10-Q 1 b37264sse10-q.txt SCANSOFT, INC. 1 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 PERIOD ENDED SEPTEMBER 30, 2000 OR [ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________ COMMISSION FILE NUMBER 0-27038 SCANSOFT, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 94-3156479 (State or Other Jurisdiction of (IRS Employer 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 [ ] 45,980,848 shares of the registrant's Common Stock, $0.001 par value, were outstanding as of October 31, 2000 2 SCANSOFT, INC. FORM 10-Q NINE MONTHS ENDED SEPTEMBER 30, 2000 INDEX PAGE PART I: FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) a) Consolidated Balance Sheets at September 30, 2000 and December 31, 1999....................................... 3 b) Consolidated Statements of Operations for the three and nine months ended September 30, 2000 and September 30, 1999...................................... 4 c) Consolidated Statements of Cash Flows for the nine months ended September 30, 2000 and September 30, 1999......... 5 d) Notes to Consolidated Financial Statements................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 11 PART II: OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders.......... 20 Item 6. Exhibits and Reports on Form 8-K............................. 20 Signatures........................................................... 21 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SCANSOFT, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) UNAUDITED
SEPTEMBER 30, DECEMBER 31, 2000 1999 ------------- ------------ ASSETS Current Assets: Cash and cash equivalents ......................... $ 4,908 $ 5,162 Short-term investments ............................ 62 62 Accounts receivable, less allowances of $6,812 and $3,690, respectively .............. 4,543 7,713 Inventory ......................................... 781 780 Deferred tax assets ............................... 3,650 -- Prepaid expenses and other current assets ......... 2,035 1,372 ------------- ------------- Total current assets ........................... 15,979 15,089 Goodwill and other intangible assets, net .............. 99,485 12,987 Property and equipment, net ............................ 3,698 1,546 Other assets ........................................... 1,015 360 ------------- ------------- TOTAL ASSETS ........................................... $ 120,177 29,982 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Short term bank borrowings ........................ $ 4,300 $ -- Note payable ...................................... -- 1,600 Accounts payable .................................. 6,763 2,226 Accrued sales and marketing expenses .............. 1,574 1,425 Deferred revenue .................................. 1,030 964 Other current liabilities ......................... 6,752 1,843 ------------- ------------- Total current liabilities ...................... 20,419 8,058 ------------- ------------- Deferred revenue long-term ............................. 2,557 -- ------------- ------------- Deferred tax liabilities ............................... 3,650 -- ------------- ------------- Stockholders' equity: Series B convertible preferred stock, 15,000,000 shares authorized; 3,562,238 issued and outstanding; liquidation value of $4,631 ..................... 4,631 4,631 Common stock, $0.001 par value; 140,000,000 shares authorized; 45,979,398 and 26,690,027 shares issued and outstanding, respectively ............ 46 27 Additional paid in capital ........................ 219,207 100,397 Accumulated deficit ............................... (130,172) (83,131) Accumulated other comprehensive loss .............. (161) -- ------------- ------------- Total stockholders' equity ..................... 93,551 21,924 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............. $ 120,177 $ 29,982 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. 3 4 SCANSOFT, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ------------------ 2000 1999 2000 1999 ---- ---- ---- ---- Revenue ............................................. $ 13,638 $ 8,210 $ 35,028 $ 22,986 Costs and expenses: Cost of revenue ................................ 2,962 1,994 9,487 5,427 Research and development ....................... 3,830 1,717 11,884 5,140 Selling, general and administrative ............ 6,842 3,234 21,051 10,288 Amortization of intangible assets .............. 6,787 655 15,799 1,288 Restructuring and other charges ................ -- -- 4,956 346 Gain on sale of hardware business, net ......... -- -- -- (882) Acquired in-process research and development ... -- -- 18,291 3,944 -------- -------- -------- -------- Total costs and expenses ............................ 20,421 7,600 81,468 25,551 -------- -------- -------- -------- Income (loss) from operations ....................... (6,783) 610 (46,440) (2,565) Other income (expense), net ......................... (257) 62 (257) 136 -------- -------- -------- -------- Income (loss) before income taxes ................... (7,040) 672 (46,697) (2,429) Provision for income taxes .......................... 36 200 344 300 -------- -------- -------- -------- Net income (loss) ................................... $ (7,076) $ 472 $(47,041) $ (2,729) ======== ======== ======== ======== Net income (loss) per share: basic .................. $ (0.15) $ 0.02 $ (1.15) $ (0.11) ======== ======== ======== ======== Net income (loss) per share: diluted ................ $ (0.15) $ 0.01 $ (1.15) $ (0.11) ======== ======== ======== ======== Weighted average common shares: basic ............... 45,963 26,472 40,800 25,220 ======== ======== ======== ======== Weighted average common and common equivalent shares: diluted ........................................ 45,963 31,937 40,800 25,220 ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 4 5 SCANSOFT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) UNAUDITED
NINE MONTHS ENDED SEPTEMBER 30, 2000 1999 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ................................................................. $(47,041) $ (2,729) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ....................................... 968 239 Provision for accounts receivable allowances ........................ (3,467) 2,024 Amortization of goodwill and other intangible assets ................ 15,799 1,288 Provision for impairment of intangible assets ....................... 3,490 -- Net gain on sale of hardware business ............................... -- (882) Write off of acquired in-process research and development ........... 18,291 3,944 Changes in assets and liabilities, net of effects from acquisitions of Caere, ScanSoft, and sale of hardware assets: Accounts receivable ............................................. 8,075 (8,037) Inventory ....................................................... 283 (122) Prepaid expenses and other assets ............................... (493) 73 Accounts payable and accrued expenses, accrued marketing, deferred revenue and other current liabilities................. (588) 1,883 -------- -------- Net cash used in operating activities .................................... (4,683) (2,319) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash acquired in connection with Caere acquisition .................. 1,419 -- Capital expenditures for property and equipment ..................... (256) (186) Net sales of short-term investments ................................. -- 397 Proceeds from sale of hardware business ............................. -- 6,782 Cash acquired in connection with ScanSoft acquisition ............... -- 1,211 Cash used for Metacreations acquisition ............................. -- (1,669) -------- -------- Net cash provided by investing activities ................................ 1,163 6,535 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Short term bank borrowings, net ..................................... 4,300 (6,000) Payment of note payable ............................................. (1,600) -- Proceeds from the issuance of common stock, net ..................... 655 118 Repurchase of common stock .......................................... -- (684) -------- -------- Net cash provided by (used in) financing activities ...................... 3,355 (6,566) -------- -------- Effects of exchange rate changes on cash and cash equivalents ............ (89) -- -------- -------- Net decrease in cash and cash equivalents ................................ (254) (2,350) Cash and cash equivalents at beginning of period ......................... 5,162 7,659 -------- -------- Cash and cash equivalents at end of period ............................... $ 4,908 $ 5,309 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 5 6 SCANSOFT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) BASIS OF PRESENTATION: Prior to 1999, the results of the Company represented the activity of Visioneer, Inc., which marketed and sold hardware and software. On January 6, 1999, the Company sold its hardware business to Primax Electronics, Ltd. On March 2, 1999, the Company acquired Xerox Corporation's ScanSoft subsidiary and subsequently renamed the Company ScanSoft, Inc. On March 13, 2000, the Company acquired Caere Corporation ("Caere"). See "Caere Acquisition" note for specific information on the Caere acquisition. The accompanying unaudited consolidated financial statements of ScanSoft, Inc. (the "Company" or "ScanSoft") have been prepared in accordance with generally accepted accounting principles. In the opinion of management, these interim consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, except with respect to the adjustments made in relation to the Caere acquisition, necessary to present fairly the financial position, results of operations, and cash flows at September 30, 2000, and for the three and nine months ended September 30, 2000 and 1999. 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 footnotes prepared in accordance with generally accepted accounting principles has been condensed or omitted pursuant to 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, 1999 and the unaudited pro forma financial statements of the Caere acquisition included in the Registration Statement on Form S-4 filed with the Securities and Exchange Commission on February 9, 2000. The results for the three and nine months ended September 30, 2000, are not necessarily indicative of the results that may be expected for the year ending December 31, 2000, or any future period. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. BALANCE SHEET COMPONENTS: The following table summarizes key balance sheet components (in thousands): SEPTEMBER 30, DECEMBER 31, 2000 1999 ------------ ------------ Inventory: Raw Materials ...................... $ 521 $ 524 Finished goods ..................... 260 256 ------ ------ $ 781 $ 780 ====== ====== Other current liabilities: Accrued compensation ............... $1,944 $ 721 Accrued restructuring .............. 2,383 -- Accrued royalties .................. 801 200 Accrued taxes payable .............. 280 351 Other current liabilities .......... 1,344 571 ------ ------ $6,752 $1,843 ====== ====== CAERE ACQUISITION: On March 13, 2000, the Company acquired Caere Corporation, a company that designed, developed and marketed a range of optical character recognition software tools, for approximately $48.5 million in cash, 19.0 million shares of Common Stock of the 6 7 Company, and the exchange of approximately 4.6 million employee stock options to purchase Common Stock of the Company in exchange for outstanding employee stock options of Caere. The common stock issued has been valued using the average quoted price of common stock for the period a few days preceding and the day of the consummation of the acquisition. The employee stock options were fair valued using the Black Scholes option pricing model. In addition, pursuant to a concurrent non-competition agreement and subject to certain other conditions, the Company agreed to pay the former President and CEO of Caere on the second anniversary of the merger the difference between $13.50 and the closing price of ScanSoft stock at that time, multiplied by the number of beneficial shares owned by the former executive. The value of this stock price guarantee at the date of acquisition was approximately $4.0 million and has been included in the total purchase price of the acquisition. Additionally, in conjunction with the acquisition, the Company incurred approximately $1.7 million of acquisition related costs. The purchase price of Caere, including acquisition costs, was $168.4 million, and was allocated to the assets acquired and liabilities assumed based on the fair value of Caere's current assets, property and equipment, and liabilities. The excess of the purchase price over the fair value of tangible assets acquired has been allocated to intangible assets (in-process research and development, core technology, developed technology, patents, favorable building lease, non-compete agreements and acquired workforce) acquired based on an independent appraisal. This acquisition has been accounted for under the purchase method of accounting. Accordingly, the results of operations of Caere and the fair market value of acquired assets and assumed liabilities have been included in the financial statements of the Company as of the date of acquisition. The Company recorded a one-time write-off of $18.3 million in the quarter ended March 31, 2000 relating to the value of in-process research and development acquired as part of the purchase. The allocation of the purchase price was as follows (in thousands): Property and equipment.......................... $ 2,865 Current and other assets........................ 58,400 Liabilities assumed............................. (16,985) Goodwill........................................ 61,095 Core technology................................. 17,905 Developed technology............................ 16,340 Other identified intangible assets.............. 10,448 Acquired in-process research and development.... 18,291 -------- $168,359 ======== The amounts allocated to identifiable tangible and intangible assets, including acquired in-process research and development, were based on the results of an independent appraisal. Goodwill represents the amount by which the cost of acquired net assets exceeded the fair values of those net assets on the date of purchase. Acquired in-process research and development represented development projects that had not yet reached technological feasibility and had no alternative future use. Accordingly, the amount of $18.3 million was immediately charged to expense in the consolidated statements of operations upon consummation of the acquisition. The values of the core technology, developed technology and acquired in-process technology were determined by a risk adjusted, discounted cash flow approach. The value of in-process research and development, specifically, was determined by estimating the costs to develop the in-process projects into commercially viable products, estimating the resulting net cash flows from the sale of such products, discounting net cash flows back to their present values, and adjusting those results to reflect the projects' stages of completion. These include projects (primarily major version upgrades) in each of Caere's major products, including OmniPage, OmniForm, and PageKeeper. The discount rates used were 14% for developed technology, 19% for core technology, and 24% for in-process technology. The discount rate for in-process technology takes into consideration the Company's weighted average cost of capital adjusted for the inherent uncertainties surrounding the successful development of the in-process research and development, the profitability levels of such technology and the uncertainty of technological advances, which could potentially impact the estimates described above. The average percentage of completion of the projects ranged from 50% to 67% at the date of the acquisition. Revenues were projected to be generated late in fiscal 2000 for each of the product versions in development at the acquisition date. If these projects are not successfully developed, future revenue and profitability of ScanSoft may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired. 7 8 The following identifies the intangible assets acquired in connection with Caere and respective lives (in thousands): AMOUNT LIFE ------ ---- Goodwill............................... 61,095 6 Years Core technology........................ 17,905 5 Years Developed technology................... 16,340 2 Years Other identified intangible assets..... 10,448 2-5 Years -------- $105,788 Other identified intangible assets consist of a non-compete agreement, acquired work force, a favorable building lease agreement, and patents on the Caere technology. These assets are being amortized over a period of 2, 3, 4 and 5 years, respectively. During the quarter ended June 30, 2000, the Company, as a result of its restructuring wrote-off $1,074,000 of acquired work-force and $2,416,000 of a favorable building lease established as part of the identifiable intangible assets acquired from Caere. These assets were deemed to be impaired to the extent employees are to be terminated and facility space is to be vacated in connection with the June 2000 restructuring actions. Pro forma Results (unaudited) The following table reflects the unaudited pro forma results of operations of the Company assuming that the acquisition of Caere had occurred at the beginning of each fiscal period presented:
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------- ---------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2000 1999 2000 1999 ------------- ------------- ------------- ------------- Revenue ............ $ 13,638 $ 19,050 $ 41,075 $ 68,053 Net loss ........... (7,076) (5,191) (45,686) (35,984) Net loss per share.. (0.15) (0.11) (0.94) (0.81)
These unaudited pro forma results of operations include the write-off of the in-process research and development charge taken in the first quarter and restructuring and other charges taken in the second quarter. The unaudited pro forma results of operations are not necessarily indicative of the actual results that would have occurred had the transaction actually taken place at the beginning of the periods. As part of the acquisition, the Company acquired deferred tax assets amounting to approximately $5,919,000, for which a full valuation allowance was initially recorded due to the uncertainty of their realization. In accordance with Financial Accounting Standards Board No. 109 "Accounting for Income Taxes" ("FAS 109"), the Company established a deferred tax liability associated with the non-deductible acquired intangibles assets excluding goodwill. As a result, the valuation allowance on the acquired Caere net deferred tax asset as well as a portion of the Company's valuation allowance on its existing net deferred tax assets was released. Also in accordance with FAS 109, this reduction in valuation allowance was accounted for in the purchase accounting and not the statement of operations during the period ended March 31, 2000. RESTRUCTURING AND OTHER CHARGES: In connection with the acquisition of Caere, the Company identified approximately 46 employees of Caere whose positions would be eliminated immediately as part of the acquisition. These positions include 22 in research and development, 14 in general and administrative functions, and 10 in sales and marketing. Additionally, the former president and CEO position of Caere was eliminated. As a result, the Company has established as part of the purchase, a restructuring reserve in the amount of $487,000 for the severance payments to employees, anticipated to be paid out over the fourth quarter, and a restructuring reserve of $1,065,000 for the former president and CEO of Caere, whose severance and benefits will continue over the next 5 years. The Company is obligated to pay retention bonuses amounting to approximately $797,000 relating to key employees who will be used in the integration of the companies. These retention bonuses will be expensed as incurred and have not been included in the purchase price of the acquisition. Additionally, approximately 24 employees of Caere have voluntarily terminated their positions. The Company does not anticipate replacing those individuals. 8 9 In June 2000, the Company committed to a restructuring plan to strategically refocus the Company and bring operating expenses in line with net revenues. The process included a review of all potentially redundant functions and facilities. As part of this process, the Company determined it would be more cost effective to eliminate duplicative activities being performed in Los Gatos, California through relocating certain of these efforts to Peabody, Massachusetts and Budapest, Hungary. These activities consisted primarily of research and development, marketing, customer support and general and administrative functions. In light of this decision, the Company notified 71 employees that their positions would be eliminated as of June 30, 2000. Of the 71 employees notified, 6 employees voluntarily terminated their employment and were not entitled to receive their severance benefits and accordingly, these employees are not included in the restructuring charge. The remaining 65 employee positions include 29 in research and development, 13 in general and administrative functions, and 23 in support and marketing. As a result, in the second quarter of 2000, the Company recorded a restructuring charge in the amount of $1,069,000 for the severance payments to these employees and a restructuring charge of $397,000 for exit costs to be incurred as a result of exiting the Los Gatos facility. Additionally, the Company wrote-off $3,490,000 of net intangible assets acquired as part of the Caere acquisition including the acquired work force amounting to $1,074,000 and a favorable building lease amounting to $2,416,000, which were impaired as a result of the restructuring. The Company is obligated to pay retention bonuses amounting to approximately $212,000 relating to key employees who will be used to complete the restructuring of the company. These amounts are charged to expense as incurred. During the nine months ended September 30, 2000, the Company paid $635,000 in severance related payments related to the restructuring activities. Additionally, the Company paid $761,000 relating to retention bonuses for the nine-month period ending September 30, 2000. The following table sets forth the 2000 restructuring reserve activity (in thousands):
EMPLOYEE EXIT INTANGIBLE RESTRUCTURING AND OTHER CHARGES RESERVE RELATED COSTS ASSETS TOTAL -------------------------------------------------------------------------------------------------------------------- Restructuring reserve provided in March 2000 acquisition $ 1,552 $ 1,552 Restructuring and other charges for June 2000 restructuring 1,069 $ 397 $ 3,490 4,956 Non-cash disposals (3,490) (3,490) Cash payments (635) (635) ------------------------------------------------------------------------ ------- ------- ------- ------- Balance at June 30, 2000 $ 1,986 $ 397 $ -- $ 2,383 ------------------------------------------------------------------------ ------- ------- ------- -------
Restructuring charges of $346,000 in the first nine months of 1999 relate to the acquisition of Xerox's ScanSoft Subsidiary and the subsequent consolidation of research and development operations and the move of the Company's headquarters to Massachusetts, which resulted in the termination of 10 employees in California. The major components of these costs were approximately $188,000 in severance costs for the 10 employees and approximately $46,000 for disposed West Coast equipment. Also included was $82,000 in non-refundable commitments associated with the West Coast development team, as well as $30,000 in other exit costs. All such costs have been fully paid as of September 30, 2000. The Company has accounted for these items using the guidance established in SEC Staff Accounting Bulletin No. 100 "Restructuring and Impairment Charges" and Emerging Issues Task Force EITF No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)", and EITF No. 95-3 "Recognition of Liabilities in Connection with a Purchase Business Combination". Accordingly, only those items meeting the requirements of these pronouncements have been included in the restructuring and purchase price, respectively. NET INCOME (LOSS) PER SHARE: Net income (loss) per share is calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 128 - "Earnings per Share" (SFAS No. 128). The following details the computation for basic and diluted income (loss) per share:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- ------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Net income (loss) ........................ $ (7,076) $ 472 $(47,041) $ (2,729) Basic: Weighted average common shares outstanding.............................. 45,963 26,472 40,800 25,220 ======== ======== ======== ======== Net income (loss) per share .............. $ (0.15) $ 0.02 $ (1.15) $ (0.11) ======== ======== ======== ======== Diluted: Weighted average common shares outstanding.............................. 45,963 26,472 40,800 25,220 Effect of diluted options and warrants ... -- 5,465 -- -- -------- -------- -------- -------- Weighted average common shares outstanding.............................. 45,963 31,937 40,800 25,220 ======== ======== ======== ======== Net income (loss) per share .............. $ (0.15) $ 0.01 $ (1.15) $ (0.11) ======== ======== ======== ========
9 10 BANK LINE OF CREDIT: On March 14, 2000, the Company entered into a one year Credit Agreement (the "Agreement") with its financial institution that consisted of a $10,000,000 revolving loan (the "Revolver"). Borrowings under the Revolver bear interest at the rate of one percent (1.0%) per annum above the Prime Rate. The maximum aggregate amount of borrowings outstanding at any one time is limited to the lesser of (a) the bank's total commitment and (b) the Borrowing Base. The Borrowing Base is equal to fifty percent (50%) of eligible accounts receivables for which invoices have been issued and are payable. As of June 12, 2000, the Agreement was amended to modify the total commitment by the bank from $10,000,000 to $5,000,000 and the Borrowing Base requirement was removed. At September 30, 2000, the Company had $4,300,000 of bank borrowings outstanding, which reflects a pay-down of $450,000. Pursuant to the Agreement, the Company is required to maintain certain financial and non-financial covenants, including certain earnings levels, liquidity ratios, restrictions on dividends and capital expenditures. Borrowings under the Agreement are secured by substantially all of the Company's assets. For the quarter ended September 30, 2000, the Company failed to comply with certain of its financial covenants and the bank has waived its requirement that the Company comply thereunder. On October 18, 2000, the Company amended the Agreement with its lending institution to waive all financial covenants until December 29, 2000, at which time the lending institution has agreed to negotiate new, less restrictive financial covenants. In conjunction with this amendment the interest rate was increased by one percent (1.0%) to two percent (2.0%) per annum above the Prime Rate, and the Company agreed not to re-borrow amounts that had been repaid. Additionally, the maturity date of the line of credit was extended from March 12, 2001 until September 30, 2001, and a gradual pay-down schedule was agreed to. Our ability to meet future financial covenants is contingent upon the lending institution's willingness to negotiate appropriate financial covenants for the Company. COMPREHENSIVE INCOME (LOSS) Total comprehensive loss was $7.0 million and $47.0 million for the three and nine months ended September 30, 2000, respectively. Comprehensive loss consists of net loss and the net changes in foreign currency translation adjustments. Total comprehensive income (loss) for the three and nine months ended September 30, 1999 equaled net income (loss). RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In March 2000, the Financial Accounting Standard Board issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application of APB Opinion No. 25 and among other issues clarifies the following: the definition of an employee for purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of previously fixed stock options or awards; and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions in FIN 44 cover specific events that occurred after either December 15, 1998 or January 12, 2000. The Company does not expect the application of FIN 44 to have a material impact on the Company's financial position or results of operations. In December 1999, the United States Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues, as well as examples of how the staff applies revenue recognition guidance to specific circumstances. SEC registrants may adopt a change in accounting principle no later than the first quarter of the fiscal year beginning after December 15, 1999 (January 1, 2000 for the Company). In June 2000, SAB 101B was issued by the SEC delaying the implementation date of SAB 101 to the fourth quarter of 2000. The Company is evaluating the impact of SAB 101 on its financial position and results of operations and will report the impact, if any, in the fourth quarter 2000. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that corresponding gains or losses be reported either in the statement of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. In June 1999, SFAS 137, 10 11 "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No. 133" was issued. In June 2000, SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133" was issued. SFAS 138 does not amend any of the fundamental concepts of Statement 133, but does address a limited number of issues causing implementation difficulties for entities that apply SFAS 133. SFAS 133, as amended by SFAS 137 and SFAS 138, remains effective for fiscal quarters beginning after January 1, 2001 for the Company, and its adoption is not expected to have a material impact on the Company's financial position or results of operations. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS Certain statements made in this report, as well as oral statements made by the Company from time to time, which are prefaced with words such as "expects", "anticipates", "believes", "projects", "intends", "plans" and similar words and other statements of similar sense, are forward looking statements. These statements are based on the Company's current expectations and estimates as to prospective events and circumstances, which may or may not be in the Company's control and as to which there can be no firm assurance given. These forward looking statements, like any other forward looking statement, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties are outlined later in this document and should not be construed as exhaustive. The Company disclaims any obligation to subsequently revise forward looking statements or to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Further discussions of risk factors are also available in the Company's registration statements filed with the Securities and Exchange Commission. The Company wishes to caution readers not to place undue reliance upon such forward-looking statements, which speak only as of the date made. 11 12 OVERVIEW On January 15, 2000, we entered into an agreement to acquire Caere Corporation, a California based digital imaging software company. The acquisition was completed on March 13, 2000 and Caere was merged into a subsidiary of ScanSoft. As a result, ScanSoft has added the OmniPage and OmniForm family of products to its own product line. The acquisition was accounted for as a purchase and accordingly, the results of operations of Caere are included in the Company's financial statements as of the acquisition date. The Company's results of operations for the nine-month period ended September 30, 2000, include a pre-tax charge of $18.3 million for the value of acquired in process research and development and amortization of $7.7 million related to intangible assets recorded as a result of the acquisition. On March 2, 1999, the Company acquired Xerox's ScanSoft subsidiary and renamed the Company ScanSoft, Inc. Many of the increases discussed below are related to the inclusion of ScanSoft's results for the entire nine months in 2000 versus just seven months in 1999, and to the inclusion of Caere since March 13, 2000. Our success in the future will depend on our ability to maintain software gross margins and increase sales of our software products. This will depend in part on our ability and the ability of our distributors, resellers and OEM partners to convince end-users to adopt paper and image input systems for the desktop and to educate end-users about the benefits of our products. There can be no assurance that the market for our products will develop or that we will achieve market acceptance of our products. Despite experiencing several quarters of minor levels of profitability throughout our history, we have incurred annual net losses since inception. There can be no assurance that we will be able to reach quarterly profitability or attain annual profitability in the near future. As of September 30, 2000, we had an accumulated deficit of $130 million. 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, 2000 and September 30, 1999:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 2000 1999 2000 1999 ---- ---- ---- ---- Revenue: 100.0% 100.0% 100.0% 100.0% Costs and expenses: Cost of revenue 21.7% 24.3% 27.1% 23.6% Research and development 28.1% 20.9% 33.9% 22.4% Selling, general and admin 50.1% 39.4% 60.1% 44.8% Restructuring and other charges 0.0% 0.0% 14.2% 1.5% Gain on sale of hardware business, net 0.0% 0.0% 0.0% (3.8)% Amortization of goodwill and other intangible Assets 49.8% 8.0% 45.1% 5.6% Acquired in-process research and development 0.0% 0.0% 52.2% 17.1% ----- ----- ------ ----- Total costs and expenses 149.7% 92.6% 232.6% 111.2% ----- ----- ------ ----- Income (loss) from operations (49.7)% 7.4% (132.6)% (11.2)% Other income/(expense), net (1.9)% 0.8% (0.7)% 0.6% ----- ----- ------ ----- Income (loss) before income taxes (51.6)% 8.2% (133.3)% (10.6)% Provision for income taxes (0.3)% (2.4)% (0.9)% (1.3)% ----- ----- ------ ----- Net income (loss) (51.9)% 5.8% (134.2)% (11.9)% ----- ----- ------ -----
REVENUE Net revenue of $13.6 million for the three months ended September 30, 2000 increased by $5.4 million or 66%, from the comparable period in 1999. The primary increase in revenue was due to the acquisition of Caere Corporation on March 13, 2000. Revenue growth occurred primarily from increased software sales through retail channels while growth to a lesser extent also occurred in the Direct and OEM channels of distribution. OEM license revenue is anticipated to grow in future quarters as existing relationships are strengthened and new partnerships are formed. During the quarter the Company announced a worldwide OEM agreement to bundle its software with the Hewlett Packard (HP) HP ScanJet 6300C Professional Series Scanners. Revenue for the nine months ended September 30, 2000 increased $12.0 million or 52% from the comparable period of 1999. During the first nine months of 2000, the Company took several steps to take full advantage of a growing scanner and digital imaging market. The first was the previously mentioned acquisition of Caere and its product lines. In addition, PaperPort 7.0 was released in 12 13 the latter half of the second quarter and TextBridge Pro Millenium Business Edition and the Developer's Kit2000 version 10.0 were also released during the second quarter. This was offset by a change in the Company's method of estimating revenue reserves to more closely align reported revenues with end user purchases, resulting in a reduction of revenue of $3.7 million for the nine months ended September 30, 2000. Net revenue by channel in the three months ended September 30, 2000 was 55% retail, 15% direct, and 30% OEM and multi-user licenses compared to 41%, 16% and 43%, respectively for the same period ended September 30, 1999. The net revenue breakdown for the nine months ended September 30, 2000, was 51% retail, 19% direct, and 30% OEM and multi-user licenses compared to 46%, 18% and 36%, respectively for the same period ended September 30, 1999. The decline in OEM revenue percent for both the three and nine months ended September 30, 2000, was a result of Caere's much lower OEM revenue percentage relative to ScanSoft's. COST OF REVENUE Cost of revenue consists primarily of material costs, third party royalties, fulfillment, and salaries for product support personnel. Cost of revenue for the three months ended September 30, 2000 was $3.0 million or 21.7% of revenue, compared to $2.0 million or 24.3% of revenue in the comparable period of 1999, an increase in cost of revenue of 48.5%. Cost of revenue for the nine months ended September 30, 2000 was $9.5 million or 27.1% of revenue, compared to $5.4 million or 23.6% in the comparable period of 1999, an increase in cost of revenue of 74.8%. The increase in cost of revenue for both the three and nine month periods are related to the increased revenue volume experienced by the Company subsequent to the acquisition of Caere, incremental support costs associated with duplicative support organizations and higher costs associated with redundant contracts of the combined organization. The Company anticipates that as a result of the restructuring actions taken during the second quarter, it will achieve approximately $1.3 million of annualized cost savings associated with a reduced support organization and consolidation of redundant operating contracts of the two organizations. The Company realized expense reductions of approximately $1.1 million in the third quarter compared to the three months ended June 30, 2000. These cost savings were attributed to synergies achieved from the combined entities as well as the restructuring initiated in the second quarter. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses consist primarily of salary and benefit costs of engineers. Research and development costs were $3.8 million or 28.1% of revenue in the three months ended September 30, 2000, compared to $1.7 million or 20.9% of revenue for the same three months in 1999. Research and development costs for the nine months ended September 30, 2000 were $11.9 million or 33.9% of revenue, compared to $5.1 million or 22.4% for the same period in 1999. The increase in research and development spending for both the three and nine month periods is due to the added software engineering headcount from the acquisition of Caere on March 13, 2000. The Company anticipates that, as a result of the restructuring actions taken during the second quarter, it will achieve approximately $3.1 million of annualized cost savings, net of incremental head count being added in Budapest Hungary and Peabody Massachusetts, starting in the fourth quarter 2000. For the three-month period ending September 30, 2000, the Company realized approximately $1.0 million in cost savings compared to the three-month period ending June 30, 2000. These cost savings were directly related to the restructuring activities initiated in the second quarter, as well as the headcount reductions that occurred during the second quarter in connection with the acquisition of Caere. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling expenses include salaries, commissions, advertising, direct mail, public relations, trade shows, travel and other related sales and marketing expenses. General and administrative expenses include personnel costs for administration, finance, human resources, information systems, and general management in addition to legal and accounting expenses and other professional services. Selling, general and administrative expenses in the three months ended September 30, 2000 were $6.8 million or 50.1% of revenue, as compared to $3.2 million or 39.4% of revenue for the same period in 1999. Selling, general and administrative expenses for the nine months ended September 30, 2000 were $21.1 million or 60.1% of revenue, as compared to $10.3 million or 44.8% for the nine months ended September 30, 1999. The increase in expenses is due primarily from the acquisition of Caere, including costs associated with the acquisition, as well as growth in spending to support higher revenue. The Company anticipates that as a result of the restructuring actions taken during the second quarter, it will achieve approximately 13 14 $5.3 million of annualized cost savings, net of incremental head count being added in Budapest Hungary and Peabody Massachusetts, starting in the fourth quarter 2000. Additionally, the Company anticipates annual facility related savings of approximately $1.0 million starting in the fourth quarter. For the three-month period ending September 30, 2000, the Company realized approximately $1.9 million reduction in SG&A expense compared to the three-month period ending June 30, 2000. This reduction was from the restructuring initiated in the second quarter, tighter expense control and the postponement of marketing communications until the fourth quarter, as well as the headcount reductions that occurred during the second quarter in connection with the acquisition of Caere, and the reclassification of former Caere support costs from SG&A to Cost of revenue. 14 15 OTHER COSTS AND EXPENSES RESTRUCTURING AND OTHER CHARGES: In connection with the acquisition of Caere, the Company identified approximately 46 employees of Caere whose positions were eliminated immediately as part of the acquisition. These positions included 22 in research and development, 14 in general and administrative functions, and 10 in sales and marketing. Additionally, the former president and CEO position of Caere was eliminated. As a result, the Company established as part of the purchase price a restructuring reserve in the amount of $487,000, for the severance payments to employees, anticipated to be paid out in the fourth quarter, and a restructuring reserve of $1,065,000 for the president and CEO of Caere, whose severance and benefits will continue over the next 5 years. The Company is obligated to pay retention bonuses amounting to approximately $797,000 relating to key employees that will be used in the integration of the companies. These retention bonuses will be expensed as incurred and have not been included in the purchase price of the acquisition. During the quarter ending June 30, 2000, the Company committed to a restructuring plan to strategically refocus the Company and bring operating expenses in line with net revenues. The process included a review of all potentially redundant functions and facilities. As part of this process, the Company determined it would be more cost effective to eliminate duplicative activities being performed in Los Gatos, California through relocating certain efforts to Peabody, Massachusetts and Budapest, Hungary. These activities consisted primarily of research and development, marketing, customer support and general and administrative functions. In light of this decision, the Company notified 71 employees that their positions would be eliminated as of June 30, 2000, of the 71 employees notified, 6 employees voluntarily terminated their employment and were not entitled to receive their severance benefits; accordingly, these employees are not included in the restructuring charge. The remaining 65 employee positions include 29 in research and development, 13 in general and administrative functions, and 23 in support and marketing. As a result, the Company has established a restructuring charge in the amount of $1,069,000 for the severance payments to these employees, which is anticipated to be paid out in the fourth quarter, and a restructuring charge of $397,000 for exit costs to be incurred as a result of exiting the Los Gatos facility. Additionally, the Company wrote-off $3,490,000 of net intangible assets acquired as part of the Caere acquisition, including the acquired work force amounting to $1,074,000 and a favorable building lease amounting to $2,416,000, which were impaired as a result of the restructuring. These restructuring actions should further reduce future operating expenses by approximately $10 million on an annualized basis. The Company is obligated to pay retention bonuses amounting to approximately $212,000 for key employees who will be used in the consolidation of the companies. These amounts are charged to expense as incurred. During the nine months ended September 30, 2000, the Company paid $635,000 in severance related payments related to the restructuring activities. Additionally, the Company paid $761,000 relating to retention bonuses for the nine-month period ending September 30, 2000. Restructuring charges of $346,000 in the first nine months of 1999 relate to the acquisition of ScanSoft, and the subsequent consolidation of research and development operations and the move of the Company's headquarters to Massachusetts, which resulted in the termination of 10 employees in California. The major components of these costs were approximately $188,000 in severance costs for the 10 employees and approximately $46,000 for disposed West Coast equipment. Also included was $82,000 in non-refundable commitments associated with the West Coast development team, as well as $30,000 in other exit costs. All such costs have been fully paid as of September 30, 2000. AMORTIZATION OF INTANGIBLE ASSETS AND IN-PROCESS RESEARCH AND DEVELOPEMENT Goodwill and other intangible assets, and related amortization expense, primarily represent assets acquired in connection with the Caere acquisition. The amounts allocated to identifiable tangible and intangible assets associated with the Caere acquisition, including acquired in-process research and development, were based on the results of an independent appraisal. Goodwill represents the amount by which the cost of acquired net assets exceeded the fair values of those net assets on the date of purchase. Acquired in-process research and development represented development projects that had not yet reached technological feasibility and had no alternative future use. Accordingly, the amount of $18.3 million was immediately charged to expense in the consolidated statements of operations upon consummation of the acquisition. 15 16 The values of core technology, developed technology and acquired in-process technology were determined by a risk adjusted, discounted cash flow approach. The value of in-process research and development, specifically, was determined by estimating the costs to develop the in-process projects into commercially viable products, estimating the resulting net cash flows from such projects, discounting net cash flows back to their present values, and adjusting those results to reflect the projects stages of completion. These include projects (primarily major version upgrades) in each of Caere's major products, including OmniPage, OmniForm, and PageKeeper. The discount rates used were 14% for developed technology, 19% for core technology and 24% for in-process technology. This discount rate takes into consideration the inherent uncertainties surrounding the successful development of the in-process research and development, the profitability levels of such technology and the uncertainty of technological advances, which could potentially impact the estimates described above. The average percentage of completion of the projects ranged from 50% to 67% at the date of the acquisition. Revenues were projected to be generated late in fiscal 2000 for each of the product versions in development at the acquisition date. If these projects are not successfully developed, future revenue and profitability of ScanSoft may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired. As a result of the second quarter 2000 restructuring actions, certain intangible assets associated with the Caere acquisition were impaired. Accordingly, the Company wrote-off $3,490,000 of net intangible assets including the acquired workforce amounting to $1,074,000 and a favorable building lease amounting to $2,416,000. After consideration of these write-offs, the Company expects amortization of goodwill and other intangible assets to be reduced by $0.3 million to equal approximately $6.8 million on a quarterly basis. GAIN ON SALE OF THE HARDWARE BUSINESS In the quarter ended March 31, 1999, the Company sold its hardware business to Primax Electronics, Ltd., for approximately $6.8 million and reported an operating gain of approximately $882,000. OTHER INCOME (EXPENSE), NET Other income (expense), net consists primarily of interest earned on cash, cash equivalents and short-term investments offset by interest incurred for borrowings under credit facilities and short-term notes and exchange gains and losses. Other expense, net was $257,000 for the three months ended September 30, 2000, compared with other income, net of $62,000 for the same period in 1999. The decrease was attributable to higher interest expense on larger bank borrowings and foreign exchange losses. Other expense, net for the nine months ended September 30, 2000 was $257,000, compared to other income of $136,000 for the same period in 1999. This was the result of higher interest expense associated with amounts borrowed under the line of credit, for the nine months ended September 30, 2000. TAXATION Tax provisions of $36,000 and $344,000 for the three and nine months ended September 30, 2000 respectively represent taxes for foreign and state jurisdictions in which the Company does business and for which no net operating loss carryforwards were available. For the same periods in 1999, we had a tax provision of $200,000, and $300,000 respectively, representing alternative minimum taxes due to our recorded losses. As part of the acquisition, the Company acquired deferred tax assets amounting to approximately $5,919,000, for which a full valuation allowance was initially recorded due to the uncertainty of their realization. In accordance with Financial Accounting Standards Board No. 109 "Accounting for Income Taxes" ("FAS 109"), the Company established a deferred tax liability associated with the non-deductible acquired intangibles assets excluding goodwill. As a result, the valuation allowance on the acquired Caere net deferred tax asset as well as a portion of the Company's valuation allowance on its existing net deferred tax assets was released. Also in accordance with FAS 109, this reduction in valuation allowance was accounted for in the purchase accounting and not the statement of operations during the period ended March 31, 2000. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2000, we had cash, cash equivalents and short-term investments of $5.0 million and a working capital deficit of $4.4 million, as compared to $5.2 million in cash, cash equivalents and short-term investments and $7.0 million of working capital 16 17 at December 31, 1999. During the nine months ended September 30, 2000, we used $4.7 million of cash for our operating activities, as compared to $2.3 million for the same period in 1999. The cash was used to fund payment of restructuring salary and personnel costs, and other normal operating costs. During the nine month period ended September 30, 2000, cash provided by investing activities was $1.2 million as compared to $6.5 million for the same period in 1999. The decline is due primarily to $6.8 million that was received for the sale of the hardware business in 1999 and $1.2 million of cash received with the acquisition of ScanSoft, also in 1999. The Company also received $1.4 million of cash related to the acquisition of Caere in 2000. During the nine months ended September 30, 2000, cash provided by financing activities was $3.4 million as compared to $6.6 million used for the same period in 1999. During the nine months ending September 30, 2000, the Company made an additional draw of $4.8 million and made payments of $0.5 million on our line of credit bringing the balance to $4.3 million at September 30, 2000. Additionally, during the nine month period ended September 30, 2000, we repaid the $1.6 million note payable. The Company also received $0.7 million from proceeds from stock option exercises and the employee stock purchase plan for the nine months ended September 30, 2000. This compares to $0.1 million for the same period in 1999. Our principal sources of liquidity as of September 30, 2000 consisted of approximately $5.0 million of cash, cash equivalents and short-term investments. On March 13, 2000, we acquired Caere Corporation for approximately $168 million. The acquisition consideration consisted of $49 million in cash, $95 million in ScanSoft common stock and $24 million in stock compensation and other transaction costs. The cash consideration was paid out of Caere's cash balance of approximately $50 million. In addition, we have arranged a secured credit facility, as amended, for $5.0 million, subject to various borrowing constraints, which has been substantially utilized. Pursuant to the credit facility, the Company is required to maintain certain financial and non-financial covenants, as defined, including certain earnings levels, liquidity ratios, restrictions on dividends and capital expenditures. Borrowings under the facility are secured by substantially all of the Company's assets. For the quarter ended September 30, 2000, the Company failed to comply with certain of its financial covenants and the bank has waived its requirement that the Company comply thereunder. On October 18, 2000, the Company amended the credit agreement with its lending institution to waive all financial covenants until December 29, 2000, at which time the lending institution has agreed to negotiate new, less restrictive financial covenants. In conjunction with this amendment the interest rate was increased by one percent (1.0%) to two percent (2.0%) per annum above the Prime Rate, and the Company agreed not to re-borrow amounts that had been repaid. Additionally, the maturity date of the line of credit was extended from March 12, 2001 until September 30, 2001, and a gradual pay-down schedule was agreed to. Our ability to meet future financial covenants is contingent upon the lending institutions willingness to negotiate appropriate financial covenants for the Company. As a result of the restructuring events undertaken in the second quarter 2000, we anticipate achieving sufficient cost savings and expect to generate cash from operations during the fourth quarter 2000. Based upon these events and existing cash balances, we believe that our existing sources of liquidity will provide adequate cash to fund our operations for at least the next twelve months. However there can be no assurance that cash generated by operations will be sufficient to satisfy our liquidity requirements beyond 12 months, and we may be required to sell additional equity or debt securities, or increase or obtain additional lines of credit. There can be no assurances that the Company will be able to sell debt or equity securities or obtain financing sufficient to continue its planned operations on terms acceptable to the Company. FOREIGN OPERATIONS: As a result of the Caere acquisition, in March 2000, the Company significantly increased its presence in Europe. The Company conducts certain business transactions in the euro, and will change its functional currencies for the affected countries to the euro by the end of the three-year transition period. The conversion to the euro has not and is not expected to have a significant operational impact or a material financial impact on the results of operations, financial position, or the liquidity of the Company's European businesses. Changes in the value of the euro or other foreign currencies relative to the value of the U.S. dollar could adversely affect future revenues and operating results. Currently, the Company does not hedge any of its foreign-currency denominated transactions. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS: In March 2000, the Financial Accounting Standard Board issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application 17 18 of APB Opinion No. 25 and among other issues clarifies the following: the definition of an employee for purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of previously fixed stock options or awards; and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions in FIN 44 cover specific events that occurred after either December 15, 1998 or January 12, 2000. The Company does not expect the application of FIN 44 to have a material impact on the Company's financial position or results of operations. In December 1999, the United States Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues, as well as examples of how the staff applies revenue recognition guidance to specific circumstances. SEC registrants may adopt a change in accounting principle no later than the first quarter of the fiscal year beginning after December 15, 1999 (January 1, 2000 for the Company). In June 2000, SAB 101B was issued by the SEC delaying the implementation date of SAB 101 to the fourth quarter of 2000. The Company is evaluating the impact of SAB 101 on its financial position and results of operations and will report the impact, if any, in the fourth quarter 2000. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that corresponding gains or losses be reported either in the statement of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. In June 1999, SFAS 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No. 133" was issued. In June 2000, SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133" was issued. SFAS 138 does not amend any of the fundamental concepts of Statement 133, but does address a limited number of issues causing implementation difficulties for entities that apply SFAS 133. SFAS 133, as amended by SFAS 137 and SFAS 138, remains effective for fiscal quarters beginning after January 1, 2001 for the Company, and its adoption is not expected to have a material impact on the Company's financial position or results of operations. FACTORS THAT MAY AFFECT FUTURE RESULTS The anticipated benefits from merging with Caere will depend in part on whether we can integrate our operations and technologies in an efficient and effective manner. We cannot guarantee that this will occur. Successful integration will require integration of each company's products and coordination of each company's operating procedures, financial controls, development efforts and sales and marketing efforts. This integration may be difficult to accomplish smoothly or successfully, and may take longer than we expect. If serious difficulties are encountered during integration, management will have to divert its attention from normal business operations to address these issues, which could have an adverse effect on the surviving corporation's business. In addition, the merger may cause potential customers to cancel or delay orders as the result of uncertainty over the successful integration of the two companies. Furthermore, there could be an adverse effect on employee morale and on the ability of the surviving corporation to retain key personnel. Failure to effectively accomplish the integration of the two companies' operations could have a material adverse effect on the surviving corporation's business, operating results and financial condition. The Company's business operates in an intensely competitive environment and operations are subject to risks and uncertainties. Such risks and uncertainties include, but are not limited to (1) the loss of, or a significant curtailment of, purchases by any one or more principal customers; (2) the cyclicality of the retail software industry; (3) inability to protect the Company's proprietary technology and intellectual property; (4) the inability to attract or retain skilled employees; (5) technological obsolescence of current products and the inability to develop new products; (6) the inability to respond to competitive technology and competitive pricing pressures; (7) quarterly operating results that fluctuate and differ materially from one quarter to the next which could have an impact on the Company's stock price. There can be no assurance that cash generated by operations will be sufficient to satisfy our liquidity requirements, and we may be required to sell additional equity or debt securities, or increase or obtain additional lines of credit. The sale of additional equity or convertible debt securities may result in additional dilution to our stockholders. It may be difficult to sell additional equity or obtain debt financing, and this could result in significant constraints on the Company's ongoing investments to grow revenue and develop new products. For further discussion regarding these and other risks, refer to the Company's Annual Report on Form 10-K for the year ended 18 19 December 31, 1999 and the Company's Prospectus/Proxy Statement dated February 9, 2000. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 19 20 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibits listed on the Exhibit Index hereto are filed or incorporated by reference (as stated therein) as part of this report on Form 10-Q. (b) Reports on Form 8-K None 20 21 SIGNATURES Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Peabody, State of Massachusetts, on November 13, 2000. SCANSOFT, INC. By: /s/ Gerald C. Kent Jr. ------------------------------ Gerald C. Kent, Jr. Chief Accounting Officer And Corporate Controller 21 22 EXHIBIT INDEX Exhibits (numbered in accordance with Item 601 of Regulation S-K) EXHIBIT NO. DESCRIPTION OF EXHIBITS ------- ----------------------- 2.1(1) Agreement and Plan of Merger dated December 2, 1998, between Visioneer, Inc., a Delaware corporation, and ScanSoft, Inc., a Delaware Corporation. 2.2(2) Agreement and Plan of Reorganization, dated January 15, 2000, by and among ScanSoft, Inc., a Delaware corporation, Scorpion Acquisitions Corporation, a Delaware corporation and a wholly-owned subsidiary of ScanSoft, and Caere Corporation, a Delaware corporation. 3.2(3) Bylaws of Registrant 3.2(4) Amended and Restated Certificate of Incorporation of Registrant. 4.1(4) Specimen Common Stock Certificate. 4.2(5) Preferred Shares Rights Agreement, dated as of October 23, 1996, between the Registrant and U.S. Stock Transfer Corporation, including the Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock, the form of Rights Certificate and Summary of Rights attached thereto as Exhibits A, B and C, respectively. 4.3(6) Voting Agreement dated March 2, 1999 between Xerox, Xerox Imaging Systems, Inc., Visioneer, Inc. and several holders of Visioneer common stock. 10.1 Employment Agreement dated August 21, 2000, by and between ScanSoft, Inc. and Paul A. Ricci. 10.2 Employment Agreement dated August 21, 2000, by and between ScanSoft, Inc. and Michael K. Tivnan. 27.1 Financial Data Schedule. ------------- (1) Incorporated by reference from the Registrant's Registration Statement on From S-4 (No. 333-70603) filed with the Commission on January 14, 1999. (2) Incorporated by reference from the Registrant's Registration Statement on Form S-4 (No. 333-96487) filed with the Commission on February 9, 2000. (3) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (No. 333-98356) filed with the Commission on October 19, 1995. (4) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (No. 333-74343) filed with the Commission on March 12, 1999. (5) Incorporated by reference from the Registrant's Registration Statement on Form S-4 (No. 333-96487) filed with the Commission on February 9, 2000. (6) Incorporated by reference from the Registrant's current Report on Form 8-K dated October 30, 1996.