $1.0 million in cash on March 5, 2002 and agreed to
make future cash payments totaling $3.3 million, with such amounts payable in
equal quarterly installments of approximately $0.4 million over the following
two years. During the nine months ended September 30, 2004, the Company paid the
final quarterly installment under this agreement totaling $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.
At September 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
86
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
software. During the nine months ended September 30, 2004, Convergys accounted
for approximately $0.3 million in total net revenues. As of September 30, 2004,
Convergys owed the Company $0.1 million, pursuant to these agreements, which are
included in receivables from related parties.
22. SUBSEQUENT EVENTS
On November 14, 2004, the Company entered into an agreement and plan of
merger to acquire Advanced Recognition Technologies, Inc. to expand its
portfolio of embedded speech solutions. The gross purchase price to be paid is
$26.5 million, representing an aggregate cash value of the transaction of
approximately $21.5 million, net of the estimated cash closing balance of ART of
$5.0 million. The purchase price will be paid in two installments. The first
installment will be paid at closing, net of the estimated cash closing balance,
and the second installment will consist of $16.5 million to be paid in December
2005.
On November 15, 2004 the Company entered into an agreement and plan of
merger to acquire Phonetic Systems, Ltd. to complement our position in automated
directory assistance and enterprise speech applications. The aggregate
consideration consists of (i) approximately $35.0 million in cash, of which
$17.5 million will be paid at closing and $17.5 million will be paid 24 months
after closing, (ii) a contingent payment of up to an additional $35.0 million in
cash to be paid, if at all, upon the achievement of certain performance targets,
and (iii) unvested warrants to purchase 750,000 shares of the Company's common
stock that will vest, if at all, upon the achievement of certain performance
targets.
On November 15, 2004, the Company commenced an offer to purchase all of the
outstanding capital stock of Rhetorical Systems Ltd. for approximately $6.7
million, consisting of approximately $4.9 million in cash and approximately $1.7
million of the Company's common stock. The acquisition was completed on December
6, 2004 for approximately three million Pounds Sterling in cash and 449,437
shares of ScanSoft common stock (valued at approximately $1.7 million based on
the closing price of ScanSoft's common stock on the Nasdaq National Market on
December 6, 2004).
The cash consideration for these acquisitions is expected to be provided by
existing cash, marketable securities and cash generated from operations or
financings.
These strategic acquisitions are expected to expand the Company's speech
capabilities and resources and extend its ability to deliver highly valued
solutions in three key speech sectors -- Directory Assistance, Enterprise Speech
Applications and Wireless Solutions.
23. QUARTERLY DATA (UNAUDITED)
The following information has been derived from unaudited consolidated
financial statements that, in the opinion of management, include all recurring
adjustments necessary for a fair presentation of such information.
FIRST SECOND THIRD NINE
QUARTER QUARTER QUARTER MONTHS
-------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2004
Total revenue............................... $42,776 $46,127 $42,004 $130,907
Net income (loss)............................. $(2,813) $ (410) $(6,155) $ (9,378)
Net income (loss) per share, basic and
diluted..................................... $ (0.03) $ (0.00) $ (0.06) $ (0.09)
Weighted average common shares outstanding:
Basic....................................... 102,847 103,881 104,604 103,780
Diluted..................................... 102,847 103,881 104,604 103,780
87
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- --------
2003
Total revenue..................... $27,836 $27,743 $32,950 $46,870 $135,399
Net income (loss)................... $ (174) $(2,943) $(3,731) $ 1,330 $ (5,518)
Net income (loss) per share, basic
and diluted....................... $ (0.00) $ (0.04) $ (0.04) $ 0.01 $ (0.07)
Weighted average common shares
outstanding:
Basic............................. 67,689 65,821 83,694 103,072 78,398
Diluted........................... 67,689 65,821 83,694 114,648 78,398
88
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On September 14, 2004, the Company filed a current report on Form 8-K,
under Item 4.01 thereunder, to report the resignation of PricewaterhouseCoopers
LLP as the registered independent public accounting firm for Scansoft, Inc.
On October 26, 2004, the Company filed a current report on Form 8-K, under
Item 4.01 thereunder, to report that the Company's Audit Committee of the Board
of Directors had engaged BDO Seidman, LLP as the Company's registered
independent public accounting firm.
There have been no disagreements with the Company's accountants on any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure.
ITEM 9A. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end
of the period covered by this report. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures as of the end of the period covered by this report were
effective in ensuring that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. We believe that a control system, no matter how
well designed and operated, cannot provide absolute assurance that the
objectives of the control system are met, and no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected.
There was no change in our internal control over financial reporting (as
defined in Rule 13a-15(f) of the Exchange Act) that occurred during the period
covered by this report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting, except as
discussed below.
In connection with their audit of our 2004 consolidated financial
statements, BDO Seidman, LLP, our independent registered public accounting firm,
advised management and our Audit Committee of the following significant
deficiencies which did not individually or in the aggregate raise to the level
of material weakness: The Company lacks the necessary corporate accounting
resources to ensure consistently complete and accurate reporting of financial
information which, when combined with the Company's need to realign and
cross-train current finance and accounting personnel, has led to a dependence on
key personnel in the organization, the loss of whom could impair the Company's
ability to ensure consistently complete and accurate financial reporting. In
certain circumstances the Company's accounting transactions, including related
judgments and estimates, were not always supported in a timely manner by a
sufficiently formal processes or sufficiently comprehensive documentation.
In the third quarter of 2003, we commenced our Section 404 compliance
efforts. During 2004, we deployed Oracle 11i to process and report all of our
general accounting functions in our three major locations (Peabody,
Massachusetts, Belgium and Hungary). In 2005, we will implement additional
modules to continue to enhance the functionality of our Oracle implementation.
We are also currently in the process of augmenting current processes,
repositioning current finance and accounting personnel and recruiting additional
personnel to ensure consistently complete and accurate reporting of financial
information and to reduce our dependence on key personnel in our finance and
accounting organization. We currently expect these efforts to extend into the
second half of fiscal 2005. We believe that these efforts will address the
conditions raised by BDO Seidman, LLP.
To the knowledge of our Chief Executive Officer and Chief Financial
Officer, our consolidated financial statements and other financial information
included in this report fairly present in all material respects our financial
condition as of the period ends presented in this report and our results of
operations and cash flows for the periods presented in this report.
89
ITEM 9B. OTHER INFORMATION
Not applicable.
90
PART III
Certain information required by Part III is omitted from this Annual Report
on Form 10-K/T since we intend to file our definitive Proxy Statement for our
next Annual Meeting of Stockholders, pursuant to Regulation 14A of the
Securities Exchange Act of 1934, as amended (the "Proxy Statement"), no later
than January 28, 2005, and certain information to be included in the Proxy
Statement is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item concerning our directors is
incorporated by reference to the information set forth in the section titled
"Election of Directors" in our Proxy Statement. Information required by this
item concerning our executive officers is incorporated by reference to the
information set forth in the section entitled "Executive Compensation,
Management and Other Information" in our Proxy Statement. Information regarding
Section 16 reporting compliance is incorporated by reference to the information
set forth in the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance" in our Proxy Statement.
Our Board of Directors adopted a Code of Business Conduct and Ethics for
all of our directors, officers and employees on February 24, 2004. Our Code of
Business Conduct and Ethics can be found at our website: www.scansoft.com. We
will provide to any person without charge, upon request, a copy of our Code of
Business Conduct and Ethics. Such a request should be made in writing and
addressed to Investor Relations, ScanSoft, Inc., 9 Centennial Drive, Peabody, MA
01960.
To date, there have been no waivers under our Code of Business Conduct and
Ethics. We will post any waivers, if and when granted, of our Code of Business
Conduct and Ethics on our website at http://www.scansoft.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the sections titled
"Executive Compensation, Management and Other Information" in our Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDERS MATTERS
The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated by reference to the
information set forth in the sections titled "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plans" in our Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item regarding certain relationships and
related transactions is incorporated by reference to the information set forth
in the section titled "Certain Relationships and Related Transactions" in our
Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this section is incorporated by reference from
the information in the section entitled "Ratification of Appointment of
Independent Auditors" in our Proxy Statement.
91
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this Report:
(1) Financial Statements -- See Index to Financial Statements in Item 8
of this Report.
(2) Financial Statement Schedules
All schedules have been omitted as the requested information is
inapplicable or the information is presented in the financial statements
or related notes included as part of this Report.
(3) Exhibits -See Item 15(b) of this Report below.
92
(b) Exhibits.
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1(1) Agreement and Plan of Merger, dated December 2, 1998,
between Visioneer, Inc., a Delaware corporation, and the
Registrant.
2.2(2) Agreement and Plan of Reorganization, dated January 15,
2000, by and among the Registrant, Scorpion Acquisitions
Corporation, a Delaware corporation and a wholly-owned
subsidiary of the Registrant, and Caere Corporation, a
Delaware corporation.
2.3(3) Asset Purchase Agreement, dated as of December 7, 2001, by
and among the Registrant and Lernout & Hauspie Speech
Products N.V., a corporation organized and existing under
the laws of the Kingdom of Belgium, L&H Holdings USA, a
Delaware corporation that is a wholly-owned subsidiary of
L&H, and certain other parties.
2.4(20) Purchase Agreement, dated October 7, 2002, between
Koninklijke Philips Electronics N.V. and the Registrant.
2.5(22) Amendment No. 1 to Purchase Agreement, dated as of December
20, 2002, between Koninklijke Philips Electronics N.V. and
the Registrant.
2.6(22) Amendment No. 2 to Purchase Agreement, dated as of January
29, 2003, between Koninklijke Philips Electronics N.V. and
the Registrant.
2.7(23) Agreement and Plan of Reorganization, dated April 23, 2003,
by and among the Registrant, Spiderman Acquisition
Corporation and SpeechWorks International, Inc.
2.8(28) Agreement and Plan of Merger, dated as of May 4, 2004, as
amended on May 28, 2004, by and among the Registrant, 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(4) Amended and Restated Certificate of Incorporation of the
Registrant.
3.2(31) Certificate of Amendment of the Amended and Restated
Certificate of Incorporation of the Registrant.
3.3(29) Amended and Restated Bylaws of the Registrant.
4.1(6) Specimen Common Stock Certificate.
4.2(7) Amended and Restated Preferred Shares Rights Agreement,
dated as of October 23, 1996, as amended and restated as of
March 15, 2004, between the Registrant and U.S. Stock
Transfer Corporation, including the Certificate of
Designation of Rights, Preferences and Privileges of Series
A Participating Preferred Stock, the form of Rights
Certificate and Summary of Rights attached thereto as
Exhibits A, B and C, respectively.
4.3(1) Common Stock Purchase Warrant.
4.4(19) Share Purchase Agreement, dated as of December 13, 2001,
between the Registrant and the State of Wisconsin Investment
Board, as amended.
4.5(19) Share Purchase Agreement, dated as of April 12, 2002,
between the Registrant and SF Capital Partners Ltd.
4.6(30) Securities Purchase Agreement, dated March 19, 2004, by and
among Xerox Imaging Systems, Inc., Warburg Pincus Private
Equity VIII, L.P, Warburg Pincus Netherlands Private Equity
VIII I C.V., Warburg Pincus Netherlands Private Equity VIII
II C.V., Warburg Pincus Germany Private Equity VIII K.G.,
and the Registrant.
93
EXHIBIT
NUMBER DESCRIPTION
------- -----------
4.7(30) Stockholders Agreement, dated March 19, 2004, by and between
the Registrant and Warburg Pincus Private Equity VIII, L.P,
Warburg Pincus Netherlands Private Equity VIII I C.V.,
Warburg Pincus Netherlands Private Equity VIII II C.V., and
Warburg Pincus Germany Private Equity VIII K.G.
4.8(30) Common Stock Purchase Warrants, dated March 15, 2004, issued
to Warburg Pincus Private Equity VIII, L.P., Warburg Pincus
Netherlands Private Equity VIII I C.V., Warburg Pincus
Netherlands Private Equity VIII II C.V., and Warburg Pincus
Germany Private Equity VIII K.G.
10.1(5) Form of Indemnification Agreement.
10.2(9) LZW Paper Input System Patent License Agreement, dated
October 20, 1995, between the Registrant and Unisys
Corporation.
10.3(9) Patent License agreement, dated November 13, 1995, between
the Registrant and Wang Laboratories, Inc.
10.4(10) Software Distribution Agreement, dated April 26, 1995,
between Xerox Imaging Systems, Inc. and Tech Data
Corporation.
10.5(10) Assignment, Assumption, Renewal and Modification Agreement,
dated June 18, 1997, between Xerox Imaging Systems, Inc.,
the Registrant and Tech Data Product Management, Inc.
10.6(21) Distribution Agreement, dated September 22, 1993, between
Ingram Micro, Inc. and Xerox Imaging Systems, Inc., as
amended.
10.7(17) Gold Disk Bundling Agreement: Pagis SE & Pagis Pro, dated
June 29, 1998, between Xerox Corporation, through its
Channels Group, and the Registrant, as amended.
10.8(17) Gold Disk Bundling Agreement, dated March 25, 1998, between
Xerox Corporation, Office Document Products Group and the
Registrant.
10.9(12)** Stand Alone Stock Option Agreement Number 1, dated as of
August 21, 2000, by and between the Registrant and Paul A.
Ricci.
10.10(13) Lease Agreement, dated December 18, 2000, by and between
James M. Salar, as trustee of the JMS Realty Trust, and the
Registrant.
10.11(18) Gold Disk Bundling Agreement, dated as of September 30,
1999, as amended by Amendment Number 1, dated as of January
1, 2000, between the Registrant and Xerox Corporation.
10.12(14) Termination Agreement, dated March 5, 2002, by and between
the Registrant and Robert Teresi.
10.13(11)** Caere Corporation 1992 Non-Employee Directors' Stock Option
Plan.
10.14(19)** 1993 Incentive Stock Option Plan, as amended.
10.15(24)** 1995 Employee Stock Purchase Plan, as amended and restated
on April 27, 2000.
10.16(8)** 1995 Directors' Stock Option Plan, as amended.
10.17(19)** 1997 Employee Stock Option Plan, as amended.
10.18(15)** 1998 Stock Option Plan.
10.19(24)** 2000 Stock Option Plan.
10.20(5)** 2000 NonStatutory Stock Option Plan, as amended.
10.21(5)** ScanSoft 2003 Stock Plan.
10.22(16) Loan and Security Agreement, dated as of October 31, 2002,
between the Registrant and Silicon Valley Bank.
10.23(25) Loan and Security Agreement, dated as of October 31, 2002,
as amended on May 7, 2003, between the Registrant and
Silicon Valley Bank.
94
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.24(26) Loan Modification Agreement, effective as of June 30, 2003,
between the Registrant and Silicon Valley Bank.
10.25(30) Loan and Security Agreement, dated as of October 31, 2002,
as amended on March 31, 2004, between the Registrant and
Silicon Valley Bank.
10.26(21) Letter of Intent, dated March 20, 2002, between the
Registrant and Digital River, Inc.
10.27(22) Technology Transfer and License Agreement, dated as of
January 30, 2003, between Koninklijke Philips Electronics
N.V. and the Registrant.
10.28(22) Promissory Note, dated January 30, 2003, between Koninklijke
Philips Electronics N.V. and the Registrant.
10.29(22) Zero Coupon Convertible Subordinated Note, dated January 30,
2003, between Koninklijke Philips Electronics N.V. and the
Registrant.
10.30(22) Plan of Distribution Agreement, dated January 30, 2003,
between Koninklijke Philips Electronics N.V. and the
Registrant.
10.31(25)** Letter, dated February 17, 2003, from the Registrant to
Jeanne McCann regarding certain employment matters.
10.32(25)** Amendment No. 1, dated April 28, 2003, to Employment
Agreement, dated August 21, 2000, by and between the
Registrant and Michael K. Tivnan.
10.33(25) Reseller Agreement, dated as of March 31, 2003, by and
between the Registrant and International Business Machines.
10.34(27)** Employment Agreement, dated August 11, 2003, by and between
the Registrant and Paul A. Ricci.
10.35(30)** Employee Separation Agreement, dated March 18, 2004, by and
between the Registrant and Stuart R. Patterson.
10.36(31)** Employment Agreement, dated March 9, 2004, by and between
the Registrant and John Shagoury.
10.37(31)** Letter, dated May 23, 2004, from the Registrant to Steven
Chambers regarding certain employment matters.
10.38** Agreement and General Release, dated September 28, 2004, by
and between the Registrant and David Gerth.
10.39** Letter, dated September 27, 2004, from the Registrant to
James R. Arnold, Jr. regarding certain employment matters.
14.1(29) ScanSoft Code of Business Conduct and Ethics.
16.1(32) Letter from PricewaterhouseCoopers LLP to the Securities and
Exchange Commission dated September 14, 2004.
21.1 Subsidiaries of the Registrant.
23.1 Consent of BDO Seidman, LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
24.1 Power of Attorney. (See Signature Page)
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) or 15d-14(a).
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a) or 15d-14(a).
32.1 Certification Pursuant to 18 U.S.C. Section 1350.
---------------
** Denotes Management compensatory plan or arrangement.
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 (No. 333-70603) filed with the Commission on January 14, 1999.
95
(2) Incorporated by reference from the Registrant's Registration Statement on
Form S-4 (No. 333-96487) filed with the Commission on February 9, 2000.
(3) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on December 27, 2001.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2001, filed with the Commission
on May 11, 2001.
(5) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (No. 333-108767) filed with the Commission on September 12, 2003.
(6) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement of Form 8-A (No. 0-27038) filed with the Commission
on December 6, 1995.
(7) Incorporated by reference from the Registrant's Amendment to Registration
Statement of Form 8-A/A (No. 0-27038) filed with the Commission on March
19, 2004.
(8) Incorporated by reference from the Registrant's Definitive Proxy Statement,
filed with the Commission on April 30, 2002.
(9) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement of Form S-1 (No. 33-98356) filed with the Commission
on November 15, 1995.
(10) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the fiscal year ended January 3, 1999, filed with the Commission on
April 5, 1999.
(11) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (No. 333-33464) filed with the Commission on March 29, 2000.
(12) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (No. 333-49656) filed with the Commission on November 9, 2000.
(13) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000, filed with the Commission on
April 2, 2001.
(14) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on March 7, 2002.
(15) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (No. 333-74343) filed with the Commission on March 12, 1999.
(16) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 2002, filed with the
Commission on November 14, 2002.
(17) Incorporated by reference from the Registrant's Amendment No. 2 to Form
10-K for the fiscal year ended January 3, 1999, filed with the Commission
on February 8, 2000.
(18) Incorporated by reference from the Registrant's Amendment No. 1 to Form
10-K for the fiscal year ended December 31, 2000, filed with the Commission
on August 8, 2001.
(19) Incorporated by reference from the Registrant's Registration Statement of
Form S-1 (No. 33-100647) filed with the Commission on October 21, 2002.
(20) Incorporated by reference from the Registrant's Amendment No. 1 to
Registration Statement of Form S-1 (No. 33-100647) filed with the
Commission on December 6, 2002.
(21) Incorporated by reference from the Registrant's Amendment No. 2 to
Registration Statement of Form S-1 (No. 33-100647) filed with the
Commission on January 6, 2003.
(22) Incorporated by reference from the Registrant's Amendment No. 4 to
Registration Statement of Form S-1 (No. 33-100647) filed with the
Commission on February 7, 2003.
(23) Incorporated by reference from the Registrant's Registration Statement of
Form S-4 (No. 33-106184) filed with the Commission on June 17, 2003.
(24) Incorporated by reference from the Registrant's Definitive Proxy Statement,
filed with the Commission on April 13, 2004.
96
(25) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2003, filed with the Commission
on May 15, 2003.
(26) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended June 30, 2003, filed with the Commission
on August 14, 2003.
(27) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 2003, filed with the
Commission on November 14, 2003.
(28) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on June 30, 2004.
(29) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2004, filed with the Commission on
March 15, 2004.
(30) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2004, filed with the Commission
on May 10, 2004.
(31) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the fiscal quarter ended June 30, 2004, filed with the Commission
on August 9, 2004.
(32) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed with the Commission on September 14, 2004.
97
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K/T to be signed on its behalf by the undersigned, thereunto duly authorized.
SCANSOFT, INC.
By: /s/ PAUL A. RICCI
--------------------------------------
Paul A. Ricci
Chief Executive Officer and Chairman
of the Board
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Paul A. Ricci and James R. Arnold, Jr.
jointly and severally, his or her attorneys-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Annual Report on Form 10-K/T and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each said
attorneys-in-fact, or his or her substitute or substitutes, may do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K/T has been signed by the following persons in the
capacities and on the dates indicated.
Date: January 6, 2005 /s/ Paul A. Ricci
--------------------------------------------------------
Paul A. Ricci, Chief Executive Officer and Chairman of
the Board (Principal Executive Officer)
Date: January 6, 2005 /s/ James R. Arnold, Jr.
--------------------------------------------------------
James R. Arnold, Jr., Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: January 6, 2005 /s/ Gerald C. Kent, Jr.
--------------------------------------------------------
Gerald C. Kent, Jr. Vice President, Chief Accounting
Officer and Controller (Principal Accounting Officer)
Date: January 6, 2005 /s/ Mark Myers
--------------------------------------------------------
Mark Myers, Director
Date: January 6, 2005 /s/ Katharine A. Martin
--------------------------------------------------------
Katharine A. Martin, Director
Date: January 6, 2005 /s/ Robert G. Teresi
--------------------------------------------------------
Robert G. Teresi, Director
Date: January 6, 2005 /s/ Robert J. Frankenberg
--------------------------------------------------------
Robert J. Frankenberg, Director
Date: January 6, 2005 /s/ Robert Finch
--------------------------------------------------------
Robert Finch, Director
Date: January 6, 2005 /s/ John C. Freker, Jr.
--------------------------------------------------------
John C. Freker, Jr., Director
Date: January 6, 2005 /s/ William H. Janeway
--------------------------------------------------------
William H. Janeway, Director
98