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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-27038
SCANSOFT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3156479
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
9 CENTENNIAL DRIVE
PEABODY, MA 01960
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(978) 977-2000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12-b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
99,610,689 shares of the registrant's Common Stock, $0.001 par value, were
outstanding as of October 31, 2003.
SCANSOFT, INC.
FORM 10-Q
SEPTEMBER 30, 2003
INDEX
PAGE
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets at September 30, 2003 and
December 31, 2002 3
b) Consolidated Statements of Operations for the three and
nine months ended September 30, 2003 and
September 30, 2002 4
c) Consolidated Statements of Cash Flows for the nine months
ended September 30, 2003 and September 30, 2002 5
d) Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk 39
Item 4. Controls and Procedures 39
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 40
Item 4. Submission of Matters to a Vote of Security Holders 40
Item 6. Exhibits and Reports on Form 8-K 40
Signatures 41
Exhibit Index 42
2
SCANSOFT, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 47,485 $ 18,853
Marketable securities ................................................. 553 --
Accounts receivable, less allowances of $6,887 and $5,903, respectively 30,216 15,650
Receivables from related party ........................................ 1,630 1,518
Inventory ............................................................. 619 1,241
Prepaid expenses and other current assets ............................. 6,523 3,167
--------- ---------
Total current assets ............................................... 87,026 40,429
Goodwill ................................................................ 225,080 63,059
Other intangible assets, net ............................................ 55,227 33,823
Property and equipment, net ............................................. 6,028 2,846
Other assets ............................................................ 2,980 3,533
--------- ---------
Total assets ....................................................... $ 376,341 $ 143,690
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ...................................................... $ 5,862 $ 7,085
Accrued compensation .................................................. 7,624 2,122
Accrued other expenses ................................................ 15,019 7,651
Deferred revenue ...................................................... 8,283 1,790
Notes payable ......................................................... 6,746 3,273
Deferred payment obligation for business acquisition .................. 1,150 --
Deferred payment obligation for technology license .................... 2,617 --
Other current liabilities ............................................. 3,350 1,666
--------- ---------
Total current liabilities .......................................... 50,651 23,587
Deferred revenue ........................................................ 359 244
Long-term notes payable ................................................. 28,085 --
Deferred tax liabilities ................................................ 1,441 --
Other liabilities ....................................................... 7,293 481
--------- ---------
Total liabilities .................................................. 87,829 24,312
--------- ---------
Commitments and contingencies (Notes 6, 7 and 17) Stockholders' equity:
Preferred stock, $0.001 par value; 40,000,000 shares authorized;
3,562,238 shares issued and outstanding
(liquidation preference $4,631) ..................................... 4,631 4,631
Common stock, $0.001 par value; 140,000,000 shares authorized;
101,708,053 and 65,540,154 shares issued and 99,176,975 and
63,422,776 shares outstanding, respectively ......................... 102 66
Additional paid-in capital ............................................ 449,846 269,858
Treasury stock, at cost (2,531,078 and 2,117,378 shares, respectively) (9,863) (8,031)
Deferred compensation ................................................. (1,930) (173)
Accumulated other comprehensive loss .................................. (500) (47)
Accumulated deficit ................................................... (153,774) (146,926)
--------- ---------
Total stockholders' equity ......................................... 288,512 119,378
--------- ---------
Total liabilities and stockholders' equity ......................... $ 376,341 $ 143,690
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
3
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenue, third parties ........................ $ 31,179 $ 27,101 $ 84,214 $ 74,598
Revenue, related parties ...................... 1,771 1,134 4,315 3,586
-------- -------- -------- --------
Total revenue ............................ 32,950 28,235 88,529 78,184
Costs and expenses:
Cost of revenue ........................ 6,768 4,199 15,643 12,937
Cost of revenue from amortization of
intangible assets .................... 2,752 1,976 7,481 7,494
Research and development ............... 9,543 7,257 25,070 21,310
Selling, general and administrative .... 15,624 11,386 42,702 31,975
Non-cash stock compensation ............ 104 26 155 76
Amortization of other intangible assets 662 236 1,446 1,446
Restructuring and other charges ........ 1,719 -- 3,065 1,041
-------- -------- -------- --------
Total costs and expenses ............ 37,172 25,080 95,562 76,279
-------- -------- -------- --------
Income (loss) from operations ................. (4,222) 3,155 (7,033) 1,905
Other income (expense):
Interest income ............................. 189 66 288 296
Interest expense ............................ (170) (85) (421) (261)
Other income(expense), net .................. 229 (149) 791 (213)
-------- -------- -------- --------
Income (loss) before income taxes ............. (3,974) 2,987 (6,375) 1,727
Provision for (benefit from) income taxes ..... (243) 162 473 (166)
-------- -------- -------- --------
Net income (loss) ............................. $ (3,731) $ 2,825 $ (6,848) $ 1,893
======== ======== ======== ========
Net income (loss) per share: basic ............ $ (0.04) $ 0.04 $ (0.10) $ 0.03
======== ======== ======== ========
Net income (loss) per share: diluted .......... $ (0.04) $ 0.04 $ (0.10) $ 0.03
======== ======== ======== ========
Weighted average common shares: basic ......... 83,694 67,865 71,286 67,116
======== ======== ======== ========
Weighted average common shares: diluted ....... 83,694 74,787 71,286 72,451
======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
SCANSOFT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .......................................................................... $ (6,848) $ 1,893
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation .......................................................................... 1,549 1,535
Amortization of intangible assets ..................................................... 8,927 8,940
Allowances for bad debts .............................................................. 540 1,246
Non-cash portion of restructuring charges ............................................. 69 113
Stock-based compensation .............................................................. 155 77
Foreign exchange loss ................................................................. (71) --
Non-cash interest expense ............................................................. 168 --
Deferred tax provision ................................................................ 1,441 --
Gain on disposal or sale of property and equipment ..................................... -- (30)
Changes in operating assets and liabilities, net of effects from business acquisitions:
Accounts receivable ................................................................ (1,151) (4,234)
Inventory .......................................................................... 1,010 (1,003)
Prepaid expenses and other current assets .......................................... (917) (1,189)
Other assets ....................................................................... (371) (273)
Accounts payable ................................................................... (2,720) (292)
Accrued expenses ................................................................... 810 2,162
Other liabilities .................................................................. (143) --
Deferred revenue ................................................................... 536 (2,682)
-------- --------
Net cash provided by operating activities ........................................... 2,984 6,263
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment .......................................... (1,441) (2,090)
Proceeds from sale of property and equipment ............................................. -- 42
Cash expenditures for licensing agreements ............................................... (6,113) --
Cash received (paid) for acquisitions, including transaction costs ....................... 31,347 (2,860)
-------- --------
Net cash provided by (used in) investing activities ................................... 23,793 (4,908)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of note payable .................................................................. (3,273) --
Payments of capital lease obligation ..................................................... -- (238)
Purchase of treasury stock ............................................................... (1,832) (7,000)
Payments of notes payable related to acquisition ......................................... -- (586)
Payments under deferred payment obligation ............................................... (1,230) (1,824)
Proceeds from issuance of common stock, net of issuance costs ............................ 6,767 5,690
Proceeds from issuance of common stock under employee stock compensation plans ........... 2,053 2,545
-------- --------
Net cash provided by (used in) financing activities ................................. 2,485 (1,413)
-------- --------
Effects of exchange rate changes on cash and cash equivalents .............................. (630) 116
-------- --------
Net increase in cash and cash equivalents .................................................. 28,632 58
Cash and cash equivalents at beginning of period ........................................... 18,853 14,324
-------- --------
Cash and cash equivalents at end of period ................................................. $ 47,485 $ 14,382
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
5
SCANSOFT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of ScanSoft,
Inc. (the "Company" or "ScanSoft") have been prepared in accordance with
accounting principles generally accepted in the United States of America. In the
opinion of management, these interim consolidated financial statements reflect
all adjustments, consisting of normal recurring adjustments, necessary for a
fair presentation of the financial position at September 30, 2003 and the
results of operations for the three and nine months ended September 30, 2003 and
2002 and cash flows for the nine months ended September 30, 2003 and 2002.
Although the Company believes that the disclosures in these financial statements
are adequate to make the information presented not misleading, certain
information normally included in the footnotes prepared in accordance with
generally accepted accounting principles has been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission. The accompanying financial statements should be read in conjunction
with the audited financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002 filed
with the Securities and Exchange Commission on March 28, 2003 and all other
subsequent periodic filings including Form 10-Q for the three months ended March
31, 2003 and June 30, 2003 filed on May 15, 2003 and August 14, 2003,
respectively. The results for the three and nine months ended September 30, 2003
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2003, or any future period.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone. The results of operations of the acquired business have been included
in the financial statements of the Company as of August 11, 2003, the date of
acquisition.
On January 30, 2003, the Company completed the acquisition of the Philips
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property (the "Philips
acquisition"). The Telephony business unit offers speech-enabled services
including directory assistance, interactive voice response and voice portal
applications for enterprise customers, telephony vendors and carriers. The Voice
Control business unit offers a product portfolio including small footprint
speech recognition engines for embedded applications such as voice-controlled
climate, navigation and entertainment features in automotive vehicles, as well
as voice dialing for mobile phones. The results of operations of the acquired
business have been included in the financial statements of the Company as of
January 30, 2003, the date of acquisition.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities on the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The most significant estimates and assumptions included in the financial
statements are revenue recognition, including estimating valuation allowances,
specifically sales returns and other allowances, the recoverability of
intangible assets, including goodwill, and valuation allowances for deferred tax
assets. Actual amounts could differ significantly from these estimates.
Certain prior year financial statement amounts have been reclassified to
conform with the current year presentation.
2. RESTATEMENT OF TAX PROVISION
In connection with the third quarter of 2003, the Company determined that
an adjustment was required to properly reflect its tax provisions in the
Company's financial statements as presented in Form 10-Q as filed for the
quarterly periods ended March 31, 2003 and June 30, 2003. These non-cash tax
adjustments result from the Company's implementation of SFAS No. 142.
Historically, the Company has netted its deferred tax liability related to
goodwill against its deferred tax asset. Following adoption of SFAS No. 142, the
temporary differences created by different treatment for book and tax of the
Company's goodwill can no longer be assumed to offset deductible temporary
differences which create deferred tax assets. Therefore, the Company was
required to record an additional tax expense to increase its deferred tax asset
valuation allowance in its financial statements for the three month period
ending March 31, 2003 and the three and six month periods ended June 30, 2003 as
follows:
6
- --------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED
SHARE DATA) MARCH 31, 2003 JUNE 30, 2003 JUNE 30, 2003
----------------------------------------------------------------------------------------
AS AS AS
PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
- --------------------------------------------------------------------------------------------------------------------
Statement of Operations:
- --------------------------------------------------------------------------------------------------------------------
Provision for income taxes $ 95 $ 345 $ 67 $ 371 $ 162 $ 716
- --------------------------------------------------------------------------------------------------------------------
Net income/(loss) $ 76 $(174) $(2,639) $(2,943) $(2,563) $(3,117)
- --------------------------------------------------------------------------------------------------------------------
Net income/(loss) per
share-Basic and diluted $0.00 $0.00 $ (0.04) $ (0.04) $ (0.04) $ (0.05)
- --------------------------------------------------------------------------------------------------------------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position
97-2, Software Revenue Recognition ("SOP 97-2"), as amended by Statement of
Position 98-9, and the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements. Revenue from the
sale of licenses to end users, value-added resellers and system integrators to
use the Company's software products is recognized upon delivery, provided that
the arrangement does not require significant modification or customization of
the software, any services included in the arrangement are not considered
essential to the functionality of the software, evidence of the arrangement
exists, the fees are fixed or determinable, and collectibility is reasonably
assured.
Sales of the Company's software products through certain distributors and
value-added resellers provide rights of return for as long as the distributors
or resellers hold the inventory. As a result, the Company recognizes revenues
from sales to these distributors and resellers only when the distributors or
resellers have sold products to retailers and end-users. Title and risk of loss
pass to the distributor or reseller upon shipment, at which time the transaction
is invoiced and payment is due. Based on reports from distributors and resellers
of their inventory balances at the end of each period, the Company records an
allowance against accounts receivable for the sales price of all inventories
subject to return. If the Company experiences significant returns from
distributors or resellers, the Company's liquidity may be adversely impacted.
The Company makes an estimate of sales returns by retailers or end users
directly or through its distributors or resellers based on historical returns
experience. The provision for these estimated returns is recorded as a reduction
of revenue at the time that the related revenue is recorded. Historically, the
Company has not experienced significant returns from retailers or end-users. If
actual returns differ significantly from its estimates, such differences could
have a material impact on its results of operations for the period in which the
actual returns become known.
Revenue from royalties on sales of the Company's products by OEMs to third
parties, where no services are included, is typically recognized upon delivery
to the third party when such information is available, or when the Company is
notified by the OEM that such royalties are due as a result of a sale, provided
that all other revenue recognition criteria are met.
7
When the Company provides professional services such as custom applications
and other services considered essential to the functionality of the software for
a fixed fee, it recognizes revenue from the fees for such services and any
related software licenses as it completes the project using the percentage-of-
completion method. The Company generally determines the percentage-of-completion
by comparing the labor hours it has incurred to date to the estimate of the
total labor hours required to complete the project based on regular discussions
with its project managers. This method is used because the Company considers
expended labor hours to be the most reliable, available measure of progress on
these projects. Adjustments to contract estimates are made in the periods in
which facts resulting in a change become known. When the estimate indicates a
loss, such loss is provided for in its entirety. Significant judgments and
estimates are involved in determining the percent complete of each contract.
Different assumptions could yield materially different results.
Other professional services not considered essential to the functionality
of the software are limited and primarily include training and feasibility
studies. When the Company provides services on a time and materials basis, it
recognizes revenue as it performs the services based on actual time incurred.
When the Company provides support and maintenance services, it recognizes
the revenue ratably over the term of the related contracts, typically one year.
The Company may sell, under one contract or related contracts, software
licenses, custom software applications and other services considered essential
to the functionality of the software and a maintenance and support arrangement.
The total contract value is attributed first to the maintenance and support
arrangement based on its fair value, equal to its stated list price as a fixed
percentage of the related software product's price. The remainder of the total
contract value is then attributed to the software license and related
professional services, which are typically recognized as revenue using the
percentage-of-completion method. As a result, discounts inherent in the total
contract value are attributed to the software license and related professional
services. The Company may sell, under one contract or related contracts,
software licenses, a maintenance and support arrangement and professional
services not considered essential to the functionality of the software. In those
arrangements, the total contract value is attributed first to the undelivered
elements of maintenance and support and professional services based on their
fair values, as described above. The remainder of the contract value is
attributed to the software licenses, which are typically recognized as revenue
upon delivery, provided all other revenue recognition criteria are met. As a
result, discounts inherent in the total contract value are attributed to the
software licenses.
The Company follows the guidance of Emerging Issues Task Force issue No.
01-09, Accounting for Consideration Given by a Vendor to a Customer or a
Reseller of the Vendor's Products ("EITF 01-09"), in determining whether
consideration, including equity instruments, given to a customer should be
recorded as an operating expense or a reduction of revenue recognized from that
same customer. Consideration given to a customer is recorded as a reduction of
revenue unless both of the following conditions are met:
o The Company receives an identifiable benefit in exchange for the
consideration, and the identified benefit is sufficiently separable
from the customer's purchase of the Company's products and services
such that the Company could have purchased the products from a third
party, and
o The Company can reasonably estimate the fair value of the benefit
received.
If both of the conditions are met, the Company records consideration paid
to customers as an expense. Consideration, including equity instruments, not
meeting the above criteria, is recorded as a reduction of revenue, to the extent
the Company has recorded cumulative revenue from the customer or reseller.
The Company records reimbursements received for out-of-pocket expenses as
revenue, with offsetting costs recorded as cost of revenue. Out-of-pocket
expenses generally include, but are not limited to, expenses related to
airfare, hotel stays and out-of-town meals.
Foreign Currency Risk Management
In certain circumstances, the Company enters into forward exchange
contracts to hedge against foreign currency fluctuations. These contracts are
used to reduce the Company's risk associated with exchange rate movements, as
the gains or losses on these contracts are intended to offset the exchange rate
losses or gains on the underlying exposures. The Company does not engage in
foreign currency speculation. Hedges of underlying exposures are designated and
documented at the inception of the hedge and are evaluated for effectiveness
monthly. Forward exchange contracts hedging firm commitments qualify for hedge
accounting when they are designated as a hedge of the foreign currency exposure
and they are effective in minimizing such exposure. Gains and losses on forward
exchange contracts that qualify for hedge accounting are recognized as other
comprehensive income (loss), along with the associated losses and gains on the
hedged item. As the terms of the forward exchange contract and underlying
exposure are matched generally at inception, hedging effectiveness is calculated
by comparing the change in fair value of the contract to the change in fair
value of the underlying exposure.
8
On January 30, 2003, the Company entered into a forward exchange contract
to hedge the foreign currency exposure of its 5.0 million euro note payable to
Philips. The contract and the note payable each have a term that expires on
December 31, 2003. Based upon period-end exchange rates, the Company estimates
the fair value of the forward exchange contract approximates the fair value of
the note payable. For the three and nine months ended September 30, 2003, the
Company recorded a net exchange rate loss of approximately $(3,000) and a net
exchange rate gain of approximately $4,000, respectively, in other comprehensive
income on the note payable and associated forward exchange contract. On August
26, 2003, the Company entered into a forward exchange contract to hedge the
foreign currency exposure of its 1.0 million euro payable to Philips. The
contract and the payable each have a term that expires on December 31, 2003.
Based upon period-end exchange rates, the Company estimates the fair value of
the forward exchange contract approximates the fair value of the payable. For
the three and nine months ended September 30, 2003 the Company recorded a net
exchange rate loss of approximately $(2,000) in other comprehensive income on
the payable and associated forward exchange contract.
Recently Issued Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150 ("SFAS 150"), "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS 150 was originally effective for financial instruments entered
into or modified after May 31, 2003, and otherwise effective at the beginning of
the first interim period beginning after June 15, 2003, however certain elements
of SFAS No. 150 have been deferred. The adoption of the provisions of SFAS No.
150 not deferred did not have a material impact on the Company's financial
position or results of operations and the Company does not expect the adoption
of the deferred elements of SFAS No. 150 to have a material impact on its
financial position or results of operations.
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 149 was effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of SFAS No. 149 did not have a
material impact on the Company's current financial position and results of
operations.
In November 2002, the Emerging Issues Task Force ("EITF") of the FASB
issued EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF No. 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which it will perform multiple revenue-generating
activities. EITF No. 00-21 establishes three principles: revenue should be
recognized separately for separate units of accounting, revenue for a separate
unit of accounting should be recognized only when the arrangement consideration
is reliably measurable and the earnings process is substantially complete, and
consideration should be allocated among the separate units of accounting in an
arrangement based on their fair value. EITF No. 00-21 is effective for all
revenue arrangements entered into on or after July 1, 2003. The adoption of EITF
00-21 did not have a material impact on the Company's results of operations or
financial position. In May 2003, as a result of questions raised regarding
applicability of EITF No. 00-21 to software revenue recognition arrangements,
the EITF reached a consensus regarding the application of the provisions of SOP
97-2 to arrangements containing software deliverables and non-software
deliverables. The consensus reached in May 2003 was confirmed in July 2003 and
was issued as Issue 03-05, "Applicability of AICPA Statement of Position 97-2 to
Non-Software Deliverables in an Arrangement Containing More-Than-Incidental
Software" ("EITF No. 03-05"). EITF No. 03-05 concludes that software-related
elements include software-related products and services such as those listed in
paragraph 9 of SOP 97-2, as well as other deliverables for which the software is
essential to their functionality (e.g., computer hardware). Elements included in
arrangements that do not qualify as software-related elements are to be
accounted for under the guidance of EITF No. 00-21 and not SOP 97-2. EITF No.
03-05 is effective for all new revenue arrangements entered into after October
1, 2003. The adoption of EITF No. 03-05 is not expected to have a material
impact on the Company's results of operations or financial position.
4. ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company recognizes compensation costs for stock-based awards to
employees using the intrinsic value-based method described in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". The
following table illustrates the effect on net income (loss) and basic and
diluted net income (loss) per share as if the fair value method prescribed in
Statement of Financial Accounting Standards No. 123, "Accounting For Stock-Based
Compensation", had been applied for the Company's employee stock-based
compensation and recorded in the consolidated financial statements:
9
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2003 2002
- ------------------------------------------------------------- ------- ------- -------- -------
Net income (loss) -- as reported ............................ $(3,731) $ 2,825 $ (6,848) $ 1,893
Add back: Stock-based compensation included in net income
(loss), as reported ......................................... 104 27 155 77
Deduct: Total stock-based employee compensation expense
determined under the fair value-based-method ................ (2,639) (2,708) (7,177) (6,643)
------- ------- -------- -------
Net loss -- pro forma ....................................... $(6,266) $ 144 $(13,870) $(4,673)
======= ======= ======== =======
Net income (loss) per share -- as reported: basic and diluted $ (0.04) $ 0.04 $ (0.10) $ 0.03
Net loss per share - pro forma: basic and diluted ........... $ (0.07) $ 0.00 $ (0.19) $ (0.07)
5. INVENTORY
Inventory consists of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Raw materials... $ 12 $ 26
Finished goods.. 607 1,215
------- ---------
$ 619 $ 1,241
======= =========
6. ACQUISITION OF SPEECHWORKS INTERNATIONAL, INC.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone.
The acquisition of SpeechWorks enhances the ability of the combined company
to promote its products and comprehensively address the needs of the system
integrators in the United States telephony markets. The addition of SpeechWorks'
professional services organization will enable the combined company to support
major accounts, channel partners and telecommunications firms, as well as
provide the ability to deliver complete solutions. In addition, the acquisition
enhances the combined company's strengths in key vertical markets, including
multiple deployments in travel/hospitality, financial services and government,
thereby expanding the combined company's market share in these key markets and
expertise in developing applications and solutions for these industries. These
incremental intangible benefits, which are reflected in the purchase
consideration, resulted in goodwill.
The results of operations of the acquired business have been included in
the financial statements of the Company since the date of acquisition.
In connection with the acquisition of SpeechWorks, ScanSoft exchanged 0.860
of a share of its common stock for each outstanding share of SpeechWorks stock.
This transaction resulted in the issuance of approximately 32.5 million shares
of ScanSoft common stock, representing approximately 33% of the outstanding
common stock of ScanSoft after the completion of the acquisition. The
SpeechWorks purchase price of $175.5 million includes the value of the ScanSoft
common stock issued at a per share value of $5.26 (the average closing price of
ScanSoft common stock for a total of five days immediately prior to and
subsequent to the announcement of the acquisition) and transaction costs of $4.5
million. Included in the transaction costs is a warrant, valued at $0.2 million,
for the purchase of 150,000 shares of ScanSoft's common stock (Note 18). In
addition, the purchase price also includes the value of 184,786 shares of
restricted ScanSoft common stock issued by ScanSoft, in replacement of
previously outstanding SpeechWorks unvested restricted common stock, of $0.7
million based on the closing price of ScanSoft common stock on the acquisition
date. The value of the unvested restricted common stock has been recorded as
deferred compensation (Note 19).
10
The preliminary purchase price allocation is as follows: (in thousands):
Total purchase consideration:
Common stock and restricted stock issued $ 170,950
Transaction costs 4,500
---------
Total purchase consideration $ 175,450
=========
Preliminary allocation of the purchase consideration:
Assets acquired:
Cash $ 39,953
Marketable securities 553
Accounts receivable 10,064
Other current assets 938
Property and equipment 2,840
Other long term assets 1,048
Identifiable intangible assets 13,310
Goodwill 128,395
---------
Total assets acquired 197,101
---------
Deferred compensation for unvested restricted common
stock 724
Liabilities assumed:
Accounts payable (1,610)
Accrued expenses (9,487)
Deferred revenue (5,034)
Other long term liabilities (4,704)
Note payable (1,540)
---------
Total liabilities assumed: (21,651)
---------
$ 175,450
=========
Current assets acquired primarily relate to cash, marketable securities and
accounts receivable. Current liabilities assumed primarily relate to accounts
payable, accrued expenses and deferred revenue. In December 2002, SpeechWorks
committed to a restructuring plan to vacate two office locations during 2003. In
connection with this restructuring plan, SpeechWorks recorded a charge of $5.9
million. As of the acquisition date, the balance of this accrual was $5.4
million, which has been included in other long-term liabilities. The Company
reduced the recorded accrual by $1.0 million to record such obligation at its
net present value, using a discount rate of 3%. The $1.0 million difference
between the lease obligations and the recorded accrual will be recognized as
incremental rent expense over the remaining life of the lease. These assumed
leases extend through 2010 and 2016, respectively, unless the Company is able to
negotiate earlier termination dates. The Company anticipates that the
facilities-related accrual will be expended equally over the remaining life of
the leases.
The amount assigned to identifiable intangible assets acquired was based on
their respective fair values determined as of the acquisition date. The Company
did not attribute any value to "in-process research and development" projects in
connection with this acquisition. The Company believes that these identified
intangible assets have no residual value. The excess of the purchase price over
the tangible and identifiable intangible assets was recorded as goodwill and
amounted to approximately $128.4 million. In accordance with current accounting
standards, the goodwill is not being amortized and will be tested for impairment
as required by SFAS No. 142. Goodwill and all other identifiable intangible
assets acquired by SpeechWorks previously may be deductible for tax purposes.
The Company is in the process of completing the purchase price allocation,
which is subject to adjustment as a result of pending analysis of lease
obligations as well as litigation which arose just prior to the acquisition
date. As discussed more fully in Note 17, the Company assumed significant lease
obligations in connection with the acquisition and is in the process of
reviewing these leases based on the provisions of the lease agreements and the
Company's expectations for post-acquisition operations. The Company expects to
complete the assessment of assumed lease obligations prior to the issuance of
the financial statements on Form 10-K for the year ending December 31, 2003. Any
adjustment resulting from the assessment would result in an adjustment to
goodwill. (See Note 17)
In connection with the SpeechWorks acquisition, the Company eliminated 54
SpeechWorks former employees. In connection with this action, a liability of
$1.3 million, representing severance and related benefits, has been included in
the purchase price allocation. Of this balance, $0.8 million has been paid as of
September 30, 2003 and the remainder is expected to be paid within the next 12
months and will be funded from working capital.
11
The following are the identifiable intangible assets acquired and the
respective periods over which the assets will be amortized on a straight-line
basis:
AMOUNT AMORTIZATION
(IN THOUSANDS) PERIOD (IN YEARS)
-------------- -----------------
Patents and core technology.. $ 1,300 10
Completed technology ........ 2,200 5
Customer relationships ...... 9,000 6
Trade names and trademarks... 800 5
Non-compete agreements ...... 10 1
-------
$13,310 6.5
=======
7. ACQUISITION OF PHILIPS SPEECH PROCESSING TELEPHONY AND VOICE CONTROL BUSINESS
On January 30, 2003, the Company completed the acquisition of the Philips
Speech Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property. The Telephony
business unit offers speech-enabled services including directory assistance,
interactive voice response and voice portal applications for enterprise
customers, telephony vendors and carriers. The Voice Control business unit
offers a product portfolio including small footprint speech recognition engines
for embedded applications such as voice-controlled climate, navigation and
entertainment features in automotive vehicles, as well as voice dialing for
mobile phones.
The acquisition of the Philips Speech Processing Telephony and Voice
Control business enhances the Company's market share in key markets and gives
the Company additional competitive momentum in its target markets, specifically
the telephony, automotive and embedded markets. In addition, it enhances the
distribution channel adding new reference accounts for both customer
relationships and technology partners. These incremental intangible benefits
attributed to excess purchase consideration resulting in goodwill.
The results of operations of the acquired business have been included in
the financial statements of the Company since the date of acquisition.
Consideration for the acquisition, before any purchase price adjustment to
be determined by the parties as described below, totaled $39.5 million,
including transaction costs of $2.1 million. The consideration consisted of 3.1
million euros ($3.4 million) in cash paid at closing, subject to adjustment in
accordance with the provisions of the purchase agreement, as amended; a deferred
payment of 1.0 million euros in cash due no later than December 31, 2003, a 5.0
million euro note due December 31, 2003; bearing 5.0% interest per annum; and a
$27.5 million three-year, zero-interest subordinated debenture, convertible at
any time at Philips' option into shares of common stock at $6.00 per share. The
fair value of the convertible debenture was determined to be $27.5 million based
on the present value of the expected cash outflows using an incremental
borrowing rate of 12% and the fair value of the conversion feature based on the
Black-Scholes option pricing model using the following assumptions: the fair
value of the Company's common stock of $3.62 per share, the closing price of the
Company's common stock on the day the parties entered into the acquisition
agreement; volatility of 100%; risk-free interest rate of 2.16%; no dividends
and an expected term of 3 years.
The purchase price is subject to adjustment based on a calculation set
forth in the purchase agreement, as amended, which must be agreed upon by the
parties and which may result in an adjustment either to increase or decrease the
total purchase consideration. Upon final determination of the purchase price
adjustment, a corresponding adjustment will be recorded to goodwill.
12
The preliminary purchase price allocation is as follows (in thousands):
Total purchase consideration:
Cash $ 3,350
Other current liability (1.0 million euro payable) 1,080
Note payable 5,410
Convertible debenture 27,520
Transaction costs 2,100
--------
Total purchase consideration $ 39,460
========
Allocation of the purchase consideration:
Current assets $ 3,930
Property and equipment 310
Identifiable intangible assets 5,650
Goodwill 33,699
--------
Total assets acquired 43,589
--------
Current liabilities (4,129)
--------
$ 39,460
========
Current assets acquired primarily relate to accounts receivable, and
current liabilities assumed primarily relate to accounts payable and assumed
contractual liabilities related to development work with customers which were
agreed to prior to the acquisition date. In determining the preliminary purchase
price allocation, the Company established a liability related to an assumed
contractual relationship which related to a project for the development of
speech and language databases with the European Union. During the quarter ended
September 30, 2003, the Company determined that based on the contractual nature
of the assignability of these contracts, there is no related liability. This
determination resulted in an adjustment to the liability established in the
preliminary purchase price allocation and a corresponding adjustment to goodwill
of $431,000, which has been reflected in the table above.
The following are the identifiable intangible assets acquired and the
respective periods over which the assets will be amortized on a straight-line
basis:
AMOUNT AMORTIZATION
(IN THOUSANDS) PERIOD (IN YEARS)
-------------- -----------------
Patents and core technology.... $ 3,990 10
Completed technology........... 460 5.5
Customer relationships......... 1,030 1.8
Trade names and trademarks..... 170 5
--------
$ 5,650 9.3
========
The amount assigned to identifiable intangible assets acquired was based on
their respective fair values determined as of the acquisition date. The Company
did not attribute any value to in-process research and development projects in
connnection with this acquisition. The Company believes that these identified
intangible assets have no residual value. The excess of the purchase price over
the tangible and identifiable intangible assets was recorded as goodwill and
amounted to approximately $33.7 million. In accordance with current accounting
standards, the goodwill is not being amortized and will be tested for impairment
as required by SFAS No. 142. All goodwill and other identifiable intangible
assets are deductible for tax purposes.
Under the terms of the purchase agreement, as amended, Philips agreed to
reimburse the Company for the costs, up to 5.0 million euros, associated with
certain restructuring actions taken through December 31, 2003, primarily
headcount and facilities related charges associated with operations based in
Germany. To the extent that the total reimbursable costs exceed 5.0 million
euros as of or at any time prior to December 31, 2003, Philips will reimburse
the Company for one-third of the excess and the Company will be responsible for
the remaining two-thirds of any excess. To the extent that the total
reimbursable costs are less than 5.0 million euros at December 31, 2003, Philips
will pay to the Company an amount equal to two-thirds of such difference. Any
adjustment will either increase or decrease the total purchase consideration and
a corresponding adjustment will be recorded to goodwill. Through September 30,
2003, the Company entered into severance agreements with a total of 70 employees
of Philips, resulting in severance costs totaling $1.3 million. Of this amount,
severance costs of $1.0 million were subject to reimbursement to the Company by
Philips pursuant to the purchase agreement. During the three months ended
September 30, 2003, the Company was reimbursed $0.9 million by Philips. The
remainder ($0.3 million of the total severance costs) was recorded by the
Company as a current liability as part of the purchase price allocation in
accordance with EITF 95-3, "Recognition of Liabilities in Connection with a
Purchase Business Combination."
13
The final purchase price, adjusted for the matters described in this
Note 7, is expected to be determined no later than December 31, 2003.
8. PRO FORMA RESULTS (UNAUDITED)
The following table reflects unaudited pro forma results of operations of
the Company assuming that the Philips and SpeechWorks acquisitions had occurred
on January 1, 2002 (in thousands, except per share data):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2003 2002 2003 2002
-------- -------- --------- ---------
Revenues ............. $ 36,674 $ 39,757 $ 113,448 $ 116,982
Net loss ............. $(14,612) $(12,950) $ (36,097) $ (41,040)
Net loss per basic and
diluted
share ................ $ (0.15) $ (0.13) $ (0.37) $ (0.43)
The unaudited pro forma results of operations are not necessarily
indicative of the actual results that would have occurred had the transactions
actually taken place at the beginning of these periods.
9. GOODWILL
As a result of the SpeechWorks acquisition (Note 6) on August 11, 2003 and
the Philips acquisition (Note 7) on January 30, 2003, goodwill increased by
$128.4 million and $33.7 million, respectively.
10. OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following (in thousands):
GROSS NET
CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT
-------- ------------ --------
SEPTEMBER 30, 2003
Patents and core technology.. $ 55,380 $26,543 $28,837
Completed technology ........ 30,371 17,608 12,763
Trademarks .................. 6,471 2,262 4,209
Non-competition agreement.... 4,058 4,049 9
Acquired favorable lease..... 553 553 --
Customer relationships ...... 11,130 1,721 9,409
Other ....................... 200 200 --
-------- ------- -------
$108,163 $52,936 $55,227
======== ======= =======
DECEMBER 31, 2002
Patents and core technology.. $ 50,090 $20,331 $29,759
Completed technology ........ 16,340 16,340 --
Trademarks .................. 5,501 1,725 3,776
Non-competition agreement.... 4,048 4,048 --
Acquired favorable lease .... 553 553 --
Customer relationships ...... 1,100 812 288
Other ....................... 200 200 --
-------- ------- -------
$ 77,832 $44,009 $33,823
======== ======= =======
On March 31, 2003, the Company entered into an agreement that grants an
exclusive license to the Company to resell, in certain geographies worldwide,
certain productivity applications. The period of exclusivity expires after seven
years, unless terminated earlier as permitted under the agreement. Total
consideration to be paid by the Company for the license was $13.0 million. On
June 30, 2003, the terms and conditions of the agreement were amended, resulting
in a $1.2 million reduction in the license fee. The initial payment of $6.4
million due on or before June 30, 2003 was paid in accordance with the terms of
the license agreement. The two remaining payments totaling $5.6 million will be
paid as follows: 1) $2.8 million on March 31, 2004 and 2) $2.8 million on March
31, 2005.
14
Based on the net present value of the deferred payments due in 2004 and 2005,
using an interest rate of 7.0%, the Company recorded $11.4 million as completed
technology, which will be amortized to cost of goods sold based on the greater
of (a) the ratio of current gross revenue to total current and expected future
revenues for the products or (b) the straight-line basis over the period of
expected use, five years. The $0.6 million difference between the stated payment
amounts and the net present value of the payments, will be charged to interest
expense over the payment period. As of September 30, 2003, payments due on or
before June 30, 2004, and the remaining balance due, have been classified as
deferred payment for technology license and other liabilities, long-term
respectively.
On March 31, 2003, the Company acquired certain intellectual property
assets related to multimodal speech technology, in exchange for $0.1 million in
cash and the issuance of a warrant valued at $0.1 million (Note 18). The
purchase price was recorded as completed technology and will be amortized over
three years.
Aggregate amortization expense was $3.4 million and $8.9 million for the
three and nine months ended September 30, 2003, respectively. Of these amounts,
$2.7 million and $7.5 million, respectively, were included in cost of revenue
and $0.7 million and $1.4 million, respectively, were recorded in operating
expenses. Aggregate amortization expense was $2.2 million and $8.9 million for
the three and nine months ended September 30, 2002, respectively. Of these
amounts, $2.0 million and $7.5 million, respectively, were included in cost of
revenue and $0.2 million and $1.4 million, respectively, were recorded in
operating expenses. Amortization expense for the remaining period of fiscal year
2003, the four succeeding fiscal years and thereafter as of September 30, 2003
is as follows (in thousands):
OTHER
COST OF OPERATING
YEAR ENDING REVENUE EXPENSES TOTAL
--------------- ---------- -------- ----------
2003........ $ 2,814 $ 731 $ 3,545
2004........ 10,813 2,749 13,562
2005........ 6,412 2,249 8,661
2006........ 5,332 2,034 7,366
2007........ 5,317 1,904 7,221
Thereafter.. 10,912 3,960 14,872
---------- -------- ----------
Total....... $ 41,600 $ 13,627 $ 55,227
========== ======== ==========
11. ACCRUED OTHER EXPENSES
Accrued other expenses consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Sales and marketing incentives .. $ 2,231 $ 1,802
Restructuring and other charges.. 1,987 665
Royalties........................ 435 238
Professional fees................ 1,438 472
Acquisition liabilities.......... 2,066 1,654
Other............................ 6,862 2,820
--------- ---------
$ 15,019 $ 7,651
========= =========
12. RESTRUCTURING AND OTHER CHARGES
In January 2002, the Company announced, and in March 2002 completed, a
restructuring plan to consolidate facilities, worldwide sales organizations,
research and development teams and other personnel following the December 12,
2001 L&H acquisition. As a result, the Company exited facilities in both North
America and Europe, eliminating 21 employee positions, including 12 in research
and development and 9 in selling, general and administrative functions. In the
first quarter of 2002, the Company recorded a restructuring charge in the amount
of $0.6 million for severance payments to these employees, and a restructuring
charge of $0.4 million for certain termination fees to be incurred as a result
of exiting the facilities, including the write-off of previously recorded
assembled workforce of $0.1 million.
In connection with the Philips acquisition (Note 7), the Company eliminated
25 ScanSoft personnel across all functional areas, resulting in a charge of
approximately $0.5 million in severance-related restructuring costs in the three
month period ended March 31, 2003.
During the three months ended June 30, 2003, the Company committed to a
plan to transfer certain research and development activities currently located
at its corporate headquarters to Budapest resulting in the elimination of 21
employees. The Company
15
recorded a restructuring charge in the amount of $0.4 million for severance
payments to these employees. In addition, the Company recorded a charge in the
amount of $0.4 million for severance payments to a former member of the senior
management team.
During the three months ended September 30, 2003, the Company eliminated 81
ScanSoft employees as a result of the SpeechWorks acquisition across all
functional areas, resulting in a charge of $1.5 million for severance costs,
representing the ratable recognition of expenses from the date the plan was
announced through September 30, 2003. Certain of these employees have
termination dates after September 30, 2003 and, as required by SFAS 112, the
Company expects to record $0.5 million of additional severance expense during
the three months ended December 31, 2003.
In addition, during the three month period ended September 30, 2003, the
Company accrued $0.2 related to the closing of certain ScanSoft offices as a
result of the SpeechWorks acquisition and related expenses.
At September 30, 2003, the remaining restructuring accrual from the current
and prior restructuring activities amounted to $2.0 million. The balance is
comprised of $0.1 million of lease exit costs and $1.9 million of
employee-related severance costs, of which $0.3 million are for severance to the
former Caere President and CEO, $0.1 million are for severance costs related to
the 2003 Philips related restructuring actions and $0.6 million and $0.9 million
are for severance costs related to the actions taken during the three months
ended June 30, 2003 and September 30, 2003, respectively, as noted above. The
lease exit costs and severance due to the former Caere President and CEO will be
paid through January 2004 and March 2005, respectively. Severance costs related
to the 2003 Philips related restructuring actions will be paid through December
31, 2003. Severance costs related to restructuring actions undertaken during the
quarter ended June 30, 2003 will be paid through March 2009. Severance costs
related to employee termination actions undertaken during the three month period
ended September 30, 2003, including the additional $0.5 million expected to be
recorded during the three months ended December 31, 2003, will be paid through
September 2004.
The following table sets forth the restructuring and other charges accrual
activity (in thousands):
FACILITIES RETIREMENT
EMPLOYEE EXIT OF
RESTRUCTURING AND OTHER CHARGES ACCRUAL RELATED COSTS FIXED ASSETS TOTAL
- ---------------------------------------- ------- --------- ------------ -------
Balance at December 31, 2001 ........... $ 634 $ -- $ -- $ 634
Restructuring and other charges ........ 576 465 -- 1,041
Non-cash write-off ..................... -- (113) -- (113)
Cash payments .......................... (764) (133) -- (897)
------- ----- ---- -------
Balance at December 31, 2002 ........... 446 219 -- 665
Restructuring and other charges ........ 2,856 120 89 3,065
Non-cash write-off ..................... -- -- (89) (89)
Cash payments .......................... (1,407) (247) -- (1,654)
------- ----- ---- -------
Balance at September 30, 2003 .......... $ 1,895 $ 92 $ -- $ 1,987
======= ===== ==== =======
13. OTHER LIABILITIES
Other liabilities consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ -----------
Facilities operating lease obligations ...... $4,377 $ --
Deferred payments for technology license .... 2,588 --
Caere acquisition related costs ............. -- 409
Other ....................................... 328 72
------ ----
$7,293 $481
====== ====
14. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed using the weighted average
number of common shares outstanding during the period. Basic net income per
share for the three and nine months ended September 30, 2002 includes the
assumed conversion
16
of the Series B Preferred Stock, which participates in dividends with common
stock when and if declared, as well as the weighted average impact of vested
shares of restricted stock. Diluted net income (loss) per share is computed
based on (i) the weighted average number of common shares outstanding, (ii) the
assumed conversion of the Series B Preferred Stock, and (iii) the effect, when
dilutive, of outstanding stock options, the convertible debenture, warrants, and
unvested shares of restricted stock using the treasury stock method.
The following is a reconciliation of the shares used in the computation of
basic and diluted net income (loss) per share (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
2003 2002 2003 2002
------- ------- ------ ------
Weighted average number of common shares
outstanding.................................. 83,694 64,303 71,286 63,554
Assumed conversion of Series B Preferred
stock.................................... -- 3,562 -- 3,562
------ ------ ------ ------
Weighted average common shares: basic......... 83,694 67,865 71,286 67,116
Effect of dilutive common equivalent shares:
Stock options.............................. -- 6,362 -- 4,772
Convertible debenture...................... -- -- -- --
Warrants................................... -- 463 -- 468
Unvested restricted stock.................. -- 97 -- 95
------ ------ ------ ------
Weighted average common shares: diluted....... 83,694 74,787 71,286 72,451
====== ====== ====== ======
For the three and nine months ended September 30, 2003, diluted net loss
per share excludes 14,355,733 and 14,284,081 common share equivalents because
their effect would be antidilutive. For the three and nine months ended
September 30, 2002, stock options to purchase 3,383,559 and 1,655,604 shares,
respectively, of common stock were outstanding but were excluded from the
calculation of diluted net income per share because the options' exercise prices
were greater than the average market price of the Company's common stock during
the periods.
15. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss), net of taxes, was ($3.9) million and
($7.3) million for the three and nine months ended September 30, 2003,
respectively, and was $3.0 million and $2.4 million for the three and nine
months ended September 30, 2002, respectively. Total comprehensive loss for
the nine months ended September 30, 2003, consisted of net loss of ($6.8)
million and foreign currency translation losses of ($0.5) million partially
offset by a net $2,000 foreign exchange gain related to the forward hedges on
the 5.0 million promissory note and 1.0 million payable to Philips (Note 16).
16. DEBT
Credit Facility
On October 31, 2002, the Company entered into a two year Loan and Security
Agreement (as amended, the "Loan Agreement") with Silicon Valley Bank (the
"Bank") that consisted of a $10.0 million revolving loan (the "Credit
Facility"). The Company amended this Loan and Security Agreement, as of
September 30, 2003, for the period September 30, 2003 through December 31, 2003,
removing the fixed charge coverage ratio covenant and replacing it with an
adjusted quick ratio covenant. Borrowings under the Credit Facility bear
interest at the Bank's prime rate plus 0.375% or 0.75%, (4.875% at September 30,
2003) which is determined by the Company's adjusted quick ratio, as defined in
the Loan Agreement. The maximum aggregate amount of borrowings outstanding at
any one time is limited to the lesser of $10.0 million or a borrowing base equal
to either 80% or 70% of eligible accounts receivable, as defined in the Loan
Agreement, based on the Company's adjusted quick ratio. Borrowings under the
Loan Agreement cannot exceed the borrowing base and must be repaid in the event
they exceed the calculated borrowing base or upon expiration of the two-year
loan term. Borrowings under the Loan Agreement are collateralized by
substantially all of the Company's personal property, predominantly its accounts
receivable, but not its intellectual property.
As of September 30, 2003, based upon the calculated borrowing base,
available borrowings totaled approximately $9.7 million. The Company can make no
guarantees as to its ability to satisfy its future financial covenant
calculations. As of September 30, 2003, there was no outstanding balance under
this Credit Facility.
17
The Loan Agreement also contains a restrictive covenant regarding the
payment or declaring of any dividends on the Company's capital stock during the
term of the agreement (except for dividends payable solely in capital stock)
without the Bank's prior written consent. As of September 30, 2003, the Company
was in compliance with all covenants.
Equipment Line of Credit
In connection with the acquisition of SpeechWorks, the Company assumed $1.5
million of principal amounts outstanding under a one-year equipment
line-of-credit with a bank which expired on June 30, 2003. As of September 30,
2003, assumed balance of $1.5 million remains outstanding. Borrowings under this
line are collateralized by the fixed assets purchased and bear interest at the
bank's prime rate (5.0% at September 30, 2003), which is payable in equal
monthly payments over a period of 36 months. In accordance with the terms of the
equipment line of credit, as of September 30, 2003, principal payments of
$226,000 are due in the year ended December 31, 2003, $904,000 are due during
the year ending December 31, 2004, $293,000 are due during the year ending
December 31, 2005 and $44,000 are due during the year ended December 31, 2006.
Under the financing agreement, the Company is obligated to comply with certain
financial covenants related to total tangible net assets; and was in compliance
as of September 30, 2003.
Notes Payable
In connection with the L&H acquisition, the Company issued a $3.5 million
promissory note (the "Note") to Lernout & Hauspie Speech Products, N.V. The Note
had a stated maturity date of December 15, 2004 and bore interest at 9% per
annum. Payments of principal and interest in the amount of $133,000 were due
quarterly commencing on March 15, 2002, for a total of eleven payments. During
the year ended December 31, 2002, four quarterly payments were made in
accordance with the terms of the promissory note. In connection with an
agreement entered into by the Company in September 2002 to repurchase 1,461,378
shares of common stock from L&H Holdings USA, Inc. and Lernout & Hauspie Speech
Products N.V. (collectively, "L&H") and to register in an underwritten offering
the remaining shares held by L&H, the terms of the Note were amended to provide
for the acceleration of the maturity date of the outstanding principal and
interest to January 1, 2003 if consummation of the underwritten public offering
did not occur by January 1, 2003. The Company did not complete the offering by
January 1, 2003 and, accordingly, the debt became immediately due and payable.
To fulfill this obligation, on January 3, 2003, the Company paid $3.3 million in
full settlement of all outstanding principal and accrued interest under the
Note. In connection with the Philips acquisition on January 30, 2003, the
Company issued a 5.0 million euro promissory note (the "Philips Note") to
Philips. The unsecured Philips Note matures on December 31, 2003 and bears
interest at 5% per annum. Payments of principal and accrued interest are due at
maturity. The Philips Note may be prepaid by the Company at any time without
penalty. In connection with the issuance of the Philips Note, the Company
entered into a forward foreign currency exchange contract on January 31, 2003 to
hedge the foreign exchange exposure on the Philips Note. The amount of the
forward foreign currency exchange contract is equivalent to the principal amount
of the Philips Note, and the duration of the forward contract coincides with the
maturity date of the Philips Note. The foreign exchange hedge on the Philips
Note resulted in a foreign exchange gain of approximately $0.1 million, which
will be recorded in income over the term of the forward contract. At September
30, 2003, the promissory note was valued at $5.8 million and was recorded as a
note payable due currently.
Convertible Debenture
On January 30, 2003, the Company issued a $27.5 million three-year,
zero-interest convertible subordinated debenture due January 2006 (the
"Convertible Note") to Philips in connection with the Philips acquisition (Note
6). The Convertible Note is convertible into shares of the Company's common
stock at $6.00 per share at any time until maturity at Philips' option. The
conversion rate may be subject to adjustments from time to time as provided in
the Convertible Note. The Convertible Debenture contains a provision in which
all amounts unpaid at maturity will bear interest at a rate of 3% per quarter
until paid.
The Convertible Note contains restrictive covenants that place restrictions
on the declaration or payment of dividends or distributions (other than
distributions of equity securities of the Company) on, or the redemption or
purchase of, any shares of the Company's capital stock while the Convertible
Note is outstanding. This restriction terminates when one-half or more of the
principal amount of the Convertible Note is converted by Philips into common
stock. The Convertible Note contains a restrictive provision, which provides
Philips the right to require the Company to redeem the Convertible Note or any
remaining portion of the principal amount, on the date a "Change in Control"
occurs. The Convertible Note provides that a "Change in Control" is deemed to
have occurred when any person or entity acquires beneficial ownership of shares
of capital stock of the Company entitling such person or entity to exercise 40%
or more of the total voting power of all shares of capital stock of the Company,
or the Company sells all or substantially all of its assets, subject to certain
exceptions. The Company's acquisition of SpeechWorks (Note 6) did not result in
a Change in Control.
18
17. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has various operating leases for office space around the world.
In connection with the acquisition of SpeechWorks, ScanSoft assumed all its
lease obligations. Among these obligations are lease payments related to two
office locations vacated during 2003 and one associated with office space which
will become available beginning in January 2005. Gross lease payments associated
with these office locations amounting to $10.1 million and $13.4 million,
respectively, have been included in the table below. No amounts have been
recorded in the Company's purchase price allocation in connection with the
facility which becomes available in January 2005. ScanSoft's plans with respect
to these operating leases, as well as all SpeechWorks facilities, are being
assessed in connection with the integration plan. These obligations extend
through 2016. The following table outlines the Company's future minimum payments
under operating leases as of September 30, 2003 (in thousands):
PAYMENTS DUE BY PERIOD,
Within one year.......................... $ 5,290
Year 2 .................................. 5,246
Year 3................................... 4,412
Year 4................................... 2,823
Year 5................................... 2,565
Thereafter............................... 17,980
--------
Total.................................... $ 38,316
========
Total future lease obligations in the table above do not reflect future minimum
sub-lease rentals of approximately $6.8 million.
Litigation and Other Claims
Like many companies in the software industry, the Company has from time to
time been notified of claims that it may be infringing certain intellectual
property rights of others. Where appropriate these claims have been referred to
counsel, and they are in various stages of evaluation and negotiation or have
been resolved. If it appears necessary or desirable, the Company may seek
licenses for these intellectual property rights. There is no assurance that
licenses will be offered by all claimants, that the terms of any offered
licenses will be acceptable to the Company or that in all cases the dispute will
be resolved without litigation, which may be time consuming and expensive, and
may result in injunctive relief or the payment of damages by the Company.
From time to time, the Company receives information concerning possible
infringement by third parties of our intellectual property rights, whether
developed, purchased or licensed by us. In response to any such circumstance,
the Company's counsel investigates the matter thoroughly and the Company takes
all appropriate action to defend our rights in these matters.
On July 15, 2003, Elliott Davis ("Davis") filed an action against
SpeechWorks in the United States District Court for the Western District for New
York (Buffalo) claiming patent infringement. Damages are sought in an
unspecified amount. In the lawsuit, Davis alleges that SpeechWorks is infringing
United States Patent No. 4,802,231 entitled "Pattern Recognition Error Reduction
System" (the "`231 Patent"). The '231 Patent generally discloses techniques for
a pattern recognition system and method wherein errors are reduced by creating
independent error templates that correspond to patterns which tend to be
erroneously matched and linked error templates which are linked to specified
reference templates which are stored for comparison. Although ScanSoft has, as a
result of the SpeechWorks acquisition has several products in the speech
recognition technology field, ScanSoft believes that the products do not
infringe the '231 Patent because SpeechWorks does not use the claimed
techniques. The Company filed an Answer and Counterclaim to Davis's Complaint on
August 25, 2003. The Company believes Davis's claim has no merit and intends to
defend the action vigorously.
On November 27, 2002, AllVoice Computing plc filed an action against the
Company in the United States District Court for the Southern District of Texas
claiming patent infringement. In the lawsuit, AllVoice alleges that the Company
is infringing United States Patent No. 5,799,273 entitled "Automated
Proofreading Using Interface Linking Recognized Words to Their Audio Data While
Text Is Being Changed" (the "'273 Patent"). The '273 Patent generally discloses
techniques for manipulating audio data associated with text
19
generated by a speech recognition engine. Although the Company has several
products in the speech recognition technology field, the Company believes that
its products do not infringe the '273 Patent because, in addition to other
defenses, they do not use the claimed techniques. Damages are sought in an
unspecified amount. The Company filed an Answer on December 23, 2002. The
Company believes this claim has no merit and intends to defend the action
vigorously.
On December 28, 2001, the Massachusetts Institute of Technology and
Electronics For Imaging, Inc. sued the Company in the United States District
Court for the Eastern District of Texas for patent infringement. The patent
infringement claim was filed against more than 200 defendants. In their lawsuit,
MIT and EFI allege that the Company is infringing United States Patent No.
4,500,919 entitled "Color Reproduction System" (the "'919 Patent"). MIT and EFI
allege that the '919 Patent discloses a system for adjusting the colors of a
scanned image on a television screen and outputting the modified image to a
device. The Company has several products that permit a user to adjust the color
of an image on a computer monitor. The Company has asserted that its products do
not infringe the '919 Patent because its products do not contain all elements of
the structure required by the claimed invention and because its products do not
perform all of the steps required by the claimed method. Further, the Company
believes there may be prior art that would render the '919 Patent invalid. The
'919 Patent expired on May 6, 2002. Damages are sought in an unspecified amount.
The Company filed an Answer and Counterclaim on June 28, 2002. The Company
believes this claim has no merit and intends to defend the action vigorously.
On August 16, 2001, Horst Froessl sued the Company in the United States
District Court for the Northern District of California for patent infringement.
In his lawsuit, Froessl alleges that the Company is infringing United States
Patent No. 4,553,261 entitled "Document and Data Handling and Retrieval System"
(the "'261 Patent"). Froessl alleges that the '261 Patent discloses a system for
receiving and optically scanning documents, converting selected segments of the
digitalized scan data into machine code, and storing and retrieving the
documents and the digitalized and converted segments. Although the Company has
several products in the scanning technology field, the Company has asserted that
its products do not infringe the '261 Patent because its products do not contain
all elements of the structure required by the claimed invention and because its
products do not perform all of the steps required by the claimed method.
Further, the Company believes there may be prior art that would render the '261
Patent invalid. The '261 Patent expired on May 31, 2003. Damages are sought in
an unspecified amount. The Company filed an Answer and Counterclaim on September
19, 2001. The Company believes this claim has no merit and intends to defend the
action vigorously.
The Company believes that the final outcome of these matters will not have
a significant adverse effect on its financial position, results of operations or
cash flows and the Company believes it will not be required to expend a
significant amount of resources defending such claims. However, should the
Company not prevail in any such litigation, its operating results, financial
position and cash flows could be adversely impacted.
Guarantees and Other
The Company has entered into agreements to indemnify its directors and
officers to the fullest extent authorized or permitted under applicable law.
These agreements, among other things, provide for the indemnification of its
directors and officers for expenses, judgments, fines, penalties and settlement
amounts incurred by any such person in his or her capacity as a director or
officer of the company, whether or not such person is acting or serving in any
such capacity at the time any liability or expense is incurred for which
indemnification can be provided under the agreements. The Company has a Director
and Officer insurance policy in effect that reduces its exposure under these
agreements and enables it to recover a portion of any future amounts paid. While
the maximum potential amount of any future payments under these agreements is
uncertain, as a result of its insurance coverage, the Company believes the
estimated fair value of these agreements is minimal.
The Company currently includes indemnification provisions in the contracts
it enters with its customers and business partners. Generally, these provisions
require the Company to defend claims arising out of its products' infringement
of third-party intellectual property rights, breach of contractual obligations
and/or unlawful or otherwise culpable conduct on its part. The indemnity
obligations imposed by these provisions generally cover damages, costs and
attorneys' fees arising out of such claims. In most, but not all, cases, the
Company's total liability under such provisions is limited to either the value
of the contract or a specified, agreed upon, amount. In some cases its total
liability under such provisions is unlimited. In many, but not all, cases, the
term of the indemnity provision is perpetual. While the maximum potential amount
of future payments the Company could be required to make under all the
indemnification provisions in its contracts with customers and business partners
is unlimited, it believes that the estimated fair value of these provisions is
minimal due to the low frequency with which these provisions have been
triggered.
20
In accordance with the terms of the SpeechWorks merger agreement, the
Company is required to indemnify the former members of the SpeechWorks board of
directors, on similar terms as described above, for a period of six months from
the acquisition date. As a result, the Company recorded a liability related to
the fair value of the obligation of $0.3 million in connection with the purchase
accounting for the acquisition. Additionally in accordance with the terms of the
merger agreement, the Company purchased a director and officer insurance policy
related to this obligation for a period of three years from the date of
acquisition.
18. EQUITY TRANSACTIONS
Acquisition of SpeechWorks International, Inc.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks (Note 6). In connection with the acquisition of SpeechWorks, the
Company exchanged 0.860 of a share of its common stock for each outstanding
share of SpeechWorks stock. This transaction resulted in the issuance of
approximately 32.5 million shares of its' common stock, representing
approximately 33% of the outstanding common stock of the Company after the
completion of the acquisition.
Shares Repurchase Program
On August 6, 2003, the Company's board of directors authorized the
repurchase of up to $25 million of the Company's common stock over the next 12
months, however, the Company may suspend or discontinue the repurchase program
at any time. From August 6, 2003 through September 30, 2003, the Company
repurchased 413,700 common shares at a purchase price of $1.8 million; the
Company records treasury stock at cost. The Company intends to use the
repurchased shares for its employee stock plans and for potential future
acquisitions.
Common Stock Warrants
In connection with the March 31, 2003 acquisition of the certain
intellectual property assets related to multimodal speech technology (Note 9),
the Company issued a warrant, expiring October 31, 2005, for the purchase of
78,000 shares of ScanSoft common stock at an exercise price of $8.10 per share.
The warrant was immediately exercisable and was valued at $0.1 million based
upon the Black-Scholes option pricing model with the following assumptions:
expected volatility of 80%, a risk-free rate of 1.87%, an expected term of 2.5
years, no dividends and a stock price of $4.57 based on the Company's stock
price at the time of issuance.
In connection with the SpeechWorks acquisition (Note 6), the Company issued
a warrant to its investment banker, expiring on August 11, 2009, for the
purchase of 150,000 shares of ScanSoft common stock at an exercise price of
$3.98 per share. The warrant does not become exercisable until August 11, 2005
and was valued at $0.2 million based upon the Black-Scholes option pricing model
with the following assumptions: expected volatility of 60%, a risk-free interest
rate of 4.03%, an expected term of 8 years, no dividends and a stock price of
$3.92 based on the Company's stock price at the time of issuance.
Underwritten Public Offering
During the three months ended March 31, 2003, the Company completed an
underwritten public offering of 8,256,906 shares of the Company's common stock
at $3.80 per share. Of the total shares sold, 6,184,406 shares were sold on
behalf of Lernout & Hauspie Speech Products N.V. and L&H Holdings USA, Inc. The
Company sold 2,072,500 common shares and received gross proceeds of $7.9
million. After considering offering costs, the net proceeds amounted to
approximately $5.5 million.
19. RESTRICTED COMMON STOCK
On August 11, 2003, the Company issued 300,000 shares of restricted common
stock to the Company's Chief Executive Officer. Unvested restricted shares may
not be sold, transferred or assigned. Of these restricted common shares, 100,000
vest on each of August 31, 2004, 2005 and 2006. Except as otherwise specified in
the restricted stock agreement, in the event that the executive's employment
with the Company terminates, any unvested shares of the restricted stock shall
be forfeited and revert to the Company. The purchase price of the shares equaled
the par value of the shares, aggregating $300. The difference between the
purchase price and the fair value of the Company's common stock on the date of
issue of $1.2 million has been recorded as deferred compensation and additional
paid-in-capital. The deferred compensation is being recognized as compensation
expense ratably over the vesting period resulting in $53,600 of stock
compensation expense during the three months ended September 30, 2003.
21
In connection with the SpeechWorks acquisition (Note 6), the Company issued
184,786 shares of restricted common stock in replacement of previously
outstanding SpeechWorks unvested restricted common stock. Unvested restricted
common stock may not be sold, transferred or assigned and are subject to
forfeiture in the event an employee ceases to be employed by the Company. The
restricted common stock vests no later than March 25, 2007. Deferred
compensation of $0.7 million was recorded associated with the issuance of these
restricted shares which is equal to the closing price of ScanSoft common stock
on the acquisition date. The deferred compensation is being recognized as
compensation expense ratably over the vesting period resulting in $25,000 of
stock compensation expense during the three months ended September 30, 2003.
20. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in a single industry segment. The following table
presents total revenue information by geographic area and principal product line
(in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2003 2002 2003 2002
------- ------- ------- -------
North America ........... $24,075 $20,824 $64,227 $58,029
Other foreign countries.. 8,875 7,411 24,302 20,155
------- ------- ------- -------
Total ................. $32,950 $28,235 $88,529 $78,184
======= ======= ======= =======
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2003 2002 2003 2002
------- ------- ------- -------
Digital Capture ..... $13,553 $16,660 $38,695 $45,915
Speech .............. 19,397 11,575 49,834 32,269
------- ------- ------- -------
Total ............. $32,950 $28,235 $88,529 $78,184
======= ======= ======= =======
Revenue classification above is based on the country in which the sale
originates or is invoiced. Revenue in other countries predominately relates to
sales to customers in Asia and Europe. Intercompany sales are insignificant as
products sold outside of the United States or Europe are sourced within Europe
or the United States.
21. INCOME TAXES
The provision for (benefit from) income taxes for the three and nine months
ended September 30, 2003 reflects a $0.9 million deferred tax provision
associated with differences between book and tax amortization for certain
goodwill. Of this amount $0.5 million relates to fiscal year 2002. The provision
also includes the impact of a $1.4 million federal tax refund relating to a use
of net operating losses in a prior period.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes thereto, located in Item 1 of this quarterly
report.
FORWARD-LOOKING STATEMENTS
This quarterly report contains forward-looking statements. These
forward-looking statements include predictions regarding:
-- OUR STRATEGY RELATING TO SPEECH AND LANGUAGE TECHNOLOGIES;
-- OUR EXPECTATIONS REGARDING OUR ACQUISITION OF SPEECHWORKS AND CERTAIN
ASSETS FROM PHILIPS;
-- THE POTENTIAL OF FUTURE PRODUCT RELEASES;
-- OUR PRODUCT DEVELOPMENT PLANS AND INVESTMENTS IN RESEARCH AND
DEVELOPMENT;
-- FUTURE ACQUISITIONS;
-- INTERNATIONAL OPERATIONS AND LOCALIZED VERSIONS OF OUR PRODUCTS; AND
-- LEGAL PROCEEDINGS AND LITIGATION MATTERS.
22
You can identify these and other forward-looking statements by the use of
words such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "intends," "potential," "continue" or the
negative of such terms, or other comparable terminology. Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.
Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth in this quarterly report under the heading "Factors That May Affect our
Future Results of Operations." All forward-looking statements included in this
document are based on information available to us on the date hereof. We assume
no obligation to update any forward-looking statements.
RECENT DEVELOPMENTS
On January 3, 2003, we paid $3.3 million in full settlement of all
principal and accrued interest on a promissory note issued in connection with
the L&H acquisition on December 12, 2001.
On January 30, 2003, we completed the acquisition of the Philips Speech
Processing Telephony and Voice Control business units of Royal Philips
Electronics N.V. ("Philips"), and related intellectual property. The Telephony
business unit offers speech-enabled services including directory assistance,
interactive voice response and voice portal applications for enterprise
customers, telephony vendors and carriers. The Voice Control business unit
offers a product portfolio including small footprint speech recognition engines
for embedded applications such as voice-controlled climate, navigation and
entertainment features in automotive vehicles, as well as voice dialing for
mobile phones. As consideration for the business, we paid 3.1 million euros
($3.4 million) in cash at closing, subject to adjustment in accordance with the
provisions of the purchase agreement, as amended, and agreed to pay an
additional 1.0 million euros in cash due no later than December 31, 2003, issued
a 5.0 million euro note due December 31, 2003 and bearing 5.0% interest per
annum and issued a $27.5 million three-year, zero-interest subordinated
debenture, convertible at any time at Philips' option into shares of our common
stock at $6.00 per share. The purchase price is subject to adjustment. We
anticipate that all related adjustments will be completed no later than December
31, 2003 and all adjustments arising from contingencies that existed at the
closing and as of March 31, 2003 will be recorded as adjustments to goodwill. In
connection with the acquisition we hired 116 employees.
During the three months ended March 31, 2003, the Company completed an
underwritten public offering of 8,256,906 shares of the Company's common stock
at $3.80 per share. Of the total shares sold, 6,184,406 shares were sold on
behalf of Lernout & Hauspie Speech Products N.V., and L&H Holdings USA, Inc. The
Company sold 2,072,500 common shares and received gross proceeds of $7.9
million. After deducting offering costs, the net proceeds amounted to
approximately $5.5 million.
On August 11, 2003, the Company acquired all of the outstanding stock of
SpeechWorks International, Inc. ("SpeechWorks"), a leading provider of software
products and professional services that enable enterprises, carriers and
government organizations to offer automated, speech-activated services over any
telephone, in exchange for 0.860 of a share of ScanSoft common stock for each
outstanding share of SpeechWorks stock. This transaction resulted in the
issuance of approximately 32.5 million shares of ScanSoft common stock,
representing approximately 33% of the outstanding common stock of ScanSoft after
the completion of the acquisition. The purchase price of approximately $175.5
million, including transaction costs of $4.5 million was determined based on the
shares of ScanSoft common stock issued multiplied by $5.26 per share (the
average closing price of ScanSoft common stock for a total of five days,
immediately prior and subsequent to the announcement of the acquisition). The
acquisition of SpeechWorks did not result in a Change in Control as defined by
the Philips subordinated debenture.
As more fully discussed in Note 2 of the Notes to Unaudited Consolidated
Financial Statements, the Company is restating its consolidated financial
statements as of and for the three month periods ended March 31, 2003 and June
30, 2003 and the six months ended June 30, 2003 to increase its deferred tax
asset valuation allowance and to record deferred tax liabilities for certain
differences between book and tax goodwill amortization. As a result of this
restatement, our reported net income for the three month periods ended March 31,
2003 decreased from $76,000 to a net loss of $174,000; for the three month
period ended June 30, 2003 the net loss increased from $2,639,000 to $2,943,000;
and the net loss for the six months ended June 30, 2003 increased from
$2,563,000 to $3,117,000. There was no impact to our reported earnings per share
in the three month periods ended March 31, 2003 and June 30, 2003. Our reported
loss per share increased from $0.04 to $0.05 per share for the six months ended
June 30, 2003. The restatement had no effect on our reported cash flows from
operations. The accompanying Management's Discussion and Analysis has been
revised to reflect the impact of this restatement.
23
OVERVIEW
ScanSoft is a leading provider of technologies, applications and services
allow users to incorporate speech, documents and images into digital
applications and automate business processes. Our solutions help enterprises,
professionals and consumers increase productivity, reduce costs and save time.
Our products are built upon speech and digital capture technologies, and are
sold as solutions into the financial, legal, healthcare, government,
telecommunications, automotive, and travel and entertainment industries. We
focus on markets where we can exercise market leadership, where significant
barriers to entry exist and where we possess competitive advantages because of
the strength of our technologies, products, channels and business processes.
RESULTS OF OPERATIONS
The following table presents, as a percentage of total revenue, certain
selected financial data for the three and nine months ended September 30, 2003
and 2002:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2003 2002 2003 2002
------ ----- ----- -----
Total revenue................................ 100.0% 100.0% 100.0% 100.0%
Cost and expenses:
Cost of revenue ........................ 20.5% 14.9% 17.6% 16.6%
Cost of revenue from amortization of
intangible assets .................... 8.4% 7.0% 8.5% 9.6%
Total cost of revenue ....................... 28.9% 21.9% 26.1% 26.2%
Gross profit................................. 71.1% 78.1% 73.9% 73.8%
Operating expenses:
Research and development................. 29.0% 25.7% 28.3% 27.3%
Selling, general and administrative...... 47.4% 40.3% 48.2% 40.9%
Non-cash stock compensation ............. 0.3% 0.1% 0.2% 0.1%
Amortization of other intangible assets.. 2.0% 0.8% 1.6% 1.8%
Restructuring and other charges.......... 5.2% --% 3.5% 1.3%
------ ----- ----- -----
Total costs and expenses.......... 112.8% 88.8% 107.9% 97.6%
----- ----- ----- -----
Income (loss) from operations................. (12.8)% 11.2% (7.9)% 2.4%
----- ----- ----- -----
Other income (expense), net................... 0.8% (0.6)% 0.7% (0.2)%
----- ------ ----- -----
Income (loss) before income taxes............. (12.0)% 10.6% (7.2)% 2.2%
Provision for (benefit from) income taxes..... (0.7)% 0.6% 0.5% (0.2)%
------ ----- ----- -----
Net income (loss)............................. (11.3)% 10.0% (7.7)% 2.4%
===== ===== ===== =====
GENERAL
We derive our revenue from sales of our software products to customers
through distribution partners and value-added resellers, royalty revenues from
OEM partners, license fees from sales of our products to customers and from
professional services, which include, but are not limited to, custom software
applications and other services considered essential to the functionality of the
software, training, and maintenance associated with software license
transactions.
Our products and solutions can be grouped in three areas: network speech
solutions, embedded speech solutions and productivity applications. Network
speech solutions include speech recognition, text to speech (TTS) and speaker
verification, as well as auto-attendant, directory assistance and other
applications. Embedded speech solutions include speech recognition, TTS and
speaker verification technologies used in automobiles, mobile devices, games and
consumer electronics. Productivity applications are based on capture and
dictation technologies and include solutions for networked scanning, document
conversion, personal document management, PDF creation, dictation and electronic
forms.
Sales of our software products through certain distributors and value-added
resellers provide rights of return for as long as the distributors or resellers
hold the inventory. As a result, we recognize revenues from sales to
distributors and resellers only when the distributors or resellers have sold
products to retailers and end-users. Title and risk of loss pass to the
distributor or reseller upon shipment, at which time the transaction is invoiced
and payment is due. Based on reports from distributors and resellers of their
inventory balances at the end of each period, we record an allowance against
accounts receivable for the sales price of all inventories subject to return. If
we experience significant returns from distributors or resellers, our liquidity
may be adversely impacted. We make an estimate of sales returns by retailers or
end users to us directl