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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 3, 1999 COMMISSION FILE NUMBER 0-27038
SCANSOFT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3156479
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9 CENTENNIAL DRIVE
PEABODY, MASSACHUSETTS 01960
(978) 977-2000
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.001 par value
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 [] 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 or any
amendment to this Form 10-K. []
The aggregate market value of voting stock held by non-affiliates of
the Registrant was approximately $23,752,027 as of March 26, 1999, based on
$1.625 per share, the last reported sales price on the Nasdaq National Market
for such date. Shares of Common Stock held by each executive officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of the registrant's Common Stock, $0.001 par
value, outstanding as of March 26, 1999 was 26,355,780.
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SCANSOFT, INC.
TABLE OF CONTENTS
Page
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PART I.........................................................................1
ITEM 1. Business.........................................................1
ITEM 2. Properties......................................................17
ITEM 3. Legal Proceedings...............................................17
ITEM 4. Submission of Matters to a Vote of Security Holders.............17
PART II.......................................................................18
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters.............................................18
ITEM 6. Selected Financial Data.........................................19
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................20
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.....31
ITEM 8. Financial Statements and Supplementary Data.....................32
ITEM 9. Changes in and Disagreements with Accounts on Accounting
and Financial Disclosure........................................51
PART III......................................................................52
ITEM 10. Directors and Executive Officers of the Registrant.............52
ITEM 11. Executive Compensation.........................................54
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.59
ITEM 13. Certain Relationships and Related Transactions.................60
PART IV.......................................................................63
ITEM 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K....................................................63
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PART I
WHEN USED IN THIS REPORT, THE WORDS "EXPECTS," "INTENDS," "BELIEVES,"
"PROJECTS," "PLANS," "ANTICIPATES," "ESTIMATES," AND SIMILAR WORDS AND
EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE
STATEMENTS, WHICH INCLUDE STATEMENTS AS TO THE TIMING OF PRODUCT RELEASES, THE
PERFORMANCE AND UTILITY OF THE COMPANY'S PRODUCTS AND EARNINGS AND
PROFITABILITY, ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. THESE RISKS AND UNCERTAINTIES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE RISKS DISCUSSED BELOW AND UNDER ITEM
7--"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND OTHER RISKS DETAILED FROM TIME TO TIME IN OUR PERIODIC REPORTS
AND OTHER INFORMATION FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE
FORWARD-LOOKING STATEMENTS SPEAK ONLY AS THE DATE HEREOF. THE COMPANY EXPRESSLY
DISCLAIMS ANY OBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR
REVISION TO ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANY
CHANGE IN THE COMPANY'S EXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN
EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.
ITEM 1. BUSINESS
GENERAL
On January 6, 1999, we sold our hardware business to a newly formed
subsidiary of Primax Electronics, Ltd. for approximately $7 million. On March 2,
1999, Visioneer acquired ScanSoft, Inc., an indirect wholly owned subsidiary of
Xerox Corporation, in a cash election merger. The corporate entity "Visioneer"
survived the merger, but changed its name to "ScanSoft, Inc." In addition, we
changed the ticker symbol for our common stock, that trades on the Nasdaq, to
"SSFT." In this Report, the "Company," the "Registrant," "ScanSoft," "We," "Our"
and "Visioneer" refer to the surviving company unless the context otherwise
requires.
Under our agreement with Primax, Primax's subsidiary acquired our
hardware business, including all of our hardware assets, liabilities and related
intellectual property, and the name "Visioneer," and assumed our Fremont,
California lease. In addition, we entered into a multi-year licensing agreement
with Primax's subsidiary (now called Visioneer) to bundle PaperPort software
products with the Visioneer line of hardware imaging products.
Pursuant to the terms of the agreement with Xerox, we acquired ScanSoft
for approximately 6.8 million shares of common stock, a warrant to purchase up
to an additional 1.7 million shares of common stock exercisable upon certain
events, approximately 3.6 million shares of non-voting Series B Preferred Stock
and the assumption of 1.7 million ScanSoft stock options. In connection with the
merger, approximately 5.1 million shares of our outstanding stock, which shares
are now owned by Xerox, were cashed out at $2.06 per share with consideration
from Xerox. Additionally, approximately 330,000 shares were cashed out at $2.06
per share with consideration from the Company. Xerox owns approximately 45% of
the outstanding shares of our common stock and has two designees on the Board,
including Paul A. Ricci, the new Chairman of the Board.
PRODUCTS
Our PaperPort products provide an integrated hardware and software
solution at the desktop through compact sheetfed scanners and larger flatbed
scanners. Our PaperPort sheetfed scanners and PaperPort flatbed scanners and
their associated intellectual property were sold as part of the sale of our
hardware business to Primax in January 1999. After the merger with ScanSoft in
March 1999, we acquired additional software products based on patented optical
character recognition ("OCR") and image processing technologies. The Software
products acquired in the merger with ScanSoft include TextBridge Pro, Pagis Pro,
ProOCR 100 and ScanWorks.
We provide digital imaging software products for retail, OEM and
corporate markets. Our products capture and convert paper documents and photos
into digital documents and images and enhance a user's ability to organize and
share digital documents and images in the office, at home and on the Internet.
Our products are based on patented optical character recognition ("OCR") and
image processing technologies, designed to address the
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needs of a broad group of users ranging from consumers and small office to
medium sized businesses and large corporations.
Our software products include OCR, personal document management and
software suites that offer various combinations of these products and often
third party offerings. We believe that our ability to achieve broad market
acceptance of our products will depend on several factors, including, but not
limited to, ease-of-use, OCR accuracy, speed, and overall functionality. In
addition, the ability of our software to integrate with desktop operating
systems, word processing applications, email software, fax applications, image
editing products and Internet publishing tools will affect our ability to
achieve market acceptance for our products. In that regard, our strategy is to
maintain and enhance our technological position by investing in OCR and image
processing technology and strategic business and technology partnerships with
other leading companies.
We also provide software in two other emerging markets: enterprise
imaging and Internet imaging software. The enterprise imaging software market
includes high-end OCR products and software targeted at the emerging network
scanning market. The network scanning and multifunction market includes devices
from Xerox, Canon, Ricoh, and Hewlett Packard. Several network multifunction
devices offer scanning options that use client software to convert, edit,
organize and distribute digital documents via fax, email and the Internet.
Currently, we bundle client software with Xerox network multifunction devices.
The Internet imaging software market includes products that make it
easier to publish and share paper documents and photos via the Internet.
Currently, our products allow users to capture and convert paper-based documents
to Joint Photographic Experts Group ("JPEG"), Hypertext Mark-up Language
("HTML") and Portable Document Files ("PDF") files and share photos and
documents via email or as part of an Internet site.
During 1998, we provided an integrated hardware and software solution
at the desktop through compact sheetfed scanners and larger flatbed scanners.
PaperPort's high-performance scanners intelligently automated the paper input
process by performing multiple operating functions without user intervention and
provided advantages in scanning speed, image quality and image orientation.
Since we sold our hardware assets, liabilities and intellectual property to
Primax on January 6, 1999, our products have been entirely focused on software
as described above.
PRODUCT DESCRIPTION
The following is a description of our PaperPort Deluxe, PaperPort
Scanner Suite and Visual Explorer software products, as well as the TextBridge
Pro, Pagis Pro, ProOCR 100 and ScanWorks software products which were acquired
in the merger with ScanSoft in March 1999.
PRODUCTS FOR BUSINESSES AND PROFESSIONAL USERS
PAPERPORT DELUXE -- PaperPort Deluxe is paper management software
designed for small office and home office users. It turns a scanner or
multi-function-peripheral into a versatile solution for filing, copying, finding
and sharing paper and photographs. PaperPort Deluxe provides a visual desktop
with thumbnail file representations that allow users to quickly browse and
locate images, Web pages and electronic files. Other key features include
SimpleSearch, which enables users to find scanned images, electronic documents
and Web pages by searching file names, content or keywords, and ScanDirect,
which enables direct scanning into linked applications. PaperPort Deluxe is
compatible with the Windows 95, Windows 98 and Windows NT 4.0 operating systems.
PAPERPORT SCANNER SUITE -- PaperPort Scanner Suite combines all the
features of PaperPort Deluxe and TextBridge Pro to provide a easy way scan,
organize, edit and share paper documents, photos, Web pages and electronic
files. PaperPort Scanner Suite is compatible with the Windows 95, Windows 98 and
Windows NT 4.0 operating systems.
TEXTBRIDGE PRO -- TextBridge Pro is a very accurate and versatile OCR
software that allows users to easily edit paper documents, turn price lists into
spreadsheets, or brochures into Web pages. TextBridge Pro combines
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OCR with page layout comprehension to recreate electronic files that are similar
to the paper originals in terms of page layout, font characteristics and
graphics. For flexibility, TextBridge Pro provides text, table and picture
zoning tools that allow users to choose what sections of a document they want to
recognize. In addition, TextBridge Pro offers built-in post-recognition editing,
which enables users to conveniently proofread converted documents against the
original scanned image. TextBridge Pro is a Windows 95, Windows 98 and Windows
NT compliant application. There are also versions available for Windows 3.x and
Macintosh System 8.x. TextBridge Pro supports recognition for twelve languages
and is localized for European distribution.
PAGIS PRO -- Pagis Pro is a comprehensive scanning suite that combines
the Pagis digital imaging desktop with TextBridge Pro and MGI PhotoSuite to
transform an office personal computer into a paper-to-digital solution for
electronically filing, copying, editing and sharing documents and photos. Pagis
Pro intelligently scans color documents and photos and creates color images that
are easy to view, share, and print. Its folders provide visual image thumbnails
to quickly browse and locate scanned images, and Pagis Pro provides powerful
full-text and keyword indexing to help users retrieve document images, photos
and electronic files. Using the Extended Image File Format ("XIFF"), Pagis Pro
can store and send high-quality color document image files that are a fraction
of the size of images saved in a standard image file format, such as Tagged
Image File Format ("TIFF"). An image viewer provides image editing, selection
and annotation tools. These tools help users enhance an image, select a portion
of the image they want to work with, and add highlights or notes to an image.
TextBridge Pro is integrated into the Pagis desktop, so users can easily convert
paper documents and bring the recognized pages into a word processor or
spreadsheet. For photo editing and photo projects, Pagis Pro integrates a third
party photo editor. Pagis Pro is compatible with Windows 95, Windows 98 and
Windows NT 4.0 operating systems.
PRODUCTS FOR CONSUMERS
VISUAL EXPLORER -- Visual Explorer enables users to visually manage all
their electronic files and Web pages. Visual thumbnails of documents and Web
pages enable users to quickly identify their files. In addition, the software
includes SimpleSearch, which enables users to find documents and Web pages by
searching file names, URLs, content or keywords. A MiniViewer allows users to
easily open and view any email attachments (documents) sent to them. Visual
Explorer is compatible with the Windows 95 and Windows 98 operating systems.
PROOCR 100 -- ProOCR100 is OCR software that is designed for simplicity
and ease-of-use. Users can simply click on the Auto-OCR button to automatically
walk through the text recognition process. Designed to handle real documents,
ProOCR100 can recognize pages with degraded text (like faxes and photocopies)
and complex documents with multiple columns and tables. ProOCR100 is compatible
with the Windows 95, Windows 98 and Windows NT 4.0 operating systems.
SCANWORKS -- ScanWorks combines the Pagis digital imaging desktop with
MGI PhotoSuite to provide an easy to use, consumer oriented scanning software
suite that enables users to edit and share photos, keep track of important
documents and conveniently make color copies at home. ScanWorks intelligently
scans color photos and documents and creates color images that are easy to view,
share, and print. ScanWorks folders provide visual image thumbnails to quickly
browse and locate scanned images, and ScanWorks provides powerful full-text and
keyword indexing to help users retrieve document images, photos and electronic
files. Using the XIFF file format, ScanWorks can store and send high-quality
color document image files that are a fraction of the size of image files saved
in an uncompressed image format. ScanWorks also has a image viewer with image
editing, selection, and annotation tools. For more advanced image editing and
photo projects, ScanWorks integrates a third party photo editor. ScanWorks is
compatible with the Windows 95, Windows 98 and Windows NT 4.0 operating systems.
OEM PRODUCTS
We bundle various versions of Pagis, PaperPort, Visual Explorer and
TextBridge with leading scanner, multifunction device and storage device
manufacturers and leading independent software vendors. OEM customers often
require us to integrate products with other applications or customize existing
products to meet specific requirements. Therefore, we offer OEM customers both
packaged products to bundle and a software developer's toolkit to facilitate the
integration of OCR functionality with other applications.
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PRODUCTS SOLD TO PRIMAX
Our sheetfed and flatbed scanners and their associated intellectual
property were sold to Primax Electronics, Ltd. on January 6, 1999. These
products are described below:
PAPERPORT SHEETFED SCANNERS -- The PaperPort sheetfed scanners are
integrated hardware and software solutions for paper input and digitized
document and image management that are easy to use, fast and cost-effective. The
PaperPort Vx and mx grayscale scanners are small in size (12" x 2.5" x 3.75")
and are designed to operate on the desktop between the keyboard and monitor. The
PaperPort Vx is compatible with Macintosh personal computers, while the
PaperPort mx is compatible with Windows 3.1, Windows 95, Windows 98 and Windows
NT. The PaperPort ix, a scanning keyboard, is a grayscale scanner fully
integrated into a keyboard and is compatible with the aforementioned Windows
releases. The PaperPort Strobe is a color scanner that was smaller (11" x 2.5" x
2") and faster than our grayscale predecessors. It is available in both
Macintosh and Windows versions, Windows 3.1, Windows 95 and Windows 98. The
Windows versions are also available in either a parallel or serial interface,
and the Macintosh version incorporates a SCSI interface. PaperPort sheetfed
scanners are designed to handle multiple sizes, shapes and textures of paper,
including business cards, newspaper articles, business memos, receipts and
photographs, and a broad range of paper types. In 1998, we recognized the end of
life of our grayscale sheetfed scanners and produced only the color PaperPort
Strobe. This scanner features 24-bit, 600 dpi color images, offering high
quality and high-resolution.
PAPERPORT FLATBED SCANNERS -- Our product line included three distinct
groups of flatbed scanners. The first group, the 30-bit line, scans 30-bit color
images in either 300 x 600 dpi optical resolution or 600 x 1200 dpi optical
resolution. In addition, we sold the 3100USB, a scanner with the above
characteristics that utilizes the Universal Serial Bus (USB) port on newer
personal computers that run Windows 98. The second group, the 36-bit line, scans
36-bit color images in 600 x 1200 dpi. The third group, the OneTouch line, scans
36-bit color images in either 300 x 600 dpi optical resolution or 600 x 1200 dpi
optical resolution with the press of a single button. This scanner features
five-button functionality that was automatically linked with the software. All
three groups of scanners are compatible with Windows 95 and Windows 98 and
featured a pass-through parallel port design, as well as USB compatibility for
the 3100USB, that allows them to easily connect to a Windows PC. In addition to
the base version of our document management and image editing software, these
flatbed scanners were bundled with Visioneer's Web Publishing Kit, a collection
of Internet tools and utilities, which simplify the creation of Web sites.
NEW PRODUCTS
We intend to design and develop products to extend the life and
usability of our products for our installed base through the development of
software upgrades and add-on accessory products. We also intend to offer these
upgrades to our OEM partners. We also plan to incorporate new software features
into our software, and to expand our software product lines in 1999 through the
development of alternative form factors comprising enhanced imaging
capabilities, and other features and functionality. We believe that the
development of these and other products and features is essential to our
success. Accordingly, we will continue to make significant investments in the
research and development of new products. Such expenses may fluctuate from
quarter to quarter depending on a wide range of factors, including the status of
various development projects.
ENABLING TECHNOLOGY
We have devoted substantial resources to develop software technologies
to create comprehensive, easy-to-use, and versatile products for users of image
capture devices, such as scanners, multifunction peripherals and digital
cameras.
Our software is developed using OCR and image processing technologies,
Application Programming Interfaces (APIs), object-oriented development tools,
and modern graphical user interface designs. In addition, our products employ
commercial text retrieval database systems, electronic document format
conversion toolkits, and standard scanner device interfaces.
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API -- Our TextBridge and PerfectScan APIs are the foundation for
products in both the TextBridge product-line and Pagis product-line. These APIs
provide an interface to the OCR and image processing technologies and provide
image text conversion, image processing and cleanup, scanner and digital camera
control, image file format read and write with image compression, and image
printing.
For PaperPort and Visual Explorer products, software applications on
the hard drive are recognized, and linking icons to applications supported by
the PaperPort API are placed on the PaperPort or Visual Explorer desktop. In
addition, "AutoLaunch" technology allows users to launch input with digitized
documents directly into third-party software applications and peripherals
already installed on the user's personal computer. The PaperPort software
locates these paper-enabled third-party software applications and peripherals
and builds drag and drop buttons for one-button distribution of these digitized
documents. Using the PaperPort API, developers can create PaperPort links to
expedite the intelligent transfer of documents between the PaperPort software
and their applications. These functions allow developers to automate certain
tasks such as user interface management, file conversion, software
initialization, object control and OCR.
OCR -- Our OCR technology provides image-to-text document conversion.
This technology provides high quality character recognition accuracy with page
layout retention, including the ability to reconstruct headers, footers,
columns, paragraphs, embedded images, captions, inverted text and character font
attributes. Additionally, the OCR engine provides document export directly to
Rich Text Format ("RTF"), PDF, HTML and ASCII text, and many other industry
standard electronic document formats via third-party conversion technology. The
OCR engine employs a number of technologies to improve document recognition
accuracy. These technologies are described below:
CHARACTER/WORD ACCURACY -- Character accuracy refers specifically to
correctly identifying the actual characters in a page image. Traditional OCR
contains basic capabilities for identifying the shapes of the characters through
pattern recognition techniques. The TextBridge OCR engine employs a variety of
different recognition "experts," which work cooperatively in the OCR process.
SEGMENTATION -- Segmentation is the process of differentiating between
the text and picture components of a given page image. The segmentation in
TextBridge performs that function as well as identifies the appropriate
lexicographical ordering of the regions of text on the page, so that the final
output will appear in correct read order.
OUTPUT FORMATTING -- TextBridge's formatting capabilities make it
possible to reconstruct most compound document formats, including multiple
columns, cell tables, pictures, captions, headers and footers, thereby saving
the end-user reformatting time and effort. The most recent additions to
TextBridge's reformatting abilities include reverse video (white-black) text
output and insets.
IMAGE PROCESSING -- Our image processing technology provides capture,
enhancement and compression techniques. The heart of the image processing core
engine is page segmentation capabilities which provide the ability to decompose
a page image into its components, including text, pictures, background tints,
and text color. The image processing core engine also provides efficient page
enhancement technologies such as auto-crop, auto-straighten, automatic picture
enhancement, high-speed rendering, line removal, speck removal, tint removal and
forms field detection.
Our advanced image compression technologies employ wavelet, JPEG,
symbol-based and Huffman compression techniques to facilitate the process of
capturing high-quality compound color documents and store them in the compact
XIFF image format. XIFF images are a fraction of the size of images saved in a
standard image file format, such as TIFF. Moreover, the text is clean and
suitable for OCR, faxing or printing.
MARKETING, SALES AND DISTRIBUTION
The primary market for our products is comprised of computer users who
required access to both paper and electronic information. The SOHO (Small
Office, Home Office) market, which represented a significant majority of our
branded business, has been targeted by us because mobile and home-based
professionals require office-like
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productivity without access to copiers, fax machines and scanners. This market,
within the last 18 months, has been increasingly attracted to scanners offering
color imaging capability. With the advent of color sheetfed and flatbed
scanners, the grayscale sheetfed scanner market continued its decline in 1998.
In 1998 we derived substantially all of our branded revenues from sales
through our independent distributors, retailers and resellers. Although we have
established strategic software OEM partnerships, we expect that sales through
our independent distributors and resellers will continue to account for a
substantial portion of our revenues for the foreseeable future. Our top four
retail customers for 1998 were Sam's Club (owned by "Wal-Mart"), Office Depot,
Inc., Best Buy Company, Inc. and CompUSA, Inc. for distribution of our products
in North America. Sales to these top four independent distributors and resellers
accounted for 46% of our total net revenues in 1998 in the aggregate, or 18%,
12%, 9% and 7%, respectively, as compared to 38% of our total revenues in 1997.
With the transition to a software only business, we expect to derive the
majority of our revenue through our independent distributors, including Ingram
Micro, Tech Data and Merisel. These distributors in turn sell to computer
superstores, such as Comp USA and Fry's Electronics; consumer electronic stores,
such as Best Buy and Circuit City; mail order houses, such as PC Connection and
MicroWarehouse; and office superstores, such as Office Max, Office Depot and
Staples. Our agreements with our distributors and resellers are not exclusive,
and each of our distributors and resellers can cease marketing our products with
limited notice and with little or no penalty. There can be no assurance that our
independent distributors and resellers will continue to offer our products or
that we will be able to recruit additional or replacement distributors. The loss
of one or more of our major distributors or resellers would have a material
adverse effect on our business, operating results and financial condition. Many
of our distributors and resellers offer competitive products. There can be no
assurance that our distributors and resellers will give priority to the
marketing of our products as compared to competitor's products. Any reduction or
delay in sales of our products by our distributors and resellers would have a
material adverse effect on our business, operating results and financial
condition.
We grant our distributors and resellers price protection and certain
rights of return with respect to products purchased by them. In addition, we
offered various end-user rebate programs for our products. We accrue for
expected returns, anticipated price reductions, and anticipated rebate
redemption in amounts that the Company believes are reasonable. However, there
can be no assurance that these accruals will be sufficient or that any future
returns, price protection charges, or rebate redemption will not have a material
adverse effect on our business and operating results, especially in light of the
rapid product obsolescence which often occurs during product transitions. The
short product life cycles of our products and the difficulty in predicting
future sales increase, the risk of new product introductions, price reductions
by our competitors, or other factors affecting the paper input market could
result in significant product returns. In addition, there can be no assurance
that new product introductions by competitors or other market factors will not
require us to reduce prices in a manner or at a time or rate which gives rise to
significant price protection charges and which would have a material adverse
effect on our operating results. Any product returns, price protection charges,
or rebate redemption in excess of recorded allowances would have a material
adverse effect on our business, operating results and financial condition.
Net revenues from resellers and distributors outside North America
represented approximately 7% of net revenues in 1998 as compared to 10% in 1997.
Prior to the acquisition of ScanSoft, we had limited experience in developing
international versions of our products and marketing, distributing, servicing
and supporting such products. However, ScanSoft derived 19% of its revenues in
1998 from international sales and has a subsidiary in the United Kingdom. We
expect our combined revenues from international sales to account for
approximately 13% of revenues in 1999.
Domestically, full-featured software product customers who register
with us currently receive limited hotline technical support and product
information at no cost. Additional technical support services are available on a
"fee for support" basis. We currently offer several technical support options to
customers of packaged products. These include telephone, fax or email support by
a customer support representative or self help by accessing our technical
information bulletins or frequently asked questions on the Internet. Outside of
the U.S., full-featured software product customers receive technical support
from a third party company on both a fee and non-fee basis.
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OEM RELATIONSHIPS
Prior to the merger with ScanSoft, we had software OEM agreements with
several companies including Western Digital Corporation, Brother Industries,
Ltd., Minolta Co. Ltd., Omron Software Company, Ltd., Agfa-Gevaert N.V. and
Epson America, Inc. These OEM agreements remained with us after the merger.
ScanSoft, as an indirect wholly owned subsidiary of Xerox Corporation,
had software OEM agreements with several companies including: Mustek Systems,
Inc., Microtek International, Inc., Seiko-Epson Corporation, Canon Computer
Systems, Inc., IBM, Plustek USA, Inc., Primax Electronics, Inc., Avision Labs,
Inc., Compaq Computer Corporation, Acer Peripherals, Inc. and Symantec
Corporation. Additionally, ScanSoft also entered into multiple non-exclusive
agreements with Xerox Corporation (a significant stockholder) in which ScanSoft
agreed to license Xerox the royalty-bearing right to copy and distribute certain
versions of Pagis and TextBridge software programs with Xerox's multi-function
peripherals.
We are pursuing and may enter into additional OEM agreements to
distribute our software products. However, there are certain risks associated
with such relationships, including whether sufficient priority will be given by
such OEM partners to market our products and whether such OEM partners will
continue to offer our products. Such risks have been experienced by us in
regards to our agreements with Hewlett-Packard and Compaq. The loss of any OEM
partnership or our inability to enter into additional OEM partnerships could
have a material adverse effect on our business, operating results and financial
condition. See "Item 7--Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."
RESEARCH AND DEVELOPMENT
Our research and development team, after the merger on March 2, 1999,
is located at our headquarters in Peabody, Massachusetts. As of December 31,
1998, we employed 21 full-time and 4 contract software design and quality
assurance engineers, technicians and support staff in Fremont, California. The
primary activities of these employees during 1998 were the design and
development of the sheetfed and flatbed scanner lines, the development of the
PaperPort flatbed line of products, the development of a new release of
PaperPort Deluxe Software, the development of other new software products
(ProOCR 100, Visual Explorer, Scanner Suite and ScannerWorks), enhancements of
existing products, product testing, and technical documentation development.
In 1998, the research and development team in Fremont, California was
restructured into a smaller group. Our strategy was to concentrate our efforts
on software development, and leverage the hardware and mechanical engineering
capabilities of our manufacturing partners to design and build our future
hardware products. The 30 bit, 36-bit, and One Touch flatbed scanners,
introduced in 1998, were designed in cooperation with our manufacturing
partners, Avision, Inc and Primax Electronic, Ltd. However, all flatbed and
sheetfed scanners and their associated intellectual property were part of the
sale of hardware assets, liabilities and intellectual property sold to Primax
Electronics, Ltd. on January 6, 1999.
Since the completion of the merger, we are consolidating the research
and development organization to the new corporate headquarters. We expect to
complete the transition by the end of June 1999.
Our growth and future financial performance will depend in part upon
our ability to enhance existing applications, and develop and introduce new
applications that keep pace with technological advances, meet changing customer
requirements, respond to competitive products and achieve market acceptance. As
a result, we expect that we will continue to commit substantial resources to
product research and development in the future.
MANUFACTURING
In the past, we contracted nearly all materials procurement,
manufacturing, assembly, testing and quality assurance to third party
manufacturers. Purchase orders were placed on our manufacturing partners for
final assemblies or subassemblies, which in turn were delivered to other
manufacturing partners who perform final assembly, pack-out and shipment to our
customers. This outsourcing strategy allowed us to leverage off of the
manufacturing
7
and engineering expertise and economies of scale of our manufacturing partners,
while allowing our manufacturing and operations team to concentrate on value
added activities, such as vendor management, product price negotiations and cost
reduction efforts. However, all flatbed and sheetfed scanners and their
associated intellectual property were part of the sale of our hardware business
in January 1999.
We had six significant independent manufacturing partners in 1998.
Primax Electronics, Ltd., Orient SemiConductor Ltd, Flextronics International
Marketing (L) Ltd., NMB Technologies, Inc., Avision, Inc. and DisCopyLabs.
Flextronics manufactured our standalone grayscale product lines, the PaperPort
Vx for Macintosh, and the PaperPort mx for Windows. NMB manufactured our
scanning keyboard product, the PaperPort ix, and our color sheetfed scanners,
the PaperPort Strobe. On January 19, 1998, we notified NMB that we wished to
terminate the manufacturing agreement for the PaperPort Strobe, based on NMB's
inability to comply with certain cost reduction stipulations as specified. As of
March 16, 1998, we had qualified two manufacturers for the PaperPort Strobe
products, Orient SemiConductors, Ltd. and Flextronics.
In 1999, following the sale of our hardware business to Primax, we have
reduced our key supplier list to one supplier on the west coast, DCL and one
supplier on the east coast, Omnet Technology Corporation, for our software
products.
Unforeseen factors with our suppliers may result in production delays.
Any performance problems or production delays could have a material adverse
effect on our business, operating results and financial condition. In addition,
there can be no assurance that current or future manufacturing partners will be
able to meet our requirements for manufactured products. Any inability to
increase manufacturing capacity as required could have a material adverse effect
on our business, operating results and financial condition. In addition, the
current purchase order arrangements with our manufacturing partners would allow
them to terminate the arrangements by not accepting our purchase orders. The
unanticipated loss of any of our manufacturing partners could cause delays in
our ability to ship orders while the Company identifies a replacement
manufacturer. Such an event would have a material adverse effect on our
business, operating results and financial condition. In addition, we are
continually exploring alternative manufacturing sources, including potential
sources for new products. However, there can be no assurance that such
alternative sources can be successfully developed.
Our manufacturing policies were designed to reduce our investment in
inventories, yet still respond to rapid changes in customer demand, but may in
certain instances result in excess or insufficient inventory, or inappropriate
mix of component inventory, if orders do not match forecasts. To the extent we
have excess inventories, we may experience inventory write-downs or may have to
lower prices of our products which would result in substantial price protection
charges and a negative impact on gross margins. To the extent we have
insufficient inventory, we may be materially adversely impacted by the loss of
one or more of our distribution and reseller relationships and the inability to
obtain market acceptance of our products.
COMPETITION
The digital imaging market is highly competitive. It is subject to
rapid change along with frequent new product introductions and enhancements, as
well as constant pressure to reduce prices. We believe that the principal
competitive factors in this market include OCR accuracy, ease of understanding
and use, product reliability, tolerance for poor media, product features and
functions, price/performance characteristics, brand recognition, and quality of
product support. Our competition within the digital imaging software market
ranges from large corporations to small independent software vendors. We also
expect to encounter continued competition, both from established companies and
from new companies that are now developing, or may develop, competing products.
The TextBridge family of OCR products face competition in two markets:
the market for packaged OCR application programs and OEM bundled OCR products.
Several companies offer packaged OCR application programs through the channel,
including companies such as Caere Corporation and Adobe Corporation and several
small independent software vendors. We face significant price pressure in the
retail channel. In the OEM market in which companies "bundle" the OCR technology
with related hardware products, such as scanners or multifunction peripherals,
or incorporate OCR technology into third party application software products,
competitors include
8
Caere Corporation and several small independent software vendors. We have
experienced significant price competition in the OEM market and expect this to
continue. In addition, the "bundled" OCR products themselves present competition
to our fully featured shrinkwrap products.
The Pagis and PaperPort family of products compete with various
products in the digital imaging software marketplace. In the personal document
management segment there are several competitors, including DocuMagix, Inc. (a
division of JetFax Corporation), Caere Corporation, Newsoft (a subsidiary of
UMAX Corporation), and Eastman Software (a subsidiary of Kodak Corporation).
With decreasing prices driving affordable scanning solutions into the
mainstream, we expect to face increasing competition in this product category
from a variety of software developers.
In the scanning software suite segment, our products include various
combinations of the products mentioned above and often include photo-editing
capabilities. Competitors include Adobe Corporation. Caere Corporation has also
announced plans to enter this market segment. Microsoft and MGI Software offer
photo-editing products and could offer products in this market segment in the
future.
We expect that some consolidation in the digital imaging software
industry will occur over the next few years through strategic acquisitions or
alliances, and we expect increased competition from new entrants, including the
possibility that Microsoft will add digital imaging components to its Windows
operating system. In addition, according to PC Data, Inc., the average retail
price of scanners dropped by 47% for the nine months ending September 30, 1998,
as compared to the same period in 1997. Based on this historical trend, we
expect that scanner prices will continue to decline in the future. We believe
that the downward price trend of scanners may reduce prices for digital imaging
software products. These changes in the market could result in price erosion,
reduced gross margins or loss of market share, any of which could have a
material adverse effect on our business, operating results and financial
condition.
There can be no assurance that we will be able to compete successfully
against current and future competitors, especially those with greater financial,
marketing, recruiting, technical and other resources, or that competitive
pressures will not materially adversely affect our business, operating results
and financial condition.
PROPRIETARY TECHNOLOGY
We rely on certain technology which we license from third parties,
including software which is integrated with internally developed software and
used in our products to perform key functions and software which is bundled with
our software to provide additional functionality. There can be no assurance that
these third-party technology licenses will continue to be available to us on
commercially reasonable terms or at all. The loss of or inability to maintain
any of these technology licenses could result in delays or reductions in product
shipments until equivalent technology is identified, licensed and integrated or
bundled. Any such delays or reductions in product shipments would materially
adversely affect our business, operating results and financial condition.
We generally enter into confidentiality or license agreements with our
employees, consultants and vendors, and generally control access to and
distribution of our software, documentation and other proprietary information.
Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without authorization, or to
develop similar technology independently. To license our products, we primarily
rely on "shrink wrap" licenses that are not signed by the end-user customer and,
therefore, may not be enforceable under the laws of certain jurisdictions.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy aspects of our products or to obtain and use information that we
regard as proprietary. Policing unauthorized use of our products is difficult.
There can be no assurance that we will be able to protect our technology, or
that our competitors will not independently develop technologies that are
substantially equivalent or superior our technology. In addition, the laws of
some foreign countries do not protect our proprietary rights to the same extent
as do the laws of the United States. Furthermore, 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. Such litigation could
result in substantial
9
costs and diversion of resources and could have a material adverse effect on our
business, operating results or financial condition.
We currently have two pending U.S. patent applications and one pending
Canadian patent application. As a result of the merger, we have entered into a
license agreement with Xerox that includes limited licenses and the assignment
of certain patents and trademarks. In addition, we have filed counterpart
applications in several European countries, Canada, Japan and Australia. We may
file additional U.S. and foreign patent applications in the future. On January
6, 1999 we sold all assets, liabilities and intellectual property associated
with our hardware business. There can be no assurance that patents will issue
from any application filed by the Company or that, if patents do issue, the
claims allowed will be sufficiently broad to protect our technology. The source
code for our proprietary software is protected both as a trade secret and as a
copyrighted work.
EMPLOYEES
As of December 31, 1998, we had a total of 54 full-time salaried
employees, 21 of which were in research and development, 19 of which were in
sales, marketing, and customer support, 4 of which were in operations and 10 of
which were in administration and finance. Prior to our merger with ScanSoft, we
implemented a restructuring plan to reduce operating expenses. This
restructuring plan included a decrease of approximately 20% of total employee
and consultant headcount.
Following the sale of our hardware business to Primax and upon the
completion of the merger with ScanSoft, we had a total of 138 full time
employees, all of whom are based in the United States and the United Kingdom. Of
the total, 46 are engaged in sales, marketing and support, 67 in research and
development, 20 in administration, MIS and finance and six in operations and
manufacturing. Following the consolidation of research and development on the
east coast, the research and development staff will be reduced to 58 people. Our
future performance depends in significant part on the continued service of our
key technical and senior management personnel. None of our employees are
represented by a labor union. We have not experienced any work stoppages and
consider our relations with our employees to be good.
FACTORS AFFECTING RESULTS
DIFFICULTIES OF INTEGRATING TWO COMPANIES. The anticipated benefits
merging with ScanSoft will depend in part on whether we can integrate our
operations and products in an efficient and effective manner. We cannot
guarantee that this will occur. Successful integration will require integration
of each company's products and coordination of each company's operating
procedures, financial controls, development efforts and sales and marketing
efforts. This integration may be difficult to accomplish smoothly or
successfully, and may take longer than we expect. If serious difficulties are
encountered during integration, management will have to divert its attention
from normal business operations to address these issues, which could have an
adverse effect on the surviving corporation's business. In addition, the merger
may cause potential customers to cancel or delay orders as the result of
uncertainty over the successful integration of the two companies. Furthermore,
there could be an adverse effect on employee morale and on the ability of the
surviving corporation to retain key personnel. Failure to effectively accomplish
the integration of the two companies' operations could have a material adverse
effect on the surviving corporation's business, operating results and financial
condition.
SUBSTANTIAL EXPENSES RESULTING FROM THE MERGER. We expect to incur
certain costs in connection with the integration of Visioneer and ScanSoft's
operations. Such costs cannot now be reasonably estimated, because they depend
on future decisions to be made by our management, but they could be material.
Such costs could relate to the elimination of duplicate facilities and
operations, integration of internal and customer-related activities, and
cancellation and/or overlap of contractual obligations. These costs and expenses
will affect results of operations in the first quarter of 1999, the quarter in
which the merger is consummated.
FAILURE TO ACHIEVE SYNERGIES COULD LEAD TO DECLINE IN STOCK PRICE. The
market price of our common stock may decline significantly if:
10
o the integration of the combined companies is not successful;
o we do not experience business synergies as quickly or to the extent
expected by financial analysts; or
o the effect of the merger on earnings per share and operating
results is not in line with the expectations of financial analysts.
DEPENDENCE ON DEVELOPING MARKET; RAPID TECHNOLOGICAL CHANGE. The market
for digital imaging software and, in particular, for our products, is new and
rapidly evolving. It is dependent on market demand for color sheetfed and
flatbed scanners, as well as for other paper input systems. It is characterized
by transforming technology and frequent new product introductions. Developing
new products and product enhancements is a complex and uncertain process
requiring high levels of innovation, as well as the accurate anticipation of
technological and market trends. Our PaperPort, Pagis and TextBridge software
products account for most of our revenues. We expect that these products will
continue to account for most of our revenues for the foreseeable future. Broad
market acceptance of these products is therefore critical to our future success
and will depend in part on the following:
o Our ability and that of our distributors and other industry
suppliers to convince end users to adopt paper input systems and
digital imaging software for the desktop.
o Our ability to educate end users about the benefits of digital
imaging products generally and the specific benefits of our
products.
o Our ability to adapt to emerging industry standards and respond to
our competitors' product announcements.
o Our ability to develop, introduce, upgrade and support competitive,
new products and product enhancements that meet changing customer
requirements and emerging industry standards.
o Our ability to maintain current market share for our products and
increase brand-name recognition.
If we are not successful in meeting the goals listed above, we may not
be able to gain broad market acceptance for our products. Further, a decline in
demand for digital imaging products generally, or for PaperPort, Pagis or
TextBridge products, in particular, could occur as a result of competitive
technological change or other factors and would have a material adverse effect
on our business, operating results and financial condition.
DIFFICULTIES ASSOCIATED WITH TIMING OF NEW PRODUCT INTRODUCTION. The
digital imaging software market is characterized by rapid technological change,
evolving customer needs, frequent new product introductions and evolving
industry standards. Rapid product advancements could erode the market position
of our products or render those products obsolete. Our success depends on how
well we are able to manage the transition to new products and new versions of
existing products. The life cycles of our products are difficult to estimate.
Further, it is not unusual in personal computer software life cycles for the
sales volume of new products to increase in the first few months after their
introduction because distributors and resellers purchase initial inventory
during that time. As a product reaches the end of its life cycle, however,
demand for that product tends to fall in anticipation of new replacement
products. Consequently, announcements about new products at the end of a product
life cycle may cause our customers to defer purchasing existing products, and we
may be forced to lower the prices of older products in anticipation of new
releases. This may result in distributors claiming price protection credits or
returning older products to us, and as a result, our revenues may decline. We
cannot accurately predict the exact timing in which a new product or version
will be ready to ship. Moreover, in order to maintain competitiveness, we must
make substantial investments in product development and testing. We cannot
guarantee that we will have sufficient resources to make the necessary
investments or that we will be able to develop new products or new product
features quickly enough to meet market demand. Any delay in the scheduled
release of new products or features, or lack of market acceptance for such new
products or features, may have a material adverse impact on our business,
results of operations and financial condition.
11
DISPOSITION OF HARDWARE BUSINESS; NEED FOR REBRANDING OF PRODUCTS; NEED
FOR SERVICES AGREEMENT WITH PRIMAX. In January 1999, we sold our hardware
business to Primax, which was a principal manufacturer of our flatbed and
sheetfed scanners and other hardware products. In this transaction, Primax
purchased substantially all of our hardware business (including the "Visioneer"
brand and company name), and it assumed all known liabilities associated with
the hardware business. We intend to take steps to rebrand all software products
carrying the Visioneer name so that in the future all such products will be
identified with a new software brand name, such as ScanSoft or PaperPort. In the
same way, Primax will rebrand any hardware products that carry the PaperPort
name so that in the future such products will be identified with a different
name. This rebranding may create confusion for our customers, including OEM
distributors and end-users, and there will necessarily be an adjustment period
during which time new brands will need to be established.
DEPENDENCE ON RELATIONSHIPS WITH XEROX, PRIMAX AND OTHER OEMS. ScanSoft
and Visioneer each had OEM relationships with Xerox prior to the merger, which
relationships remain in effect following the merger. In connection with the sale
of the hardware business to Primax, Visioneer entered into a software license
agreement granting Primax certain rights to "bundle" and sell Visioneer's
software products with certain Primax hardware products. Under the license,
Primax must pay us certain minimum annual royalties during the license term.
Primax, however, is not obligated to bundle or sell our software products with
its hardware products. Other risks include whether Primax will give sufficient
priority to marketing our products, whether Primax will continue to offer our
products at all, and whether Primax will elect instead to bundle software
products of our competitors with its hardware products. Any of the foregoing
actions could adversely impact our future business, results of operations and
financial condition since we expect Primax to become an important OEM partner.
We also rely on other OEM partners to bundle, market and sell our
products with their products. However, there are certain risks associated with
such relationships, including whether sufficient priority will be given by such
OEM partners to marketing our products. In addition, our OEM partners may not
continue to offer our products. If we do not maintain and build our OEM
relationships, our business, operating results and financial condition may
suffer.
COMPETITION. The digital imaging market is highly competitive and
subject to rapid change, with frequent new product introductions and
enhancements, and constant pressure to reduce prices. We believe that the
principal competitive factors in the digital imaging software market include:
o OCR accuracy;
o ease of understanding and use,
o product reliability;
o tolerance for poor media;
o product features and functions;
o price/performance characteristics;
o brand recognition; and
o quality of product support.
Our current competitors include developers of digital image processing
software (including photo-editing software), personal document management
software and scanning software suites and manufacturers of scanners and
multi-function peripheral devices. We also face competition in the market for
packaged OCR application programs and bundled OCR products, both in the retail
channel and in the OEM market. We experience significant price competition in
both the retail channel and the OEM market and expect this to continue. In
addition, our "bundled" OCR products themselves compete with our fully featured
shrinkwrap products. In addition to our
12
current competitors, Microsoft Corporation and MGI Software offer photo-editing
products and could offer products in this market segment in the future.
Increased competition may force us to lower our prices, experience decreased
gross margins or lose market acceptance. We face the following challenges from
our competitors:
o Certain of our competitors offer products comparable to ours at
retail prices that are lower than ours.
o Many of our current and potential competitors have longer operating
histories and significantly greater financial, technical, support,
sales, marketing, recruiting and other resources.
o Certain of our competitors have greater name recognition and larger
customer bases than we do.
o Certain of our competitors may be better able to withstand
significant price decreases or devote greater resources to the
development, promotion, sale and support of their products than we
can.
o Certain of our competitors may be able to develop digital image
processing software with superior OCR accuracy, ease of
understanding and use, product reliability, tolerance for poor
media, product features and functions and price/performance
characteristics.
We may not be able to compete successfully against current and future
competitors, especially those with greater financial, technical, support, sales,
marketing, recruiting and other resources. If we are not successful in meeting
the challenges listed above, we may not be able to gain broad market acceptance
for our products and our business, financial condition and operating results may
suffer. Competitive pressures may materially affect our business, operating
results, and financial condition.
Further, we expect that some consolidation in the digital imaging
software industry will occur over the next few years through strategic
acquisitions or alliances. We expect increased competition from new entrants,
including the possibility that Microsoft will add digital imaging components to
the Windows operating system. In addition, according to PC Data, Inc., the
average retail price of scanners dropped by 47% for the nine months ending
September 30, 1998, as compared to the same period in 1997. Based on this
historical trend, we expect that scanner prices will continue to decline in the
future. We believe that the downward price trend of scanners may reduce prices
for digital imaging software products. These changes in the market could result
in price erosion, reduced gross margins or loss of market share, any of which
could have a material adverse effect on our business, operating results and
financial condition.
PRESSURE ON GROSS MARGIN. We may suffer adverse operating results if
our gross margin fluctuates. Retail prices on software products drop quickly. In
addition, our competitors will attempt to offer products which meet or exceed
our products' performance and capabilities. We intend to introduce new software
products, software upgrades and software features in response to anticipated
competitive price pressures and new product introductions. If prices fall faster
than we expect or if we must reduce our prices for any reason, we may experience
pressure on our gross margin. In addition, our gross margin will depend in part
on certain factors listed below:
o Our success in introducing new products to the market and easing
out old ones.
o Our competitors prices, products and market share.
o The amount of royalties we receive under our OEM arrangements.
o General economic conditions.
If we are not successful in meeting these challenges, our business,
operating results and financial condition may suffer.
DEPENDENCE ON DISTRIBUTORS AND RESELLERS. We expect to continue to
receive a substantial portion of our revenues from sales through our independent
distributors and resellers, but we anticipate that our dependence on
13
any one independent distributor or reseller will decrease in the future as we
expand distribution channels. Our agreements with distributors and resellers are
not exclusive; many of our distributors and resellers offer competitive products
and are not required to give our products priority. Each of our distributors and
resellers can cease marketing our products with limited notice and with little
or no penalty. If we lose any one of our independent distributors or resellers,
we may not be able to recruit replacements. If our distributors or resellers
reduce or cease their marketing and sales efforts on our behalf, our business,
operating results and financial condition may suffer.
INTERNATIONAL SALES RISKS. We plan to expand our international sales by
establishing a more extensive network of international distributors and
resellers. We also plan to develop versions of our products suitable to the
market requirements of particular foreign countries, such as different
languages. We have limited experience in developing international versions of
our products and marketing, distributing, servicing and supporting such
products. We may not be able to develop new or additional versions of our
existing products or successfully market, sell, deliver, service or support our
products in international markets. In conducting business outside of the United
States, we are exposed to the risks listed below:
o Unexpected changes in regulatory requirements.
o Import and export duties and restrictions.
o Tariffs and other trade barriers.
o Difficulties in staffing and managing foreign operations.
o Longer payment cycles.
o Uncertainties in connection with collecting accounts receivable.
o Political instability.
o Fluctuations in currency exchange rates.
o Logistical difficulties in managing multinational operations.
o Seasonal reductions in business activity during summer months in
Europe and certain other parts of the world.
o Potentially adverse tax consequences, including our inability to
recover withholding taxes.
If we are not successful in managing the risks listed above, our
business, operating results and financial condition may suffer. One or more of
these factors could have a material adverse effect on our international
operations and, consequently, on our business, operating results and financial
condition.
QUALITY CONTROL RISKS. Our products are complex and may contain certain
software errors or failures which are detected only after we begin to ship a
product, especially when first introduced as new versions or when enhancements
are released. Although we conduct testing during product development, we have at
times been forced to delay commercial release of software until problems were
corrected and, in some cases, have provided enhancements to correct errors in
released software. If we do detect any errors before we ship a product, we might
have to limit product shipment for an extended period of time while we address
the problem. Delay in commercial release, correction of errors or limiting
product shipment could lead to loss of revenues, credibility with customers and
market acceptance of our products. We would also be exposed to additional
warranty and engineering expenses. Despite our testing and testing by current
and potential customers, errors may be found in software or releases after
commencement of commercial shipments, resulting in loss or delay of revenue or
delay in market acceptance, diversion of development resources, damage to our
reputation, or increased service and warranty costs. If we do not successfully
manage our quality control, our business, operating results and financial
condition may suffer.
14
DEPENDENCE ON THIRD-PARTY LICENSES. We rely on certain technology which
we license from third parties, including software which is integrated with our
own software and used in our products to perform key functions and provide
additional functionality. Because our products incorporate software developed
and maintained by third parties, we are, to a certain extent, dependent upon
such third parties' ability to maintain or enhance their current products, to
develop new products on a timely and cost-effective basis, and to respond to
emerging industry standards and other technological changes. Further, these
third-party technology licenses may not always be available to us on
commercially reasonable terms or at all.
In the event that our agreements with third-party vendors should fail
to be renewed or the products licensed from such vendors should fail to address
the requirements of our software products, we would be required to find
alternative software products or technologies of equal performance or
functionality. There can be no assurance that we would be able to replace such
functionality provided by software that we currently license from third parties
in the event that we lose the license to such software, such software becomes
obsolete or incompatible with future versions of our products or is otherwise
not adequately maintained or updated. The absence of or any significant delay in
the replacement of that functionality could have a material adverse effect on
our business, operating results and financial condition. Moreover, if we were to
lose any of these technology licenses we might experience product shipment
delays or reductions until equivalent technology were identified, licensed and
used. If we do experience product shipping delays and reductions due to
licensing problems, our business, operating results and financial condition
would suffer.
RISKS ASSOCIATED WITH PROTECTION OF CONFIDENTIAL INFORMATION AND
PROPRIETARY RIGHTS. We generally enter into confidentiality or license
agreements with our employees, consultants and vendors. We also generally
control access to and distribution of our software, documentation and other
proprietary information. We primarily rely on "shrink wrap" licenses that are
not signed by the end-user customer and, therefore, may not be enforceable under
the laws of certain jurisdictions. Unauthorized parties may attempt to copy
aspects of our products or to obtain and use information that we regard as
proprietary. Policing unauthorized use of our products is difficult and we may
not be able to protect our technology from unauthorized use. Additionally, our
competitors may independently develop technologies that are substantially the
same or superior to ours. In addition, the laws of some foreign countries do not
protect our proprietary rights to the same extent as the laws of the United
States. Although the source code for our proprietary software is protected both
as a trade secret and as a copyrighted work, litigation may be necessary to
enforce our intellectual property rights, to protect our trade secrets, to
determine the validity and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Litigation, regardless of
the outcome, can be very expensive and can divert management efforts. These
risks, if not managed successfully, could have a material adverse effect on our
business, operating results or financial condition.
DEPENDENCE ON KEY PERSONNEL; RISKS ASSOCIATED WITH HIRING AND RETENTION
OF EMPLOYEES. We rely to a significant extent upon our senior management team
and other key employees. Competition for such employees is intense. We cannot
guarantee that we will be able to retain our key employees following the merger.
Our operations could be materially and adversely affected if we were unable to
retain such key employees, or attract new ones. From time to time, we will need
to hire additional or replacement employees. We may not be successful in hiring,
integrating or retaining new employees. If we are not successful in attracting
or retaining qualified personnel, our business, financial condition and
operating results could suffer.
HISTORY OF LOSSES; FLUCTUATIONS IN OPERATING RESULTS. ScanSoft had net
losses for 1996, 1997 and 1998. Visioneer also had net losses for its fiscal
1996, 1997 and 1998, although a substantial portion of those losses were
attributable to the hardware business that was sold to Primax. On a pro forma
basis, the combined companies had a net loss for 1997 and 1998. We may never
become profitable or sustain profitability.
Our revenues frequently fluctuate from quarter to quarter due, to a
large extent, on the following:
o volume, timing and filling of customer orders;
o reduction in prices in response to competition;
15
o increased expenditures to pursue new product or market
opportunities;
o fluctuation in sales orders, juxtaposed with a significant portion
of our operating expenses being fixed in advance, based in large
part on forecasts of future sales;
o inability to adjust operating expenses to compensate for shortfalls
in sales orders against forecast;
o price protection charges in excess of recorded allowances;
o demand for products;
o seasonality;
o customer deferrals in anticipation of new versions of products;
o introduction of new products by us or our competitors;
o timing of new product acquisitions; and
o timing of significant marketing and sales promotions.
Further, backlog early in a quarter is generally not large enough to
assure than we will meet our revenue target for any particular quarter. A
shortfall in shipments at the end of any quarter may cause operating results for
that quarter to fall significantly short of anticipated levels.
In addition, if we need to reduce our prices in response to price
competition, we will therefore be at a significant disadvantage with respect to
our competitors that have substantially greater resources. Such competitors may
more readily withstand an extended period of downward pricing pressure. In such
event, we may also incur price protection charges from our distributors and
resellers. Any price protection charges in excess of recorded allowances would
have a material adverse effect on our business, operating results and financial
condition.
Due to the foregoing factors, among others, our revenues are difficult
to forecast. We intend to base our expense levels in significant part on our
expectations of future revenue. As a result, we expect our expense levels to be
relatively fixed in the short term. Our failure to meet revenue expectations
would have a material adverse affect on our business, operating results and
financial condition. Further, an unanticipated decline in revenue for a
particular quarter may disproportionately affect our net income because a
relatively small amount of our expenses are intended to vary with our revenue in
the short term. As a result, we believe that period-to-period comparisons of our
results of operations are not and will not necessarily be meaningful, and you
should not rely upon them as an indication of future performance.
XEROX AS A SIGNIFICANT STOCKHOLDER. Xerox Imaging Systems, Inc., a
wholly owned subsidiary of Xerox, owns approximately 45% of our outstanding
common stock and all of our outstanding Series B Preferred Stock. In addition,
Xerox has the opportunity to acquire additional shares of our common stock
pursuant to a warrant. Xerox is currently our largest stockholder. Although
Xerox does not control us and is restricted for at least two years after the
merger from holding more than 50% of the voting power of our capital stock,
Xerox will have a strong influence over matters requiring approval by our
stockholders. In addition, Xerox has two designees on the board of directors,
including Paul A. Ricci, the new Chairman of the Board.
Xerox has advised us that its current intent is to hold all of its
shares of common stock. However, there can be no assurance concerning the
periods of time during which Xerox will maintain its ownership of our common
stock.
YEAR 2000 RISKS. We have a number of installed computer systems and
software products that are coded to accept only two digit entries in the date
code field. These date code fields will need to distinguish 21st century
16
dates from 20th century dates (the "Year 2000 bug"). The Year 2000 bug could
lead to system failures or miscalculations causing disruptions of operations
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. We are currently
in the process of establishing procedures for evaluating and managing the risks
and costs associated with this problem. See, "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Year 2000." Finally,
many of our customers' and suppliers' operations may be affected by Year 2000
complications. As such, the failure of these customers and suppliers to ensure
that their systems are Year 2000 compliant could have a material adverse effect
on our customers and suppliers, resulting in a material adverse effect on our
business, operating results and financial condition.
ITEM 2. PROPERTIES
On January 6, 1999, Primax assumed the lease on our former headquarters
in Fremont, California. Following the completion of the merger with ScanSoft,
Inc., the combined company relocated its headquarters, administrative, sales,
marketing and support functions to our leased headquarters facility in Peabody,
Massachusetts. We currently occupy 37,636 square feet of space at this facility,
and the lease will expire in July 2001. We also lease warehouse space in
Topsfield, Massachusetts and research and development space at a Xerox facility
in Palo Alto, California. In addition, our subsidiary, ScanSoft Europe Ltd.,
leases a sales and support office in Reading, England.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are parties to various legal proceedings or
claims, either asserted or unasserted, which arise in the ordinary course of
business. In addition, during 1998, we were involved in separate legal matters
with Caere Corporation, Flashpix, Incorporated and Storm Technology, Inc.
(1) We were named as the defendant in a complaint filed by Caere
Corporation on August 10, 1998, in the United States District
Court for the Northern District of California. Caere
Corporation alleged that we engaged in false and misleading
advertising concerning our software product, ProOCR100.
Pursuant to a settlement agreement, we agreed to pay Caere the
sum of $75,000, and the lawsuit was dismissed with prejudice.
(2) We were named as a defendant as part of the Digital Imaging
Group, in a complaint filed by Flashpix, Incorporated on July
16, 1998, in the United States District Court for the Eastern
District of Louisiana. The complaint alleged, among other
things, trademark infringement, unfair competition, unfair
trade practices, and dilution of trademark. Subsequent to
December 31, 1998, we have, along with the Digital Imaging
Group, settled this matter.
(3) We were named as the defendant in a complaint filed by Storm
Technology, Inc. on June 2, 1998, in the United States
District Court for the Northern District of California,
alleging patent infringement of specified scanner technology.
Subsequently, the parties settled the matter and executed an
updated Patent Cross License Agreement. Primax assumed this
matter when it purchased our hardware business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
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 under the symbol "SSFT." 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 1997:
1st quarter........................ $6 $ 3-1/8
2nd quarter........................ 4-3/8 2-1/2
3rd quarter........................ 4-3/4 2-13/16
4th quarter........................ 5-3/4 1-5/8
Fiscal 1998:
1st quarter........................ 3-1/2 1-5/8
2nd quarter........................ 4-1/8 2-1/16
3rd quarter........................ 2-1/4 11/16
4th quarter........................ 2-7/8 11/16
HOLDERS OF RECORD
As of March 26, 1999, there were approximately 244 holders of record of
our common stock.
DIVIDENDS
To date, we have not paid any cash dividends on shares of our common
stock. We presently intend to retain all future earnings for our business and do
not anticipate paying cash dividends on our common stock in the foreseeable
future.
18
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with the
information contained in Item 7--"Management's Discussion and Analysis of
Financial Condition" and Results of Operations and the Financial Statements and
Notes to Financial Statements contained in Item 8 of this Report.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ----------- ----------- ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA(1):
Product revenues............................ $74,674 $50,523 $44,233 $34,734 $ 3,903
Royalty and development revenues............ 4,396 7,100 11,848 2,605 --
------------ ----------- ----------- ------------ ------------
Total net revenues........................ 79,070 57,623 56,081 37,339 3,903
------------ ----------- ----------- ------------ ------------
Cost of revenues:
Cost of product revenues.................... 58,486 49,838 42,164 25,664 4,481
Cost of royalty and development revenues.... 884 887 3,303 1,274 --
------------ ----------- ----------- ------------ ------------
Total cost of revenues.................... 59,370 50,725 45,467 26,938 4,481
------------ ----------- ----------- ------------ ------------
Gross profit (loss)............................ 19,700 6,898 10,614 10,401 (578)
------------ ----------- ----------- ------------ ------------
Operating expenses:
Research and development.................... 4,408 8,115 10,938 8,975 4,532
Selling, general and administrative......... 19,150 22,428 26,342 11,805 6,482
Non-recurring items(2)...................... -- 675 -- 1,600 --
------------ ----------- ----------- ------------ ------------
Total operating expenses.................. 23,558 31,218 37,280 22,380 11,014
------------ ----------- ----------- ------------ ------------
Operating loss................................. (3,858) (24,320) (26,666) (11,979) (11,592)
Net interest income............................ 53 940 2,274 426 137
------------ ----------- ----------- ------------ ------------
Net loss....................................... $(3,805) $(23,380) $(24,392) $(11,553) $(11,455)
============ =========== =========== ============ ============
Net loss per share: basic and diluted......... (0.19) (1.20) (1.34) (4.28) (6.76)
============ =========== =========== ============ ============
Weighted average common shares outstanding:
basic and diluted........................... 19,728 19,450 18,255 2,669 1,694
============ =========== =========== ============ ============
19
DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ----------- ----------- ------------ ------------
(IN THOUSANDS)
BALANCE SHEET DATA(1):
Cash, cash equivalents and short-term
investments............................... $ 8,123 $14,452 $31,200 $46,166 $ 4,032
Working capital............................. 6,569 8,389 28,807 46,677 3,376
Total assets................................ 28,445 33,550 51,785 65,793 7,378
Long-term liability......................... 91 125 -- -- --
Capital lease obligations, less current -- -- -- -- 248
portion.....................................
Total stockholders' equity (deficit) ....... 7,582 10,930 33,193 49,860 4,053
- -----------
(1) See Note 1 of Notes to Financial Statements for an explanation of the
Company's fiscal year ends.
(2) See Note 10 of Notes to Financial Statements. Also, the charge in 1995
related to the fair value of securities issued and cash paid in connection
with the settlement of a patent matter.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED IN ITEM 8 OF THIS REPORT.
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE FOLLOWING DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH
AS STATEMENTS OF OUR PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. OUR ACTUAL
RESULTS MAY DIFFER MATERIALLY AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE
DISCUSSED IN THIS REPORT AND OTHER RISKS DETAILED FROM TIME TO TIME IN OUR
PERIODIC REPORTS.
OVERVIEW
ScanSoft, Inc. was incorporated as Visioneer, Inc. in California in
March 1992, and commenced shipment of our initial product in the first quarter
of 1994. Through September 1995, we financed our operations primarily through
private placements of equity securities, from which we raised an aggregate of
approximately $33 million, net of issuance costs. In December 1995, we
reincorporated in Delaware in conjunction with our initial public offering and
raised $43.5 million, net of issuance costs. In January 1996, the over allotment
option granted to the underwriters in the initial public offering was exercised,
resulting in additional net proceeds of approximately $6.4 million. We have
experienced sequential growth in annual net revenues since the first year of
product shipments. The annual growth rates between 1994 and 1996 were directly
attributable to the growth of the sheetfed scanner and document management
software markets, the development of OEM relationships and new product
introductions. In contrast, the single digit growth rate from 1996 to 1997 was
attributed to several factors. First, the grayscale sheetfed scanner market
declined sharply with the advent of color sheetfed scanners. The transition of
the market from grayscale to color occurred at a much faster rate than we had
anticipated, and as a result, we recorded significant charges relating to
grayscale inventory reserves, purchase order commitments and price protection
charges in the first half of 1997. Second, we were late in introducing a color
scanner product, and as a result, did not capture planned market share. Third,
increased competition caused overall sheetfed scanner average selling prices to
drop significantly. Finally, the growth of the sheetfed scanner market has
leveled off, and, in fact, may be decreasing in size.
A key component of our business strategy in 1997 and 1998 was to
penetrate the much larger and growing flatbed market by leveraging off of our
software. Historically, we have bundled our PaperPort software with our scanner
products, which has provided significant product differentiation. The PaperPort
flatbed scanner line was introduced in September 1997. This line was enhanced
with the introduction of additional 30-bit products as well as the entire 36-bit
and One Touch line of flatbed scanners in 1998. In addition, our focus over time
has shifted from the hardware business to the software business. During 1997 we
implemented a strategy to focus our research and
20
development efforts on software development rather than hardware development and
to leverage the engineering resources of our manufacturing partners to design
future hardware products. In furtherance of this strategy, on December 3, 1998,
we entered into an agreement to sell our hardware business and the Visioneer
brand name to Primax, and to merge with ScanSoft. Following the sale to Primax
and the merger with ScanSoft, our business will focus on software products in
the PaperPort line, and the TextBridge and Pagis line of software products.
Our success in the future will depend on our ability to maintain
software gross margins and increase sales of our software products. This will
depend in part on our ability and the ability of our distributors, resellers and
OEM partners to convince end-users to adopt paper and image input systems for
the desktop and to educate end-users about the benefits of our products. There
can be no assurance that the market for our products will develop or that we
will achieve market acceptance of our products. Despite experiencing several
quarters of minor levels of profitability throughout our history, we have
incurred annual net losses since inception. There can be no assurance that we
will be able to reach quarterly profitability or attain annual profitability in
the near future. As of December 31, 1998, we had an accumulated deficit of $80.4
million.
As a result of the sale of our hardware business in January, our
revenues will decline significantly in the first quarter of 1999. We expect our
revenues to start improving gradually from the quarter ended June 1999, as
revenues from ScanSoft start impacting our operating results.
RESULTS OF OPERATIONS
The following table presents, as a percentage of total net revenues,
certain selected financial data for each of the three years in the period ended
December 31, 1998:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Revenues:
Product revenues................................ 94.4% 87.7% 78.9%
Royalty and development revenues................ 5.6% 12.3% 21.1%
----------------- ----------------- -----------------
Total net revenues............................ 100.0% 100.0% 100.0%
Cost of revenues:
Cost of product revenues........................ 74.0% 86.5% 75.2%
Cost of royalty and development revenues........ 1.1% 1.5% 5.9%
----------------- ----------------- -----------------
Total cost of revenues........................ 75.1% 88.0% 81.1%
----------------- ----------------- -----------------
Gross profit....................................... 24.9% 12.0% 18.9%
----------------- ----------------- -----------------
Operating expenses:
Research and development........................ 5.6% 14.1% 19.5%
Selling, general and administrative............. 24.2% 38.9% 47.0%
Non-recurring item(1) .......................... 0.0% 1.2% 0.0%
----------------- ----------------- -----------------
Total operating expenses...................... 29.8% 54.2% 66.5%
----------------- ----------------- -----------------
Operating loss..................................... (4.9%) (42.2%) (47.5%)
Interest income.................................... 0.6% 1.7% 4.2%
Interest expense................................... (0.6%) (0.1%) (0.1%)
----------------- ----------------- -----------------
Net loss........................................... (4.8%) (40.6%) (43.5%)
----------------- ----------------- -----------------
- ----------
(1) See Note 10 of Notes to Financial Statements
21
TOTAL NET REVENUES
We derived our revenue primarily from three sources, the sale of
PaperPort hardware products, PaperPort software products, and royalties and
custom software development revenue earned pursuant to arrangements with certain
OEM customers. Through the end of 1998, approximately 86% of our product
revenues have been derived from sales of our PaperPort products to authorized
resellers and independent distributors in North America and, to a lesser extent,
in Europe and the Asia-Pacific regions. Revenues from all sales to distributors
and authorized resellers are subject to agreements allowing price protection and
certain rights of return. Under the price protection rights granted by us, if we
lower our selling price, we are then obligated to issue credit to our
distributors and resellers equal to the difference between the new selling price
and the price paid for all unsold inventory held by the distributor and
reseller. Accordingly, reserves for estimated future returns, exchanges and
price protection are provided upon revenue recognition.
Total net revenues increased 37% to $79.1 million in 1998 from $57.6
million in 1997, despite a 38% reduction in royalty and development revenues
from $7.1 million in 1997 to $4.4 million in 1998. The decline in royalty
revenues in 1998 was due to the termination, in the third quarter of 1996, of
royalties under an OEM agreement with Hewlett-Packard and the termination of
royalties under our OEM agreement with Compaq in the first quarter of 1997. In
regards to another OEM agreement with Hewlett-Packard, which involved the
licensing of our software for Hewlett-Packard scanners, Hewlett-Packard informed
us, in the fourth quarter of 1997, that commencing January 1, 1998, it would no
longer be building new scanner products incorporating our software. We
experienced declining royalties from this agreement in 1998 as Hewlett-Packard
sold existing inventory of products incorporating our software which it held at
December 31, 1997. Net revenues from hardware product sales increased to $66.0
million in 1998 compared to $41.5 million in 1997. As a result of the addition
of the PaperPort 36-bit and OneTouch flatbed color scanner lines in 1998,
overall scanner unit sales in 1998 increased by approximately 248% over 1997,
despite a 79% decrease in grayscale scanner unit sales. Revenues did not
increase at the same rate as unit increases because of the sharp decline in
average retail prices offset the net revenue from the increased hardware unit
sales from 1997 to 1998. Software revenues increased 4.3% to $8.7 million in
1998 from $8.3 million in 1997. The increase was primarily attributable to the
commencement of sales of new PaperPort software products that included ProOCR
100, PaperPort ScannerSuite, Visual Explorer, and PaperPort Deluxe 5.3 released
in the second quarter of 1998.
Total net revenues increased 3% to $57.6 million in 1997 from $56.1
million in 1996, despite a 40% reduction in royalty and development revenues
from $11.8 million in 1996 to $7.1 million in 1997. The decline in royalty
revenue in 1997 was due to the termination of the royalties associated with our
OEM agreement with Hewlett-Packard and our OEM agreement with Compaq Computers.
Our second OEM agreement with Hewlett-Packard, which related to the licensing of
our software for Hewlett-Packard scanners, was terminated in the fourth quarter
of 1997.
Our ability to increase our revenues will depend upon our ability to
attain wider market acceptance for our software products and our ability to
introduce new products with enhanced end-user features on a timely basis. As a
result of the sale of our hardware assets, liabilities and intellectual property
to Primax Electronics, Ltd., our revenues will be substantially reduced in 1999,
even taking into consideration the addition of revenues from the merger with
ScanSoft.
Our four largest resellers for 1998 were Sam's Club, Office Depot,
Inc., Best Buy Company, Inc. and CompUSA, Inc. for distribution of our products
in North America. Sales to these top four independent resellers accounted for
46% of our total net revenues in 1998 in the aggregate, or 18%, 12%, 9% and 7%,
respectively. Our four largest resellers and distributors of our products in
1997 were Ingram, Best Buy, Office Depot and Micro Warehouse. Sales to these
independent distributors and resellers, in the aggregate, accounted for
approximately 38% of total net revenues in 1997. The four largest distributors
and resellers in 1996 were Ingram, Best Buy, Tech Data and Merisel. Sales to
these independent distributors, in the aggregate, accounted for approximately
52% of our total net revenues in 1996. In 1998, all four of our top customers
were resellers compared to 1997, when three out of four of our largest
customers, excluding OEMs, were resellers. In contrast in 1996, three out of
four of our customers were distributors. We have focused on establishing direct
relationships with major resellers, thus
22
bypassing distributors. This strategy, to a limited extent, reduces a layer of
our inventory in the retail channel, thereby reducing inventory risk and
increasing channel inventory visibility.
Total net revenues from independent distributors outside North America,
primarily in Europe and the Asia-Pacific regions, were approximately 7%, 10% and
13% of total net revenues in 1998, 1997 and 1996, respectively. Net revenues
from international sales increased from $5.6 million in 1997 to $5.9 million in
1998, whereas sales decreased from $7.1 million in 1996 to $5.6 million in 1997.
The reduction in international revenues from 1996 to 1997 was primarily due to
the delayed introduction of Japanese localized PaperPort Strobe products, the
first of which were shipped in February 1998, and our decision to restructure
our international sales and marketing operations in May 1997. Although our
international sales are all denominated in U.S. dollars, these sales are subject
to a number of risks inherent in doing business on an international level, such
as unexpected changes in regulatory requirements, import and export duties and
restrictions, fluctuations in currency exchange rates, and the logistical
difficulties of managing multinational operations, any of which could adversely
impact the success of our international operations. The growth of our
international business will depend, in part, on our ability to increase
awareness of our products in international markets. See "Item 1--Business--
Marketing, Sales and Distribution."
The introduction of major new software products and enhancements of
existing products, such as PaperPort Deluxe, as well as potential OEM
agreements, are expected to have a significant impact on our quarterly and
annual revenues. As is characteristic of the initial stages of personal computer
product life cycles, we expect that sales volumes of any new software product
may increase in the first few months following introduction due to the purchase
of initial inventory by our distribution channel. Thereafter, revenues may
stabilize or decline until the end of a product life cycle, at which time
revenues are likely to decline significantly, as a result of unit sales and
price reductions. At the end of a product life cycle we may experience higher
rates of return and/or increased price protection charges as a result of price
reductions. This could have a material adverse impact on our total net revenues
and operating results. Although we have sought to mitigate the effect of such
transition by controlling inventory levels of our distributors and resellers,
channel inventory levels are very difficult to quantify accurately, and we may
experience higher than normal rates of return on our older version products and
may incur significant price protection charges in connection with our planned
release of new PaperPort products and price reductions in 1999. In this regard,
receivable allowances were $4.2 million and $5.3 million at December 31, 1998
and 1997, respectively. A substantial portion of these reserves related to the
hardware business and were eliminated as part of the sale to Primax on January
6, 1999. Due to the inherent uncertainties of product development and new
product introductions, we cannot accurately predict the exact quarter in which a
new product or version will be ready to ship. Any delay in the scheduled release
of major new products would have a material adverse impact on our total net
revenues and operating results.
We have experienced and may continue to experience significant
fluctuations in revenues and operating results from quarter to quarter and from
year to year due to a combination of factors, many of which are outside of our
direct control. After taking into consideration the sale of our hardware
business in January 1999, and the merger with ScanSoft in March 1999, these
factors include the integration of the Visioneer and ScanSoft businesses,
development of the paper input systems market, demand for our products, our
success in developing, introducing and shipping new products and product
enhancements, the market acceptance of such products, our ability to respond to
new product introductions and price reductions by our competitors, the timing,
cancellation or rescheduling of significant orders, the purchasing patterns and
potential product returns from our distribution channels, our relationships with
our OEM partners and distributors, our ability to attract, retain and motivate
qualified personnel, the timing and amount of research and development and
selling, general and administrative expenditures, and general economic
conditions.
Revenues and operating results in any quarter depend, to a large
extent, on the volume, timing and ability to fulfill customer orders, which is
difficult to forecast. A significant portion of our operating expenses are
relatively fixed, based in large part on our forecasts of future sales. If sales
are below expectations in any given period, the adverse effect of a shortfall in
sales on our operating results may be magnified by our inability to adjust
operating expenses to compensate for such shortfall. Accordingly, any
significant shortfall in revenues relative to our expectations would have an
immediate material adverse impact on our business, operating results and
financial condition. We may also be required to reduce prices in response to
competition or to increase our spending to
23
pursue new product or market opportunities. In the event of significant price
competition in the market for our products, which is anticipated, we will be
required to decrease costs at least proportionately and we will be at a
significant disadvantage with respect to our competitors that have substantially
greater resources. Such competitors may more readily withstand an extended
period of downward pricing pressure. In such event, we will also incur price
protection charges from our distributors. Any price protection charges in excess
of recorded allowances would have a material adverse effect on our business,
operating results and financial condition.
Due to all of the foregoing factors, it is likely that at some point in
the future our operating results will be below the expectations of public market
analysts and investors. In such event, the price of our common stock would
likely be materially adversely affected. Accordingly, our prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies participating in new and rapidly evolving markets.
There can be no assurance that we will be successful in addressing such risks.
TOTAL COST OF REVENUES
Total cost of revenues consists primarily of the costs associated with
the purchase of PaperPort products and related costs of freight, inventory
rework, inventory obsolescence and warranty. For 1998, our PaperPort hardware
products were manufactured, assembled and tested by five manufacturing partners,
Avision, Primax, Flextronics, NMB and Orient SemiConductor. Grayscale sheetfed
scanners were manufactured by Flextronics. Our scanning keyboard, PaperPort ix,
and the color sheetfed scanner, the PaperPort Strobe, were manufactured by NMB
and Orient SemiConductor; and the PaperPort flatbed scanners were manufactured
by Primax and Avision. We sold our hardware business to Primax in January 1999.
Our software products are manufactured by DCL, which also package and ships the
majority of our hardware and software products to our customers. See "Item
1--Business--Manufacturing."
Total cost of revenues, as a percentage of total net revenues,
decreased in 1998 to 75% as compared to 88% in 1997. The decrease was primarily
a result of approximately $9.5 million of charges taken in the first quarter of
1997 for write-offs and increased reserves relating to excess and obsolete
grayscale inventory and cancellation charges relating to adverse purchase
commitments for grayscale products. Total cost of revenues as a percentage of
total net revenues was 88% in 1997 as compared to 81% in 1996. The increase was
primarily a result of the charges taken in 1997 as described above.
As a result of the sale of our hardware business, we expect our total
cost of revenues, as a percentage of revenue, to decline significantly from the
historical levels reported in the statement of operations.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist principally of personnel
costs, costs of contractors and outside consultants, supplies and material
expenses, equipment depreciation and overhead costs relating to occupancy. As of
December 31, 1998, we employed 21 full-time and 3 contract software design
engineers, technicians and support staff. Upon the completion of the merger on
March 2, 1999, we employed 67 full-time technicians and support staff.
Research and development expenses were 6%, 14% and 20% of total net
revenues for 1998, 1997 and 1996, respectively. Research and development
expenses decreased 46% in absolute dollars to $4.4 million in 1998 from $8.1
million in 1997. Due to our strategy to concentrate our engineering efforts on
software development, all of our flatbed scanner lines that were introduced in
1997 and 1998 were designed in cooperation with our manufacturing partners,
Primax and Avision.
Research and development expenses decreased 26% in absolute dollars to
$8.19 million in 1997 from $10.6 million in 1996. The decrease was primarily the
result of the restructuring of the engineering group in May 1997.
24
We believe that the development of new products and the enhancement of
existing products are essential to our success. Accordingly, we will continue to
invest in research and development activities. However, such expenses may
fluctuate from quarter to quarter depending on a wide range of factors including
the status of various development projects. To date, we have not capitalized any
development costs and do not anticipate capitalizing any such costs in the
foreseeable future.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include personnel and
related overhead costs for sales, marketing, customer support, finance, human
resources and general management. Such costs also include advertising,
commissions to manufacturers' representative organizations, co-op paid to our
distributors and resellers, trade shows and other marketing and promotional
expenses.
Selling, general and administrative expenses decreased 14% in absolute
dollars to $19.2 million in 1998 from $22.4 million in 1997, and also declined
as a percentage of total net revenues, to 24% in 1998 from 39% in 1997. The
decrease was the direct result of a Company-wide restructuring plan implemented
in May 1997, in which we reduced overall headcount and spending by approximately
40% of first quarter 1997 levels, as well as an additional restructuring in
August 1998 which cut existing headcount by an additional 20%. We believe that
these spending reductions were necessary in order to reduce our cost structure
to allow us to compete more effectively. As noted below, the May 1997
restructuring resulted in a $675,000 one-time charge. The restructuring in
August 1998 did not result in a significant one-time charge.
Selling, general and administrative expenses decreased 15% in absolute
dollars to $22.4 million in 1997 from $26.3 million in 1996. As a percentage of
total net revenues, selling, general and administrative expenses decreased to
39% in 1997 from 47% in 1996. The decrease in spending was primarily attributed
to the restructuring plan implemented in May 1997, described above.
We will continue to attempt to control selling, general and
administrative expenses. However, if net revenues continue to grow, in order to
support our growing operations, selling, general and administrative expenses may
increase in absolute terms. Such expenses may fluctuate from quarter to quarter
depending on a variety of factors, including the timing of the introduction of
any new products, expansion of our distribution channels, general advertising
not related to product introductions and expansion into international markets.
NON-RECURRING ITEM
The non-recurring item in 1997 represents expenses incurred for
severance and other charges related to the termination of approximately 40
employees and 20 contract employees in connection with the Company-wide
restructuring plan implemented in May 1997. The restructuring actions were fully
completed as of December 1997.
OTHER INCOME, NET
Other income, net, consists primarily of interest earned on cash
equivalents and short-term investments. Other income, net, was $53,000,
$940,000, and $2.3 million for the years ended December 31, 1998, 1997 and 1996,
respectively. The decrease in other income, net from 1997 to 1998, and 1996 to
1997 was a result of decreased interest income from significantly lower cash,
cash equivalents and short-term investments, which were used primarily to fund
our operating losses.
TAXATION
At December 31, 1998, we had federal net operating loss carryforwards
of approximately $61 million, of which approximately $900,000 related to tax
deductions from stock compensation. The tax benefit related to the stock
compensation benefit, when realized, will be accounted for as an addition to
additional paid in capital rather than as a reduction of the provision for
income tax. Research and development credit carryforwards as of December 31,
1998 were approximately $2.0 million. The net operating loss and credit
carryforwards will expire at
25
various dates beginning in 2007, if not utilized. Utilization of the net
operating losses and credits may be subject to a substantial annual limitation
due to the ownership change limitations provided by the Internal Revenue Code of
1986 and similar state provisions. The annual limitation may result in the
expiration of net operating losses and credits before utilization. As a result
of the new stock issued in conjunction with the merger with ScanSoft, we are not
certain whether we will be able to utilize our net operating loss and credit
carryforwards without limitations. (See Note 6 of Notes to Financial
Statements).
LIQUIDITY AND CAPITAL RESOURCES
Through September 30, 1995, we financed our operations primarily
through private placements of equity securities, from which it raised an
aggregate of approximately $33 million, net of issuance costs. In December 1995,
we completed our initial public offering, and raised approximately $43.5
million, net of issuance costs. In January 1996, the over allotment option
granted to the underwriters in the initial public offering was exercised,
resulting in proceeds of approximately $6.4 million, net of issuance costs. As
of December 31, 1998, we had cash, cash equivalents and short-term investments
of $7.9 million and working capital of $6.6 million, as compared to $14.5
million in cash, cash equivalents and short-term investments and $8.4 million of
working capital at December 31, 1997.
We used $9.5 million of cash for our operating activities for 1998, as
compared to $20.0 million for 1997 and $18.9 million for 1996. Negative cash
flows from operating activities for these periods were attributed primarily to
net losses incurred of $3.8 million, $23.4 million and $24.4 million for 1998,
1997 and 1996, respectively, offset by non-cash charges and changes in working
capital.
Cash provided by investing activities during 1998 was $2.3 million as
we decreased short-term investments by $2.6 million and made capital
expenditures of $0.3 million. Capital expenditures for 1998 consisted primarily
of purchases of manufacturing tools and molds, computer equipment and software
tools.
Cash provided by financing activities was $3.5 million during 1998. At
December 31, 1998, we had short-term bank borrowings of $3.2 million, and $0.3
million was provided by proceeds from the issuance of Common Stock in connection
with our employee stock purchase plan and the exercises of stock options.
On March 19, 1998, we amended our $7.5 million line of credit,
increasing the line to $12.5 million and extending the expiration date to March
1999. The line bore an interest rate of 0.25% over the Prime Rate, and was
collateralized by a security interest in our assets. As of December 31, 1998, we
had $6.0 million of short-term borrowings and $0.3 million of letters of credit
outstanding under the line of credit, and we were not in compliance with all
financial covenants under the agreement. As a result of the sale of our hardware
business to Primax, we paid all amounts owed on the line, cancelled the line and
obtained a waiver of covenant default for the period ended December 31, 1998.
Our principal sources of liquidity as of December 31, 1998 consisted of
approximately $7.9 million of cash, cash equivalents and short-term investments.
Subsequent to our year end, we sold our hardware business to Primax for $7
million. In addition, the merger with ScanSoft provided additional cash of $0.8
million with no associated long- or short-term debt. Based upon these events and
existing cash balances, we believe that our existing sources of liquidity will
provide adequate cash to fund our operations for at least the ne