-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FberDzC3QGgSAZf/uAZ6YxKCBSpUR0tVvPVa15LvyA56uLvLWxAW2j7y0rZTAj+m PGIRnk9M0KLJrNnujfJTng== 0000950135-03-005683.txt : 20031114 0000950135-03-005683.hdr.sgml : 20031114 20031114144141 ACCESSION NUMBER: 0000950135-03-005683 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCANSOFT INC CENTRAL INDEX KEY: 0001002517 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 943156479 STATE OF INCORPORATION: DE FISCAL YEAR END: 0103 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27038 FILM NUMBER: 031003387 BUSINESS ADDRESS: STREET 1: 9 CENTENNIAL DRIVE CITY: PEABODY STATE: MA ZIP: 01960 BUSINESS PHONE: 9789772000 MAIL ADDRESS: STREET 1: 2560 W BAYSHORE RD CITY: PALO ALTO STATE: CA ZIP: 94303 FORMER COMPANY: FORMER CONFORMED NAME: VISIONEER INC DATE OF NAME CHANGE: 19951020 10-Q 1 b48103sse10vq.txt SCANSOFT, INC. 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 directly or through our 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, we have not experienced significant returns from retailers or end-users. If actual returns differ significantly from our estimates, such differences could have a material impact on our results of operations for the period in which the actual returns become known. 24 Royalty revenue derived from sales to OEM customers is recognized when software copies are deployed based upon reports of actual deployments received from OEM customers and payment is due. We generate revenue from professional services, provided that evidence of the arrangement exists, the fees are fixed or determinable and collectibility is reasonably assured. When we provide professional services such as custom applications and other services considered essential to the functionality of the software for a fixed fee, we recognize revenue from the fees for such services and any related software licenses as we complete the project using the percentage-of-completion method. We generally determine the percentage-of-completion by comparing the labor hours we have incurred to date to our estimate of the total labor hours required to complete the project based on regular discussions with our project managers. This method is used because we consider 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 we provide services on a time and materials basis, we recognize revenue as we perform the services based on actual time incurred. We may sell, under one contract or related contracts, software licenses, custom software applications and other services considered essential to the functionality of the software and a maintenance and support arrangement. The total contract value is attributed first to the maintenance and support arrangement based 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. We may sell, under one contract or related contracts, software licenses, a maintenance and support arrangement and professional services not considered essential to the functionality of the software. In those arrangements, the total contract value is attributed first to the undelivered elements of maintenance and support and professional services based on 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. Under our maintenance and support arrangements, we offer unspecified upgrades and enhancements on software products only on a when-and-if-available basis. Typically, we do not contract in advance for specified upgrades, enhancements or additional software products. When we provide support and maintenance services, we recognize the revenue ratably over the term of the related contracts, typically one year. We characterize our revenues in three ways: Direct, VAR/Retail, and OEM. Direct revenue consists of sales of our Capture and Dictation products through our e-Commerce channels, as well as revenue recognized from volume sales of our Capture and Dictation products directly to the end user. VAR/Retail is made up of revenue recognized from sales of our Capture and Dictation products through our two-tiered distribution/reseller channels. This includes, but is not limited to, sales to retailers, VAR's and Corporate Resellers. OEM revenues consist of all licensing revenues recognized from third party royalties due the Company. Cost of revenue consists primarily of material and fulfillment costs, third-party royalties, salaries for product support personnel and engineering costs associated with contracts which are accounted for under the percentage-of-completion method of accounting. Cost of revenue from amortization of intangible assets includes the amortization of acquired patents and core and completed technology. Research and development expenses consist primarily of salary and benefits costs of engineers. We believe that the development of new products and the enhancement of existing products are essential to our success. Accordingly, we plan to continue to invest in research and development activities. To date, we have not capitalized any development costs as the cost incurred after technological feasibility but before release of product has not been significant. Selling expenses include salaries, commissions, advertising, direct mail, public relations, trade shows, travel and other related sales and marketing expenses. General and administrative expenses include personnel costs for administration, finance, human resources, information systems and general management, in addition to legal and accounting expenses and other professional services. We attempt to control selling, general and administrative expenses; however, if revenue continues to grow, we expect selling, general and administrative expenses to increase to support our growing operations. In addition, we may increase selling, general and administrative expenses in advance of revenue to support expected future revenue growth in specific product lines or geographic regions. Amortization of other intangible assets excludes amortization of acquired patents and core and completed technology, which is included in cost of revenue from amortization of intangible assets. 25 Total Revenue Total revenue for the three months ended September 30, 2003 increased by $4.7 million or 17% from the comparable period in 2002. This growth in revenue is attributed to a $7.8 million growth in our Speech and Language revenues, offset by an overall decrease of $3.1 million in our Digital Capture revenues from the comparable period 2002. The increase in our Speech and Language revenues are imputed to a $7.1 million increase in our networked solution technologies, as well as a $1.3 million increase in our embedded speech technologies, from the comparable period 2002. The growth in these sectors was partially offset by a small seasonal decrease in our dictation product lines. The overall decrease in our Digital Capture products can be solely attributed to a decrease in revenues recognized from our OCR products. This overall decrease is the result of the timing of the launch of OmmiPage Pro 12.0 in Q3 2002. The decrease in the OCR revenues was offset to some extent by an overall strengthening of our other Digital Capture product lines, in particular, PaperPort, as well as the revenues from the launch of our new product, PDF Converter. Total revenue for the nine months ended September 30, 2003 increased by $10.3 million or 13% from the comparable period in 2002. The increase in revenue from the comparable period 2002 is ascribed to a $17.5 million increase in our Speech and Language revenues, offset by a decline in our overall Digital Capture revenues of $7.2 million. The growth in Speech and Language revenues is accredited to growth in all three of our speech and language categories, networked, embedded, and dictation. Networked solutions saw an increase for the nine months ended September 30, 2003 of $12.3 million from the comparable period 2002, dictation productivity applications increased $3.6 million year over year, and while our embedded Text-to-Speech (TTS) product experienced considerable softening in the Asian market, our other embedded speech applications revenues were able to counterbalance resulting in an overall $1.6 million increase. The overall decrease in our Digital Capture revenues from 2002 was due primarily to lower sales of our OCR product line of which the timing of the September 2002 launch of OmmiPage 12 was a major factor, as well as the recognition in the first quarter 2002 of revenue previously deferred associated with completed OEM services. A strengthening in our Pager Management products offset these decreases to some extent, of which the launch of PaperPort 9.0 in March 2003 was the primary factor, as well as the initial launch of our PDF Converter product. Geographic revenue classification is based on the country in which the sale is invoiced. Revenue for the three months ended September 30, 2003 was 73% North America and 27% international versus 70% and 30%, respectively for the comparable period in 2002. Revenue for the nine months ended September 30, 2003 was 73% North America and 27% international, versus 74% North America and 26% international for the comparable period in 2002. A number of the Company's OEM partners distribute their products throughout the world and do not provide us with the geographical dispersion of their products. We believe, if provided with this information, our geographical revenue classification would indicate a higher international percentage. Based on an estimate that factors our OEM partners' geographical revenue mix to our revenues generated from these OEM partners, revenue for the three months ended September 30, 2003 is approximately 66% North America and 34% international, compared to 62% and 38%, respectively, for the comparable period in 2002. The decrease in the international revenues for the three months ended September 30, as a percent of total revenues, is primarily driven by the SpeechWorks acquisition, whose product revenues are heavily weighted to the domestic market. Revenue for the nine months ended September 30, 2003, based on the above-mentioned estimate, is approximately 65% North America and 35% international, compared to 69% North America and 31% international. The increase in our international revenue is driven primarily from Europe. The increase is the result of increased sales and marketing resources, the addition of resellers, the release of Dragon Naturally Speaking 7.0 increased demand from OEMs for our RealSpeak product (TTS), as well as the continued growth of our PaperPort 9.0 in the international market space. The following table presents the breakdown of our revenue by distribution channel:
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- -------------------- 2003 2002 2003 2002 ---------- ------- --------- ------- VAR/Retail.... 30% 44% 34% 43% Direct........ 21% 27% 26% 23% OEM........... 49% 29% 40% 34% --- --- --- --- 100% 100% 100% 100% ==== === === ===
26 The increase in our OEM revenues and the corresponding decrease in our other sales channels, as a percentage of revenue, for the three and nine months ended September 30, 2003 as compared to the same period 2002, was primarily due to the Philips and SpeechWorks acquisitions. Cost of Revenue Cost of revenue for the three months ended September 30, 2003 was $6.8 million or 20.5% of total revenue, compared to $4.2 million or 14.9% in the comparable period of 2002. Cost of revenue for the nine months ended September 30, 2003 was $15.6 million or 17.6% of total revenue, compared to $12.9 million or 16.6% for the same period in 2002. The increase in cost of revenue in absolute dollars and as a percentage of revenue for the three and nine months ended September 30, 2003 is attributable to an increase in engineering costs related to professional services revenue resulting from the Philips and SpeechWorks acquisitions and increased technical support costs primarily related to the creation of a customer service department in Europe, partially offset by an increase in higher-margin license revenue. The Company expects gross margins will decline slightly over the remainder of the fiscal year due to an increase of professional services revenue as a percentage of total revenue. Cost of Revenue from Amortization of Intangible Assets Cost of revenue from amortization of intangible assets for the three months ended September 30, 2003 was $2.8 million or 8.4% of revenue, compared to $2.0 million or 7.0% for the comparable period in 2002. The increase in cost of revenue from amortization of intangible assets for the three months ended September 30, 2003 was due to $0.6 million of amortization related to an exclusive worldwide license to resell certain desktop dictation products and technologies acquired by the Company during the first quarter of 2003, amortization of intangibles of $0.1 million related to the Philips acquisition which was completed on January 30, 2003 and $0.1 million related to the SpeechWorks acquisition which was completed on August 11, 2003. Cost of revenue from amortization of intangible assets for the nine months ended September 30, 2003 was $7.5 million or 8.5% of revenue, compared to $7.5 million or 9.6% for the same period in 2002. The cost of revenue from amortization of intangible assets for the nine months ended September 30, 2003 of $7.5 million includes $1.1 million of amortization related to the exclusive worldwide license to certain desktop dictation products and technologies, $0.3 million related to the Philips acquisition which was completed on January 30, 2003 and $0.1 million related to the SpeechWorks acquisition which was completed on August 11, 2003. The comparable period in 2002 includes $1.6 million of intangible assets that became fully amortized during fiscal year 2002. Research and Development Expense Research and development expenses were $9.5 million or 29.0% of revenue for the three months ended September 30, 2003, compared to $7.3 million or 25.7% of revenue for the comparable period in 2002. Research and development costs for the nine months ended September 30, 2003 were $25.1 million or 28.3% of revenue, compared to $21.3 million or 27.3% for the comparable period in 2002. The increase in research and development expenses for both the three and nine months ended September 30, 2003 is the result of increased headcount and related costs associated with both the Philips and SpeechWorks acquisitions. The Company expects research and development expenses as a percentage of revenue to decline over the remainder of the fiscal year due to an increase in revenue and the realization of operational synergies. Selling, General and Administrative Expense Selling, general and administrative expenses for the three months ended September 30, 2003 were $15.6 million or 47.4% of revenue, compared to $11.4 million or 40.3% of revenue for the same period in 2002. Selling, general and administrative expenses for the nine months ended September 30, 2003 were $42.7 million or 48.2% of revenue, compared to $32.0 million or 40.9% for the nine months ended September 30, 2002. The increase in selling, general and administrative expenses in absolute dollars for the three and nine months ended September 30, 2003 was the result of increased compensation costs of approximately $3.5 million and $6.6 million, respectively, resulting from the addition of 58 sales and marketing employees and 23 general and administrative employees primarily due to the Philips and SpeechWorks acquisitions. The remaining increase in selling, general and administrative expenses for the three and nine months ended September 30, 2003, is due primarily to increased channel marketing expenses of $0.1 million and $1.0 million, respectively, increased professional fees of approximately $0.6 million and $1.5 million, respectively, bad debt expense of $0.1 million and $0.4 million, respectively, and transition expenses associated with the Philips integration. The Company expects selling, general and administrative expenses as a percentage of revenue to decline slightly over the remainder of the fiscal year. 27 Amortization of Other Intangible Assets Amortization of other intangible assets for the three months ended September 30, 2003 was $0.7 million compared to $0.2 million for the comparable period in 2002. Amortization of other intangible assets for each of the nine months ended September 30, 2003 and 2002 was $1.4 million. Amortization of other intangible assets for the nine months ended September 30, 2003 of $1.4 million includes $0.5 million related to the Philips acquisition which was completed on January 30, 2003 and $0.2 million related to the SpeechWorks acquisition which was completed on August 11, 2003. The comparable period in 2002 includes $0.7 million of amortization expense related to intangible assets that were fully amortized during fiscal year 2002. Restructuring and Other Charges During the three months ended September 30, 2003, we 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 we expect to record $0.5 million of additional severance expense during the three months ended December 31, 2003. However, as employees will not receive the related termination benefits if such employees voluntarily leave prior to their expected termination dates, the $0.5 million of additional severance expense may be reduced. In addition, during the three month period ended September 30, 2003, we accrued $0.2 related to the closing of certain ScanSoft offices as a result of the SpeechWorks acquisition and other restructuring related expenses. 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. As a result of ongoing restructuring activities, which include these employee termination actions, we estimate full year operating synergies of approximately $27.0 million. Reduced employee compensation costs resulting from employee termination actions account for approximately $16.7 million of this total. We expect that the remaining synergies will be achieved through reductions in redundant marketing programs, travel expenses, professional services and facilities related expenses. During the three month period ended June 30, 2003, the Company committed to a plan to transfer certain research and development activities currently located at the corporate headquarters to Budapest resulting in the elimination of 21 employees. The Company recorded a restructuring charge in the amount of $0.4 million for severance payments to these employees. In addition, the Company recorded a charge in the amount of $0.4 million for severance payments to a former member of the senior management team. In connection with the Philips acquisition, we eliminated 25 ScanSoft personnel across all functional areas resulting in approximately $0.5 million in severance related restructuring costs in the three month period ended March 31, 2003. 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. For the nine months ended September 30, 2003, the Company paid a total of $1.4 million in severance payments, of which $0.5 million relates to the March 2002 restructuring and $0.1 million relates to severance paid to the former Caere President and CEO, pursuant to a 2000 restructuring charge. 28 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 actions taken during the quarters ended June 30, 2003 and September 30, 2003, respectively. 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 three month period 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. Income (Loss) from Operations As a result of the above factors, loss from operations was $(4.2) million for the three months ended September 30, 2003 or (12.8)% of revenue, compared to income of $3.2 million or 11.2% of revenue for the comparable period in 2002. Loss from operations was $(7.0) million for the nine months ended September 30, 2003 or (7.9)% of revenue, compared to income of $1.9 million or 2.4% of revenue for the comparable period in 2002. Other Income (Expense), Net Other income (expense), net consists primarily of interest earned on cash and cash equivalents, offset by interest incurred for borrowings under notes payable, and foreign currency exchange gains and losses. Other income (expense), net was $0.3 million for the three months ended September 30, 2003, compared to $(0.2) million for the same period in 2002. Other income (expense), net was $0.7 million for the nine months ended September 30, 2003 compared to $(0.2) million for the same period in 2002. The change in other income (expense), net for the three months ended September 30, 2003 from the comparable period of 2002 is the result of higher interest income and foreign currency gains, offset by higher interest expense. The change in other income (expense), net for the nine months ended September 30, 2003 from the comparable period of 2002 is the result of higher foreign currency gains, offset by higher interest expense. Income (Loss) Before Income Taxes Income (loss) before income taxes was $(4.0) million for the three months ended September 30, 2003 or (12.0)% of revenue, compared to $3.0 million or 10.6% of revenue for the comparable period in 2002. Loss before income taxes was $(6.4) million for the nine months ended September 30, 2003 or (7.2)% of revenue, compared to income before income taxes of $1.7 million or 2.2% of revenue for the comparable period in 2002. Income Taxes The (benefit from) income taxes was $(0.2) million for the three months ended September 30, 2003 and consists of a $1.4 million federal tax refund relating to the carryback of net operating losses to a prior period and a $0.9 million deferred tax provision associated with differences between the book and tax amortization for certain goodwill, of which $0.5 million relates to 2002. The remainder of the provision includes foreign income and foreign withholding taxes. The provision for income taxes was $0.2 million for the three months ended September 30, 2002 and consisted of foreign and state tax provisions for which no operating loss carryforwards are available to offset the related taxable income. The provision for income taxes was $0.5 million for the nine months ended September 30, 2003 and consisted of foreign income taxes, foreign withholding taxes and a $1.4 million deferred tax provision associated with differences between the book and tax amortization for certain goodwill, of which $0.5 million relates to 2002. The provision also includes the impact of a $1.4 million federal tax refund relating to the carryback of net operating losses to a prior period net operating loss refund. The (benefit from) income taxes of ($0.2) million for the nine months ended September 30, 2002 consisted of foreign and state tax provisions, offset by a federal tax benefit of ($0.9) million, related to a refund of taxes paid by Caere Corporation prior to its acquisition by us. 29 Net Income (Loss) As a result of all these factors, net loss totaled $(3.7) million or (11.3)% of revenue for the three months ended September 30, 2003, compared to net income of $2.8 million or 10.0% of revenue for the comparable period in 2002. Net loss totaled $(6.8) million or (7.7)% of revenue for the nine months ended September 30, 2003, compared to net income of $1.9 million or 2.4% of revenue for the comparable period in 2002 LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2003, we had cash, cash equivalents and marketable securities of $48.0 million and working capital of $36.4 million as compared to $18.9 million in cash and cash equivalents and working capital of $16.8 million at December 31, 2002. Net cash provided by operating activities for the nine months ended September 30, 2003 was $3.0 million compared to $6.3 million for the comparable period in 2002. Cash provided by operations in the 2003 period came primarily from income from operations, after adjustments for non-cash amortization and depreciation, lower inventory balances and increases in other liabilities, partially offset by payments of accounts payable including those assumed in the Philips and SpeechWorks acquisitions, an increase in accounts receivable balances and an increase in prepaid expenses and other current assets. Net cash provided by investing activities for the nine months ended September 30, 2003 was $23.8 million compared to cash used in investing activities of $4.9 million for the comparable period in 2002. Net cash provided by investing activities during the 2003 period consisted $40.0 million acquired in the SpeechWorks transaction, partially offset by $1.4 million in capital expenditures, which included costs to build-out facilities in both North America and Europe, $8.6 million of payments associated with acquisitions and $6.1 million of payments associated with an exclusive licensing agreement. Net cash used in investing activities during 2002 consisted of $2.1 million in capital expenditures to build-out facilities in both North America and Europe and $2.9 million associated with acquisitions. Net cash provided by financing activities for the nine months ended September 30, 2003 was $2.5 million compared to net cash used in financing activities of $1.4 million for the comparable period in 2002. Net cash provided by financing activities during the nine months ended September 30, 2003 consisted of proceeds of $2.0 million from the issuance of common stock in connection with employee stock compensation plans and net proceeds of $6.8 million, excluding offering costs of $1.3 million paid in the prior year, from the underwritten offering of our common stock. This was offset by a $1.2 million payment to the former Caere President and CEO in connection with the settlement of the non-competition and consulting agreement, the payment of the $3.3 million note payable related to the acquisition of Lernout & Hauspie assets during 2001, and $1.8 million of payments to repurchase outstanding common shares. Net cash used in financing activities during 2002 consisted of net proceeds of $5.7 million from the private placement of our common stock and $2.5 million from the exercise of stock options, offset by a $0.2 million payment on our capital lease obligation, a $7.0 million payment to repurchase shares of our treasury stock held by L&H, a $0.6 million principal payment on a note payable that was issued in connection with the acquisition of the L&H assets and a $1.8 million payment to the former Caere President and CEO in connection with the settlement of the non-competition and consulting agreement. On August 11, 2003, we completed the SpeechWorks acquisition. As consideration for the acquisition, we exchanged 0.860 of a share of our common stock for each outstanding share of SpeechWorks stock. This transaction resulted in the issuance of approximately 32.5 million shares of our common stock. In addition, we assumed significant lease obligations totaling $30.9 million, an equipment line of credit of $1.5 million, standby letters of credit of $1.5 million, royalty commitments of $1.1 million and purchase commitments of $0.5 million. Assumed lease obligations of $30.9 million does not reflect future minimum sub-lease rentals of approximately $6.8 million. On January 30, 2003, we completed the Philips acquisition. As consideration for the acquisition, 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. 30 The following table outlines our contractual payment obligations as of September 30, 2003:
PAYMENTS DUE BY PERIOD -------------------------------------------------------------- MORE LESS THAN 1-3 3-5 THAN 5 CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS YEARS - ------------------------------------------------------ ------- -------- ------- ------ ------- (IN THOUSANDS) Convertible debenture ............................... $27,524 -- $27,524 -- $ -- Deferred payment associated with Philips acquisition, including imputed interest ........................ 1,150 1,150 -- -- -- Euro denominated note (5 million) associated with Philips acquisition ............................... 5,843 5,843 -- -- -- Deferred payments for technology license ............ 5,205 2,617 2,588 -- -- Operating leases .................................... 38,316 5,290 9,658 5,388 17,980 Caere acquisition related costs ..................... 847 847 -- -- -- Equipment line of credit ............................ 1,467 1,130 293 44 -- Standby letters of credit ........................... 1,460 366 44 44 1,006 Royalty commitments ................................. 1,080 50 820 60 150 Purchase commitments ................................ 527 527 -- -- -- Imputed interest .................................... 409 197 212 -- -- ------- ------- ------- ------ ------- Total contractual cash obligations .................. $83,828 $18,017 $41,139 $5,536 $19,136 ======= ======= ======= ====== =======
Total future lease obligations in the table above do not reflect future minimum sub-lease rentals of approximately $6.8 million. Through September 30, 2003, we have not entered into any off balance sheet arrangements or transactions with unconsolidated entities or other persons. Historically and through December 31, 2001 we sustained recurring losses from operations in each reporting period. We reported net income (loss) of $6.3 million for 2002 and $(6.8) million for the nine months ended September 30, 2003, and have an accumulated deficit of $153.8 million at September 30, 2003. We believe that we have the ability to maintain operating expenses at levels commensurate with revenues to maintain positive cash flows from operations. We also believe that our existing working capital, including the cash received in connection with the SpeechWorks acquisition, cash flows from future operations and available borrowings under our line of credit facility, as amended, will be sufficient to meet our operating, investing and financing needs, for at least the next twelve months, including the integration and debt obligations incurred in connection with the Philips and SpeechWorks acquisition and the planned repurchase of up to $25 million of our common stock. FOREIGN OPERATIONS We develop and sell our products throughout the world. As a result of the Caere acquisition in March 2000, the L&H acquisition in December 2001, and our Philips and SpeechWorks acquisitions, we significantly increased our presence in Europe and added operations in Asia. With our increased international presence in a number of geographic locations and with international revenues projected to increase in 2003 and thereafter, we are exposed to changes in foreign currencies including the euro and Japanese yen. Changes in the value of the euro or other foreign currencies relative to the value of the United States dollar could adversely affect future revenues and operating results. We do not generally hedge any of our foreign-currency denominated transactions or expected cash flows. However, in connection with the Philips acquisition on January 30, 2003, we entered into a forward hedge in the amount of $5.3 million to meet our obligation to pay the 5.0 million euro promissory note issued as part of the acquisition. On August 26, 2003, we entered into a forward hedge in the amount of $1.1 million to meet our obligation to pay the 1.0 million euro note payable to Philips issued as part of the acquisition RECENT 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 31 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 our 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 in fiscal periods beginning after June 15, 2003, with early adoption permitted. 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. Adoption of EITF No. 03-05 would require a cumulative catch-up adjustment and may be applied to new revenue arrangements entered into after the beginning of an entity's next reporting period beginning after August 13, 2003. The adoption of EITF No. 00-21 and EITF No. 0-05 did not have a material impact on our results of operations or financial condition. FACTORS THAT MAY AFFECT FUTURE RESULTS ScanSoft 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 cyclical nature of the retail software industry; (3) the inability to protect ScanSoft'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; and (7) the ability to sustain product revenues upon the introduction of new products. Our quarterly operating results may fluctuate and differ materially from one quarter to the next, which could have an impact on our stock price. There can be no assurance that any 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 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 ScanSoft's ongoing investments to grow revenue and develop new products. You should also carefully consider the additional risks described below when evaluating our company. The risks described below are not the only ones facing us. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations and financial situation. Our business, financial condition and results of operations could be seriously harmed by any of these risks. OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND SEASONALITY. IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR SHARE PRICE MAY DECREASE SIGNIFICANTLY. Our revenue and operating results have fluctuated in the past and may not meet the expectations of securities analysts or investors in the future. If this occurs, the price of our stock would likely decline. Factors that may cause fluctuations in our operating results include the following: -- SLOWING SALES BY OUR DISTRIBUTION AND FULFILLMENT PARTNERS TO THEIR CUSTOMERS, WHICH MAY PLACE PRESSURE ON THESE PARTNERS TO REDUCE PURCHASES OF OUR PRODUCTS; -- VOLUME, TIMING AND FULFILLMENT OF CUSTOMER ORDERS; 32 -- CUSTOMERS DELAYING THEIR PURCHASE DECISIONS IN ANTICIPATION OF NEW VERSIONS OF PRODUCTS; -- CUSTOMERS DELAYING, CANCELING OR LIMITING THEIR PURCHASES AS RESULT OF THE THREAT OR RESULTS OF TERRORISM OR MILITARY ACTIONS TAKEN BY THE UNITED STATES OR ITS ALLIES; -- INTRODUCTION OF NEW PRODUCTS BY US OR OUR COMPETITORS; -- SEASONALITY; -- REDUCTION IN THE PRICES OF OUR PRODUCTS IN RESPONSE TO COMPETITION OR MARKET CONDITIONS; -- RETURNS AND ALLOWANCE CHARGES IN EXCESS OF RECORDED AMOUNTS; -- TIMING OF SIGNIFICANT MARKETING AND SALES PROMOTIONS; -- INCREASED EXPENDITURES INCURRED PURSUING NEW PRODUCT OR MARKET OPPORTUNITIES; -- INABILITY TO ADJUST OUR OPERATING EXPENSES TO COMPENSATE FOR SHORTFALLS IN REVENUE AGAINST FORECAST; -- DEMAND FOR PRODUCTS; AND -- GENERAL ECONOMIC TRENDS AS THEY AFFECT RETAIL AND CORPORATE SALES. Due to the foregoing factors, among others, our revenue and operating results are difficult to forecast. Our expense levels are based in significant part on our expectations of future revenue. Therefore, our failure to meet revenue expectations would seriously harm our business, operating results, financial condition and cash flows. Further, an unanticipated decline in revenue for a particular quarter may disproportionately affect our profitability because a relatively small amount of our expenses are intended to vary with our revenue in the short term. WE HAVE A HISTORY OF LOSSES. WE MAY INCUR LOSSES IN THE FUTURE. We sustained recurring losses from operations in each reporting period through December 31, 2001. We reported net losses of $(3.7) million and $(2.9) million, and $(0.2) million in the quarters ended September 30, 2003, June 30, 2003 and March 31, 2003 and net income of $6.3 million for the fiscal year ended December 31, 2002, respectively. If we are unable to regain profitability, the market price for our stock may decline, perhaps substantially. OUR BUSINESS COULD BE HARMED IF WE DO NOT SUCCESSFULLY MANAGE THE INTEGRATION OF THE BUSINESSES THAT WE ACQUIRE, INCLUDING OUR RECENTLY COMPLETED ACQUISITION OF SPEECHWORKS. As part of our business strategy, we have in the past acquired, and expect to continue to acquire, other businesses and technologies. Our acquisition of the speech and language technology operations of Lernout & Hauspie Speech Products N.V. and certain of its affiliates, including L&H Holdings USA, Inc. (collectively, L&H) and our acquisition of the Speech Processing Telephony and Voice Control business units from Philips required substantial integration and management efforts. Our recently completed acquisition of SpeechWorks International, Inc., will pose similar, and potentially greater, challenges. Acquisitions of this nature involve a number of risks, including: -- DIFFICULTY IN TRANSITIONING AND INTEGRATING THE OPERATIONS AND PERSONNEL OF THE ACQUIRED BUSINESSES; -- POTENTIAL DISRUPTION OF OUR ONGOING BUSINESS AND DISTRACTION OF MANAGEMENT; -- POTENTIAL DIFFICULTY IN SUCCESSFULLY IMPLEMENTING, UPGRADING AND DEPLOYING IN A TIMELY AND EFFECTIVE MANNER NEW OPERATIONAL INFORMATION SYSTEMS AND UPGRADES OF OUR FINANCE, ACCOUNTING AND PRODUCT DISTRIBUTION SYSTEMS; -- DIFFICULTY IN INCORPORATING ACQUIRED TECHNOLOGY AND RIGHTS INTO OUR PRODUCTS AND TECHNOLOGY; 33 -- UNANTICIPATED EXPENSES AND DELAYS IN COMPLETING ACQUIRED DEVELOPMENT PROJECTS AND TECHNOLOGY INTEGRATION; -- MANAGEMENT OF GEOGRAPHICALLY REMOTE UNITS BOTH IN THE UNITED STATES AND INTERNATIONALLY; -- IMPAIRMENT OF RELATIONSHIPS WITH PARTNERS AND CUSTOMERS; -- ENTERING MARKETS OR TYPES OF BUSINESSES IN WHICH WE HAVE LIMITED EXPERIENCE; AND -- POTENTIAL LOSS OF KEY EMPLOYEES OF THE ACQUIRED COMPANY. As a result of these and other risks, we may not realize anticipated benefits from our acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses and technologies could seriously harm our business. The size of the SpeechWorks acquisition significantly increases both the scope and consequences of our integration risks. OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED AS A RESULT OF PURCHASE ACCOUNTING TREATMENT, AND THE CORRESPONDING IMPACT OF AMORTIZATION OF OTHER INTANGIBLES RELATING TO OUR RECENTLY COMPELTED ACQUISITION OF SPEECHWORKS, IF OUR RESULTS OF THE COMBINED COMPANY DO NOT OFFSET THESE ADDITIONAL EXPENSES. Under accounting principles generally accepted in the United States of America, ScanSoft has accounted for the acquisition of SpeechWorks using the purchase method of accounting. Under purchase accounting, ScanSoft has recorded the market value of its common stock issued in connection with the acquisition and the amount of direct transaction costs as the cost of acquiring SpeechWorks. ScanSoft has allocated that cost to the individual assets acquired and liabilities assumed, including various identifiable intangible assets such as acquired technology, acquired trade names and acquired customer relationships based on their respective fair values. Intangible assets generally will be amortized over a five to ten year period. The amount of purchase price allocated to goodwill is approximately $128.4 million and the amount allocated to identifiable intangible assets is approximately $13.3 million. Goodwill is not subject to amortization but is subject to at least an annual impairment analysis, which may result in an impairment charge if the carrying value exceeds its implied fair value. As a result, purchase accounting treatment of the acquisition could decrease net income for ScanSoft in the foreseeable future, which could have a material and adverse effect on the market value of ScanSoft common stock. THE COMBINED COMPANY WILL BE MANAGED BY A MANAGEMENT TEAM CONSISTING OF CURRENT SCANSOFT AND FORMER SPEECHWORKS EXECUTIVES, AND THIS MANAGEMENT TEAM MAY UNDERTAKE A STRATEGY AND BUSINESS DIRECTION WHICH IS DIFFERENT FROM THAT WHICH WOULD BE UNDERTAKEN BY SCANSOFT'S CURRENT MANAGEMENT TEAM. The new management team of the combined company will consist of certain current ScanSoft and SpeechWorks executives. The manner in which the new management team conducts the business of the combined company, and the direction in which the new management team moves the business, may differ from the manner and direction in which the current management of either ScanSoft or SpeechWorks would direct the combined or separate companies on a stand-alone basis. Such control by the new management team, together with the effects of future market factors and conditions, could ultimately evolve into an integration and business strategy that, when implemented, differs from the strategy and business direction currently recommended by ScanSoft's or SpeechWorks' current respective management and board of directors. The new management team, and any change in business or direction, may not improve, and could adversely impact, the combined company's financial condition and results of operations. A LARGE PART OF OUR REVENUE IS DEPENDENT ON CONTINUED DEMAND FOR OUR PRODUCTS FROM OEM PARTNERS. A SIGNIFICANT REDUCTION IN OEM REVENUE WOULD SERIOUSLY HARM OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION AND STOCK PRICE. Many of our technologies are licensed to partners that incorporate our technologies into solutions that they sell to their customers. The commercial success of these licensed products depends to a substantial degree on the efforts of these licensees in developing and marketing products incorporating our technologies. The integration of our technologies into their products takes significant time, effort and investment, and products incorporating our technologies may not be successfully implemented or marketed by our licensees. OEM revenue represented 34% and 40% of our consolidated revenue for the year ended December 31, 2002 and for the nine months ended September 30, 2003, respectively. A select few of our OEM partners account for a majority of our OEM revenues. Our partners are not required to continue to bundle or embed our software, and they may choose the software products of our competitors 34 in addition to, or in place of, our products. A significant reduction in OEM revenue would seriously harm our business, results of operations, financial condition and our stock price. SPEECH TECHNOLOGIES MAY NOT ACHIEVE WIDESPREAD ACCEPTANCE BY BUSINESSES, WHICH COULD LIMIT OUR ABILITY TO GROW OUR SPEECH BUSINESS. The market for speech technologies is relatively new and rapidly evolving. Our ability to increase revenue in the future depends in large measure on acceptance by both our customers and the end users of speech technologies in general and our products in particular. The continued development of the market for our current and future speech solutions will also depend on the following factors: -- WIDESPREAD DEPLOYMENT AND ACCEPTANCE OF SPEECH TECHNOLOGIES; -- CONSUMER DEMAND FOR SPEECH-ENABLED APPLICATIONS; -- DEVELOPMENT BY THIRD-PARTY VENDORS OF APPLICATIONS USING SPEECH TECHNOLOGIES; AND -- CONTINUOUS IMPROVEMENT IN SPEECH TECHNOLOGY. Sales of our speech products would be harmed if the market for speech software does not continue to develop or develops more slowly than we expect, and, consequently, our business could be harmed. WE HAVE GROWN AND MAY CONTINUE TO GROW, THROUGH ACQUISITIONS, WHICH MAY RESULT IN SIGNIFICANT INTANGIBLE ASSETS, DILUTION OF OUR EXISTING STOCKHOLDERS, USE OF CASH AND OTHER RISKS. We have recently completed the purchase of certain businesses and intellectual property from Philips and completed the acquisition of SpeechWorks on August 11, 2003, and may acquire additional complementary assets, technologies or businesses in the future. Our past acquisitions have given rise to, and future acquisitions may result in, substantial levels of intangible assets that will be amortized or subject to impairment analyses in future years, and our future results will be adversely affected if we do not achieve benefits from these acquisitions commensurate with amortization and potential impairment charges. For example, our acquisition of Caere Corporation included a substantial write-off of acquired in-process research and development costs, and this also may occur as a result of other acquisitions. In connection with the Caere, the L&H and SpeechWorks acquisitions, we issued 19.0 million, 7.4 million and 32.5 million shares of our common stock respectively. We may continue to issue equity securities for future acquisitions and working capital purposes that could dilute our existing stockholders. In connection with the L&H acquisition, we issued a promissory note for $3.5 million. Under the terms of the Philips acquisition, we paid 3.1 million euros in cash at closing, subject to adjustment in accordance with the provisions of the purchase agreement, as amended, and agreed to pay an additional 1.0 million euros in cash prior to December 31, 2003, issued a 5.0 million euro note 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. Future acquisitions may also require us to expend significant funds or incur debt. If we expend funds or incur additional debt, our ability to obtain financing for working capital or other purposes could decrease. SALES OF OUR DOCUMENT AND PDF CONVERSION PRODUCTS AND OUR DIGITAL PAPER MANAGEMENT PRODUCTS REPRESENTED APPROXIMATELY 51% AND 40%, RESPECTIVELY, OF OUR REVENUE FOR THE YEAR ENDED DECEMBER 31, 2002 AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003. ANY REDUCTION IN REVENUE FROM THESE PRODUCT AREAS COULD SERIOUSLY HARM OUR BUSINESS. Historically, a few product areas have generated a substantial portion of our revenues. For the year ended December 31, 2002, our document and PDF conversion products represented approximately 39% of our revenue and our digital paper management products represented approximately 12% of our revenue. For the nine months ended September 30, 2003, our document and PDF conversion products represented approximately 26% of our revenue, and our digital paper management products represented approximately 14% of our revenue. A significant reduction in the revenue contribution from these product areas could seriously harm our business, results of operations, financial condition, cash flows and stock price. THE PROTECTION OF OUR PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY IS KEY TO OUR SUCCESS. We rely heavily on our proprietary technology, trade secrets and other intellectual property. Unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult and we may not be able to protect our technology from unauthorized use. Additionally, our competitors may independently develop technologies that are substantially the same or superior to ours. In addition, the laws of some foreign countries 35 do not protect our proprietary rights to the same extent as the laws of the United States. Although the source code for our proprietary software is protected both as a trade secret and as a copyrighted work, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation, regardless of the outcome, can be very expensive and can divert management efforts. THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE THAT WE ARE INFRINGING THEIR INTELLECTUAL PROPERTY. WE COULD BE EXPOSED TO SIGNIFICANT LITIGATION OR LICENSING EXPENSES OR BE PREVENTED FROM SELLING OUR PRODUCTS IF SUCH CLAIMS ARE SUCCESSFUL. Like other technology companies, from time to time, we are subject to claims that we or our customers may be infringing or contributing to the infringement of the intellectual property rights of others. We may be unaware of intellectual property rights of others that may cover some of our technologies and products. If it appears necessary or desirable, we may seek licenses for these intellectual property rights. However, we may not be able to obtain licenses from some or all claimants, the terms of any offered licenses may not be acceptable to us, and we may not be able to resolve disputes without litigation. Any litigation regarding intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. In the event of a claim of intellectual property infringement, we may be required to enter into costly royalty or license agreements. Third parties claiming intellectual property infringement may be able to obtain injunctive or other equitable relief that could effectively block our ability to develop and sell our products. On July 15, 2003, Elliott 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. We filed an answer and CounterClaim to Davis's Complaint on August 25, 2003. We believe Davis's claim has no merit, and we intend to defend the action vigorously. On November 27, 2002, AllVoice Computing plc filed an action against us in the United States District Court for the Southern District of Texas claiming patent infringement. Damages are sought in an unspecified amount. We filed an Answer on December 23, 2002. We believe this claim has no merit and we intend to defend the action vigorously. On December 28, 2001, we were sued for patent infringement initiated by the Massachusetts Institute of Technology and Electronics For Imaging, Inc. We were one of more than 200 defendants named in this suit. Damages are sought in an unspecified amount. We filed an Answer and Counterclaim on June 28, 2002. We believe this claim has no merit and we intend to defend the action vigorously. On August 16, 2001, we were sued by Horst Froessl for patent infringement. Damages are sought in an unspecified amount. We filed an Answer and Counterclaim on September 19, 2001. We believe this claim has no merit and we intend to defend the action vigorously. We believe that the final outcome of the current litigation matters described above will not have a significant adverse effect on our financial position and results of operations and we believe that we will not be required to expend a significant amount of resources defending such claims. However, should we not prevail in these litigation matters or if we are required to expend a significant amount of resources defending such claims, our operating results, financial position and cash flows could be adversely impacted. If any third parties are successful in intellectual property infringement claims against us, we may be subject to significant damages or injunctions and our operating results and financial position could be harmed. THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE AND RAPIDLY CHANGING. WE MAY BE UNABLE TO COMPETE SUCCESSFULLY AGAINST NEW ENTRANTS AND ESTABLISHED COMPANIES WITH GREATER RESOURCES. There are a number of companies that develop or may develop products that compete in our targeted markets; however, there is no one company that competes with us in all of our product areas. The individual markets in which we compete are highly competitive, and are rapidly changing. Within digital capture, we compete directly with ABBYY, I.R.I.S. and NewSoft. Within speech, we compete with AT&T, IBM and Nuance Communications. Vendors such as Adobe and Microsoft offer solutions that can be considered alternatives to some of our solutions. In addition, a number of smaller companies produce technologies or products that are in some markets competitive with our solutions. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of our prospective customers. The competition in these markets could adversely affect our operating results by reducing the volume of the products we sell or the prices we can charge. Some of our current or potential competitors have significantly greater financial, technical and marketing 36 resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do. The price and performance of our products and technologies may not be superior relative to the products of our competitors. As a result, we may lose competitive position that could result in lower prices, fewer customer orders, reduced revenue, reduced gross margins and loss of market share. Our products and technologies may not achieve market acceptance or sell at favorable prices, which could hurt our revenue, results of operations and the price of our common stock. Some of our customers, such as Microsoft, have developed or acquired products or technologies that compete with our products and technologies. These customers may give higher priority to the sale of these competitive products or technologies. To the extent they do so, market acceptance and penetration of our products, and therefore our revenue, may be adversely affected. Our success will depend substantially upon our ability to enhance our products and technologies and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and incorporate technological advancements. If we are unable to develop new products and enhance functionalities or technologies to adapt to these changes, or are unable to realize synergies among our acquired products and technologies, our business will suffer. OUR SOFTWARE PRODUCTS MAY HAVE BUGS, WHICH COULD RESULT IN DELAYED OR LOST REVENUE, EXPENSIVE CORRECTION, LIABILITY TO OUR CLIENTS AND CLAIMS AGAINST US. Complex software products such as ours may contain errors, defects or bugs. Defects in the solutions or products that we develop and sell to our customers could require expensive corrections and result in delayed or lost revenue, adverse client reaction and negative publicity about us or our products and services. Customers who are not satisfied with any of our products could bring claims against us for damages, which, even if unsuccessful, would likely be time-consuming to defend, and could result in costly litigation and payment of damages. Such claims could harm our financial results and competitive position. WE RELY ON A SMALL NUMBER OF DISTRIBUTION AND FULFILLMENT PARTNERS, INCLUDING 1450, DIGITAL RIVER, INGRAM MICRO AND TECH DATA, TO DISTRIBUTE MANY OF OUR PRODUCTS. ANY DISRUPTION IN THESE CHANNELS COULD HARM OUR RESULTS OF OPERATIONS. Our products are sold through, and a substantial portion of our revenue is derived from, a network of over 2000 channel partners, including value-added resellers, computer superstores, consumer electronic stores, mail order houses, office superstores and eCommerce Web sites. We rely on a small number of distribution and fulfillment partners, including 1450, Digital River, Ingram Micro and Tech Data to serve this network of channel partners. For the year ended December 31, 2002, two distribution and fulfillment partners, Ingram Micro and Digital River, accounted for 25% and 17% of our consolidated revenue, respectively. During the nine-month period ended September 30, 2003, Ingram Micro and Digital River accounted for 18% and 13% of our consolidated revenue, respectively. A disruption in these distribution and fulfillment partner relationships could negatively affect our results of operations in the short term. Any disruption for which we are unable to compensate could have a more sustained impact on our results of operations. A SIGNIFICANT PORTION OF OUR ACCOUNTS RECEIVABLE IS CONCENTRATED AMONG OUR THREE LARGEST DISTRIBUTION AND FULFILLMENT PARTNERS, INGRAM MICRO, INC., TECH DATA CORPORATION, AND DIGITAL RIVER, INC. Our products are sold through, and a substantial portion of our accounts receivable is derived from, three distribution and fulfillment partners. At September 30, 2003, Ingram Micro, Tech Data and Digital River represented 16%, 5% and 3% of our net accounts receivable, respectively. At December 31, 2002, Ingram Micro, Tech Data and Digital River represented 16%, 11% and 9%, of our net accounts receivable, respectively. In addition, although we perform ongoing credit evaluations of our distribution and fulfillment partners' financial condition and maintain reserves for potential credit losses, we do not require collateral. While, to date, such losses have been within our expectations, we cannot assure you that these actions will be sufficient to meet future contingencies. If any of these distribution and fulfillment partners were unable to pay us in a timely fashion or if we were to experience significant credit losses in excess of our reserves, our results of operations, cash flows and financial condition would be seriously harmed. A SIGNIFICANT PORTION OF OUR REVENUE IS DERIVED FROM SALES IN EUROPE AND ASIA. OUR RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER RISKS ASSOCIATED WITH THESE AND OTHER INTERNATIONAL REGIONS. Since we sell our products worldwide, our business is subject to risks associated with doing business internationally. We anticipate that revenue from international operations will represent an increasing portion of our total revenue. Reported international revenue for both the year ended December 31, 2002 and nine months ended September 30, 2003 represented 27% of our consolidated revenue. Most of these international revenues are produced by sales in Europe and Asia. A number of our OEM partners distribute their products throughout the world and do not provide us with the geographical dispersion of their products. However, based on an estimate that factors our OEM partners' geographical revenue mix to our revenue generated from these OEM partners, international revenue would have represented approximately 33% and 35% of our consolidated revenue for the year ended December 31, 2002 and nine months ended September 30, 2003, respectively. 37 Therefore, in addition to risks to our business based on a potential downturn in the world economy, a region-specific downturn affecting countries in Western Europe and/or Asia could have a negative effect on our future results of operations. In addition, some of our products are developed and manufactured outside the United States. A significant portion of the development and manufacturing of our speech products are completed in Belgium, and a significant portion of our digital capture research and development is conducted in Hungary. In addition, in connection with the Philips acquisition, we have added an additional research and development location in Germany. Our future results could be harmed by a variety of factors associated with international sales and operations, including: -- CHANGES IN A SPECIFIC COUNTRY'S OR REGION'S POLITICAL OR ECONOMIC CONDITIONS; -- TRADE PROTECTION MEASURES AND IMPORT OR EXPORT LICENSING REQUIREMENTS IMPOSED BY THE UNITED STATES OR BY OTHER COUNTRIES; -- NEGATIVE CONSEQUENCES FROM CHANGES IN APPLICABLE TAX LAWS; -- DIFFICULTIES IN STAFFING AND MANAGING OPERATIONS IN MULTIPLE LOCATIONS IN MANY COUNTRIES; -- DIFFICULTIES IN COLLECTING TRADE ACCOUNTS RECEIVABLE IN OTHER COUNTRIES; AND -- LESS EFFECTIVE PROTECTION OF INTELLECTUAL PROPERTY. WE ARE EXPOSED TO FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES. Because we have international subsidiaries and distributors that operate and sell our products outside the United States, we are exposed to the risk of changes in foreign currency exchange rates or declining economic conditions in these countries. We generally do not engage in hedging transactions to manage our exposure to currency fluctuations. However, in connection with the Philips acquisition on January 30, 2003, we entered into a forward hedge in the amount of $5.3 million to meet our obligation to pay the 5.0 million euro promissory note (Philips Note) issued as part of the acquisition. On August 26, 2003, we entered into a forward exchange contract to hedge the foreign currency exposure of its 1.0 million euro note payable to Philips. Our exposure to currency rate fluctuations could affect our results of operations and cash flows. IF WE ARE UNABLE TO ATTRACT AND RETAIN TECHNICAL AND OPERATIONAL PERSONNEL, OUR BUSINESS COULD BE HARMED. If any of our key employees were to leave us, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any successor obtains the necessary training and experience. Our employment relationships are generally at-will and we have had key employees leave us in the past. We cannot assure you that one or more key employees will not leave us in the future. We intend to continue to hire additional highly qualified personnel, including software engineers and operational personnel, but we may not be able to attract, assimilate or retain qualified personnel in the future. Any failure to attract, integrate, motivate and retain these employees could harm our business. THE STOCKHOLDINGS OF OUR TWO LARGEST STOCKHOLDERS MAY ENABLE THEM TO INFLUENCE MATTERS REQUIRING STOCKHOLDER APPROVAL. As of September 30, 2003, Xerox beneficially owned approximately 15.4% of our outstanding common stock, including warrants exercisable for up to 525,732 shares of our common stock and 3,562,238 shares of our outstanding Series B Preferred Stock, each of which is convertible into one share of our common stock. The number of shares of common stock issuable upon exercise of the Xerox warrant may increase in accordance with a formula defined in the warrant agreement. The State of Wisconsin Investment Board (SWIB) is our second largest stockholder, owning approximately 11.5% of our common stock as of September 30, 2003. Because of their large holdings of our capital stock relative to other stockholders, Xerox and SWIB, acting individually or together, could have a strong influence over matters requiring approval by our stockholders. THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE SUBJECT TO WIDE FLUCTUATIONS. Our stock price historically has been and may continue to be volatile. Various factors contribute to the volatility of our stock price, including, for example, quarterly variations in our financial results, new product introductions by us or our competitors and general economic and market conditions. While we cannot predict the individual effect that these factors may have on the market price of our common stock, these factors, either individually or in the aggregate, could result in significant volatility in our stock price during any given period of time. Moreover, companies that have experienced volatility in the market price of their stock 38 often are subject to securities class action litigation. If we were the subject of such litigation, it could result in substantial costs and divert management's attention and resources. WE HAVE IMPLEMENTED ANTI-TAKEOVER PROVISIONS, WHICH COULD DISCOURAGE OR PREVENT A TAKEOVER, EVEN IF AN ACQUISITION WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Provisions of our amended and restated certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include: -- A PREFERRED SHARES RIGHTS AGREEMENT; -- AUTHORIZED "BLANK CHECK" PREFERRED STOCK; -- PROHIBITING CUMULATIVE VOTING IN THE ELECTION OF DIRECTORS; -- LIMITING THE ABILITY OF STOCKHOLDERS TO CALL SPECIAL MEETINGS OF STOCKHOLDERS; -- REQUIRING ALL STOCKHOLDER ACTIONS TO BE TAKEN AT MEETINGS OF OUR STOCKHOLDERS; AND -- ESTABLISHING ADVANCE NOTICE REQUIREMENTS FOR NOMINATIONS OF DIRECTORS AND FOR STOCKHOLDER PROPOSALS. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOREIGN CURRENCY RISK The Company faces exposure to adverse movements in foreign currency exchange rates, as a significant portion of its revenues, expenses, assets, and liabilities are denominated in currencies other than the U.S. Dollar, primarily the Euro Dollar. These exposures may change over time as business practices evolve. The Company evaluates its foreign currency exposures on an ongoing basis and makes adjustments to its foreign currency risk management program as circumstances change. In certain instances, 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. The success of the Company's foreign currency risk management program depends upon the ability of the forward exchange contracts to offset the foreign currency risk associated with the hedged transaction. To the extent that the amount or duration of the forward exchange contract and hedged transaction vary, the Company could experience unanticipated foreign currency gains or losses that could have a material impact on the Company's results of operations. In January 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. A forward exchange contract to exchange a total of $5.3 million for 5.0 million Euros with a weighted-average settlement price of 1.0636 Euro/USD, with an original term of 11 months, was outstanding at September 30, 2003. In August 2003, the Company entered into a forward exchange contract to hedge the foreign currency exposure of its 1.0 million euro note payable to Philips. A forward exchange contract to exchange a total of $1.1 million for 1.0 million Euros with a weighted-average settlement price of 1.0820 Euro/USD, with an original term of 4 months, was outstanding at September 30, 2003. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, except as provided below, our disclosure controls and procedures as of the end of the period covered by this report were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Subsequent to the end of the third quarter of 2003, we determined that a deferred tax provision was required in the first two quarters of 2003 to appropriately account for goodwill that was created as a result of taxable acquisitions. As a result, we have restated our results by increasing our tax provision by $250,000 for the first quarter of 2003 and $304,000 for the second quarter of 2003. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the 39 objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Changes in internal controls. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Subsequent to the end of the third quarter of 2003, we adopted additional controls and procedures related to accounting for income taxes associated with acquisitions including involvement of our tax personnel in the financial reporting process. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS This information is included in Note 17 ("Commitments and Contingencies") of the Notes to the Unaudited Consolidated Financial Statements, which information is incorporated herein by reference from Item 1 of Part I hereof. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On August 11, 2003 the Company held a Special Meeting of its stockholders. At such meeting, the following actions were voted upon: (a) To approve the issuance of shares of ScanSoft common stock in connection with a merger of Spiderman Acquisition Corporation, a wholly-owned subsidiary of the Company, with and into SpeechWorks International, Inc. - -------------------------------------------------------------------------- VOTES FOR VOTES AGAINST ABSTAINED BROKER NON-VOTES - -------------------------------------------------------------------------- 37,724,407 1,092,688 121,023 20,669,112 - -------------------------------------------------------------------------- (b) To approve the amendment of the Company's 1995 Employee Stock Purchase Plan to increase the number of shares of ScanSoft common stock reserved for issuance under the plan from 1,000,000 to 1,500,000. - ---------------------------------------------------- VOTES FOR VOTES AGAINST ABSTAINED - ---------------------------------------------------- 56,852,697 2,579,417 175,116 - ---------------------------------------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibits listed on the Exhibit Index hereto are filed or incorporated by reference (as stated therein) as part of this report on Form 10-Q. (b) Reports on Form 8-K On August 22, 2003, ScanSoft filed a report on Form 8-K reporting under Item 2 the acquisition of SpeechWorks International, Inc. 40 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Peabody, State of Massachusetts, on November 14, 2003. SCANSOFT, INC. By: /s/ David A. Gerth ----------------------------- David A. Gerth Chief Financial Officer 41 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------ ----------------------------------------------------------------- 2.1(1) Agreement and Plan of Reorganization, dated as of April 23, 2003, by and among the Registrant, Spiderman Acquisition Corporation and SpeechWorks International, Inc. 3.1(2) Amended and Restated Certificate of Incorporation of the Registrant. 3.2(3) Amended and Restated Bylaws of the Registrant. 10.1** Employment Agreement, dated August 11, 2003, by and between the Registrant and Paul A. Ricci. 10.2** Letter, dated May 23, 2003, from the Registrant to David A. Gerth regarding certain employment matters. 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a). 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a). 32.1 Certification Pursuant to 18 U.S.C. Section 1350. - ---------- ** Denotes Management compensatory plan or arrangement. (1) Incorporated by reference from the Registrant's Registration Statement on Form S-4 (No. 33-106184) filed with the Commission on June 17, 2003. (2) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2001, filed with the Commission on May 11, 2001. (3) Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003, filed with the Commission on May 15, 2003. 42 EX-10.1 3 b48103ssexv10w1.txt EMPLOYMENT AGREEMENT - RICCI Exhibit 10.1 CONFORMED TO ORIGINAL SIGNED 8/11/03 SCANSOFT, INC. EMPLOYMENT AGREEMENT This Agreement is made by and between ScanSoft, Inc. (along with its successors and assigns, the "Company") and Paul A. Ricci (the "Executive") as of August 11, 2003 (the "Effective Date"). 1. Duties and Scope of Employment. (a) Positions and Duties. Executive will serve as Chairman of the Board and Chief Executive Officer of the Company. Executive will render such business and professional services in the performance of Executive's duties, consistent with Executive's position within the Company, as shall reasonably be assigned to him by the Company's Board of Directors (the "Board"). (b) Board Membership. During the Employment Term (as defined below), Executive will serve as the Chairman of the Board, subject to any required stockholder approval. (c) Obligations. During the Employment Term, Executive will devote Executive's full business efforts and time to the Company. For the duration of the Employment Term, Executive agrees not to actively engage in any other employment, occupation or consulting activity for any direct or indirect remuneration without the prior approval of the Board of Directors of the Company, which approval will not be unreasonably withheld; provided, however, that Executive may, without the approval of the Board, serve in any capacity with any civic, educational or charitable organization, or as a member of corporate Boards of Directors (but in all cases subject to Executive's compliance with the terms of the Confidential Information Agreement). 2. Employment Term. Subject to earlier termination as provided for below, the Company will employ Executive for an initial term of three (3) years commencing on the Effective Date. The term of employment hereunder shall automatically extend for successive additional terms of one (1) year each (each, a "Successive One-Year Term") unless, at least forty-five (45) days prior to the end of the initial three (3) year term or any Successive One-Year Term, the Company or Executive gives written notice of intent to terminate this Agreement (a "Notice of Non-Renewal"). The term of employment under this Agreement shall include the initial three (3) year period and any extension thereof (the "Employment Term"). If Executive terminates employment as a result of the receipt of a Notice of Non-Renewal from the Company, Executive shall be entitled to the payments and benefits under Section 4(a) of this Agreement. Notwithstanding the foregoing, Executive and the Company acknowledge that this employment relationship may be terminated at any time prior to the expiration of the Employment Term, upon ninety (90) days written notice to the other party, with or without CONFORMED TO ORIGINAL SIGNED 8/11/03 good cause or for any or no cause, at the option either of the Board or Executive and that in the event the Company or Executive terminate Executive's employment with the Company prior to the end of the Employment Term, Executive only will be entitled to those payments and benefits, if any, provided for in Section 4 of this Agreement. 3. Compensation. (a) Base Salary. The Company will pay Executive as compensation for Executive's services a base salary at the annualized rate of $300,000 through December 31, 2003 and $400,000 beginning on January 1, 2004 (respectively, the "Base Salary"). On July 1, 2005 and each anniversary thereafter, the Base Salary will increase by at least $25,000. The Base Salary will be paid through payroll periods that are consistent with the Company's normal payroll practices and will be subject to the usual, required withholding. (b) Performance Bonus. For the 2003 fiscal year of the Company, Executive will be eligible to receive a target bonus of up to fifty percent (50%) of Executive's Base Salary in 2003 based upon the achievement of performance criteria established by the Compensation Committee of the Board, after consultation with Executive. For each fiscal year of the Company following its 2003 fiscal year, Executive will be eligible to receive a target bonus of up to one-hundred percent (100%) of Executive's then Base Salary based upon the achievement of performance criteria established within four (4) months of the start of the applicable bonus period by the Compensation Committee of the Board, after consultation with Executive. The performance standards will be based on the Company's achievement of revenue and diluted earnings per share ("EPS"). The actual percentage of Base Salary payable as a bonus for any year will depend upon the extent to which the applicable performance criteria have been achieved. Any bonus that actually is earned will be paid as soon as practicable (but no later than 2-1/2 months) after the end of the fiscal year for which the bonus is earned, but only if Executive was employed with the Company through the end of such fiscal year. (c) Restricted Stock. At the next meeting of the Board following the Effective Date, Executive will be issued three hundred thousand (300,000) shares of common stock of the Company at a per share purchase price equal to the par value of the Company's common stock (the "Restricted Stock"). The Restricted Stock will vest as to 1/3 of the shares of Restricted Stock at the end of each twelve-month period following the date of grant. Except as otherwise specified herein, in the event that Executive's employment with the Company terminates, any unvested shares of Restricted Stock shall be forfeited and revert to the Company. The grant of the Restricted Stock shall be represented by, and subject to, the terms of a restricted stock agreement to be prepared in accordance with the terms herein. (d) Stock Options. For each fiscal year of the Company during the Employment Term, Executive will be eligible to receive a stock option grant to acquire shares of the Company's common stock. The number of shares subject to each stock option grant, if any, for each fiscal year will be based on Executive's performance as assessed by the Compensation Committee of the Board. The terms and conditions of any stock options granted to Executive hereunder (including vesting restrictions) will be established by the Compensation Committee of the Board; provided, that CONFORMED TO ORIGINAL SIGNED 8/11/03 Executive will have the right to exercise the vested shares subject to any stock options that are granted after the Effective Date during the term of the applicable stock option whether or not Executive remains employed with the Company through such term. (e) Living Expenses. During the Employment Term, Executive will receive semi-monthly living expense bonuses equal to $4,458, which will be subject to the usual, required withholding and subject to Executive's continued employment with the Company through the applicable semi-monthly payment date. (f) Professional Services. During the Employment Term, the Company will reimburse Executive for reasonable professional services expenses incurred by Executive for tax, financial and/or estate planning. The Company will reimburse Executive only for expenses that do not exceed $20,000 per calendar year. (g) Employee Benefits. During the Employment Term, Executive will be entitled to participate in the employee benefit plans currently and hereafter maintained by the Company of general applicability to other senior executives of the Company, including, without limitation, the Company's group medical, dental, vision, disability, life insurance, and flexible-spending account plans. The Company reserves the right to cancel or change the benefit plans and programs it offers to its employees at any time. 4. Severance. Upon termination of employment for any reason, Executive shall receive payment of (a) his Base Salary, as then in effect, through the date of termination of employment, and (b) all accrued vacation, expense reimbursements and any other benefits (other than severance benefits, except as provided below) due to Executive through the date of termination of employment in accordance with established Company plans and policies or applicable law (the "Accrued Obligations"). In addition, the following will apply: (a) Involuntary Termination other than for Cause, Death or Disability. If Executive's employment with the Company is terminated for a reason other than (i) Cause (as defined below), (ii) Executive becoming Disabled (as defined below) or (iii) Executive's death, or if the Executive terminates his employment with the Company for Good Reason, then, subject to Executive's compliance with the provisions in Section 4(e), Executive will be entitled to: (i) continuing payments of Executive's Base Salary, as then in effect but no less than a Base Salary of $400,000, during the Severance Period, to be paid periodically in accordance with the Company's normal payroll policies and subject to the usual, required withholding; (ii) continued payment by the Company of the group medical, dental and vision continuation coverage premiums for Executive and Executive's eligible dependents under Title X of the Consolidated Budget Reconciliation Act of 1985, as amended ("COBRA") during the Severance Period under the Company's group health plans, as then in effect; (iii) immediately fully vest on the termination date in Executive's stock options and unvested Restricted Stock; and (iv) exercise Executive's outstanding stock options until the end of the term of the applicable stock option. CONFORMED TO ORIGINAL SIGNED 8/11/03 (b) Termination due to Death or Disability. If the Executive's employment with the Company is terminated due to his death or his becoming Disabled, then Executive or Executive's estate (as the case may be) will (i) receive the Base Salary through the date of termination of employment, (ii) be entitled to immediate 100% of any Company stock options or Restricted Stock held by the Executive that were unvested immediately prior to his termination of employment, (iii) receive Company-paid coverage for a period of two (2) years for Executive (if applicable) and Executive's eligible dependents under the Company's health benefit plans (or, at the Company's option, coverage under a separate plan), providing benefits that are no less favorable than those provided under the Company's plans immediately prior to Executive's death, (iv) receive all accrued vacation, expense reimbursements and any other benefits due to Executive through the date of termination of employment in accordance with Company-provided or paid plans and policies, and (v) not be entitled to any other compensation or benefits from the Company except to the extent required by law (for example, under Section 4980B of the Code). (c) Change of Control Benefits. If, within six (6) months following a Change of Control, Executive's employment with the Company is terminated for a reason other than (i) Cause, (ii) Executive becoming Disabled or (iii) Executive's death, or if the Executive terminates his employment with the Company for Good Reason, then, subject to Executive's compliance with the provisions in Section 4(e), Executive will be entitled to the severance payments and benefits set forth in Section 4(a). (d) Other Termination. If the Executive terminates employment with the Company other than for Good Reason (as defined), or if Executive's employment with the Company is terminated for Cause, then Executive will receive payment of the Accrued Obligations but he shall not be entitled to any other compensation or benefits (including, without limitation, accelerated vesting of stock options and unvested Restricted Stock) from the Company, except to the extent provided under the applicable stock option agreement(s), Company benefit plans or as may be required by law (for example, under COBRA). (e) Conditions to Receive Severance Package. Except for the Accrued Obligations, the applicable provisions of the Option Plan and Option Agreement, and other payments to which Executive may be entitled by law, the severance payments, continued benefits, continued vesting, vesting acceleration and the ability to exercise stock options described in this Section 4 will be provided to Executive if the following conditions are satisfied: (i) Executive complies with all surviving provisions of the Confidential Information Agreement and any confidentiality or proprietary rights agreement signed by Executive; and (ii) Executive executes and delivers to the Company, and does not revoke, a full general release, in a form acceptable to the Company, releasing all claims, known or unknown, that Executive may have against the Company, and any subsidiary or related entity, their officers, directors, employees and agents, arising out of or any way related to Executive's employment or termination of employment with the Company. (f) Cause. For purposes of this Agreement, "Cause" means Executive's employment with the Company is terminated after a majority of the Board has found any of the following to exist: (i) Executive's theft, dishonesty that materially harms the Company or falsification of any Company records; (ii) disclosure of the Company's confidential or proprietary information which violates the terms of the Confidential Information Agreement; (iii) Executive's continued substantial willful nonperformance (except by reason of Disability) of his employment duties after Executive has received a written demand for performance by the Board and has failed to cure such nonperformance within 15 business days of receiving such notice; or (iv) Executive's conviction of, or plea of nolo contendere to, a felony which such conviction or plea materially harms the business or reputation of the Company. (g) Change of Control. For the purposes of this Agreement, a "Change of Control" means: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) becomes the "beneficial owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 50% or more of the total voting power represented by the Company's then outstanding voting securities; or (ii) a change in the composition of the Board occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors ("Incumbent Directors" will mean directors who either (A) are members of the Board as of the Effective Date, or (B) are elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the Board at the time of such election or nomination (but will not include an individual whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company)); or (iii) the date of the consummation of a merger or consolidation of the Company with any other corporation that has been approved by the stockholders of the Company, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation; or (iv) the date of the consummation of the sale or disposition by the Company of all or substantially all the Company's assets. (h) Disabled. For purposes of this Agreement, "Disabled" means Executive being unable to perform the principal functions of his duties due to a physical or mental impairment, but only if such inability has lasted or is reasonably expected to last for at least six months. Whether Executive is Disabled will be determined by the Board based on evidence provided by one or more physicians selected by the Board. (i) Good Reason. For purposes of this Agreement, "Good Reason" means (i) without the Executive's consent, a significant reduction of the Executive's duties, position, reporting status, or responsibilities relative to the Executive's duties, position, reporting status, or responsibilities in effect immediately prior to such reduction, or the removal of the Executive from such position, duties and responsibilities or change in reporting status, unless the Executive is provided with comparable duties, position and responsibilities or reporting status; provided, however, that a reduction in duties, position, reporting status or responsibilities solely by virtue of the Company being acquired and made part of a larger entity will not constitute "Good Reason" to the extent CONFORMED TO ORIGINAL SIGNED 8/11/03 Executive remains in a comparable position with a division or subsidiary of the acquiror, which division or subsidiary conducts substantially the same core operations, business and activities as were conducted by the Company prior to any such acquisition or similar corporate transaction; (ii) without the Executive's consent, a substantial reduction, by the Board of the Executive's Base Salary as in effect immediately prior to such reduction (unless such reduction is part of an overall Company effort that effects similarly situated senior executives of the Company); (iii) without the Executive's consent, the requirement that Executive relocate his principal place of employment more than fifty (50) miles from the current location of the Company's principal executive offices; (iv) a material breach by the Company of this Agreement; and (iv) failure of Executive to be nominated as a Board member. (j) Severance Period. For purposes of this Agreement, "Severance Period" means the period beginning on the date of Executive's termination of employment with the Company and ending on the date eighteen (18) months later. 5. Confidential Information. Executive agrees to continue to comply with any agreement Executive has entered into with the Company regarding confidential information and/or invention assignment (the "Confidential Information Agreement"). 6. Assignment. This Agreement will be binding upon and inure to the benefit of (a) the heirs, executors and legal representatives of Executive upon Executive's death and (b) any successor of the Company. Any such successor of the Company will be deemed substituted for the Company under the terms of this Agreement for all purposes. For this purpose, "successor" means any person, firm, corporation or other business entity which at any time, whether by purchase, merger or otherwise, directly or indirectly acquires all or substantially all of the assets or business of the Company. None of the rights of Executive to receive any form of compensation payable pursuant to this Agreement may be assigned or transferred except by will or the laws of descent and distribution. Any other attempted assignment, transfer, conveyance or other disposition of Executive's right to compensation or other benefits will be null and void. 7. Notices. All notices, requests, demands and other communications called for hereunder will be in writing and will be deemed given (i) on the date of delivery if delivered personally, (ii) one (1) day after being sent by a well established commercial overnight service, or (iii) four (4) days after being mailed by registered or certified mail, return receipt requested, prepaid and addressed to the parties or their successors at the following addresses, or at such other addresses as the parties may later designate in writing: If to the Company: ScanSoft, Inc. 9 Centennial Drive Peabody, MA 01960 Attn: Chief Financial Officer CONFORMED TO ORIGINAL SIGNED 8/11/03 If to Executive: at the last residential address known by the Company. 8. Severability. In the event that any provision hereof becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement will continue in full force and effect without said provision. 9. Original Agreement. Executive previously entered into an employment agreement with the Company on August 21, 2000 (the "Original Agreement") and Amendment No. 1 to the employment agreement dated July 26, 2001. Executive and the Company agree that this Agreement will supersede and replace the Original Agreement and Amendments to the Original Agreement in its entirety. 10. Non-Competition, Non-Solicitation and Non-Disparagement. For a period beginning on the Effective Date and ending one year after the Executive ceases to be employed by the Company, Executive, directly or indirectly, whether as employee, owner, sole proprietor, partner, director, member, consultant, agent, founder, co-venturer or otherwise, will: (i) not engage, participate or invest in any business activity anywhere in the United States that is directly competitive with the principal markets, products and services of the Company at the time of Executive's termination; provided, however, that it will not be a violation of this Section 10 for Executive to own (as a passive investment): (A) not more than two percent of any class of publicly traded securities of any entity or (B) not more than five percent of any class of non-publicly traded securities of any entity; (ii) not solicit, induce or influence any person to leave employment with the Company; (iii) not directly or indirectly solicit business from any of the Company's customers and users on behalf of any business that directly competes with the principal business of the Company. In addition, following the date Executive ceases to be employed by the Company, Executive will not disparage in any way the Company, its officers, directors, employees, investors, shareholders, administrators, affiliates, divisions, subsidiaries, predecessor or successor corporations, or assigns, and will refrain from any defamation, libel or slander of any of those parties, and any tortious interference with the contracts, relationships and prospective economic advantage of any of those parties. 11. Entire Agreement. This Agreement, together with the Confidentiality Agreement, represents the entire agreement and understanding between the Company and Executive concerning the subject matter herein and Executive's employment relationship with the Company, and supersedes and replaces any and all prior or contemporaneous agreements and understandings whether written or oral between the Executive and the Company. 12. Arbitration and Equitable Relief. (a) Except as provided in Section 12(d) below, Executive and the Company agree that to the extent permitted by law, any dispute or controversy arising out of, relating to, or in connection with this Agreement, or the interpretation, validity, construction, performance, breach, or termination thereof will be settled by arbitration to be held at a location within 30 miles of the Company's CONFORMED TO ORIGINAL SIGNED 8/11/03 principal executive offices in Massachusetts, in accordance with the National Rules for the Resolution of Employment Disputes then in effect of the American Arbitration Association (the "Rules"). The arbitrator may grant injunctions or other relief in such dispute or controversy. The decision of the arbitrator will be final, conclusive and binding on the parties to the arbitration. Judgment may be entered on the arbitrator's decision in any court having jurisdiction. (b) The arbitrator will apply Massachusetts law to the merits of any dispute or claim, without reference to rules of conflict of law. Executive hereby expressly consents to the personal jurisdiction of the state and federal courts located in Massachusetts for any action or proceeding arising from or relating to this Agreement and/or relating to any arbitration in which the parties are participants. (c) The Company will pay the direct costs and expenses of the arbitration. The Company and Executive each will separately pay its counsel fees and expenses; provided, however, the Company shall reimburse Executive for his reasonable costs (including without limitation attorneys' fees) incurred if Executive succeeds on the merits with respect to a material breach of this Agreement at any such arbitration, including enforcing any judgment entered on an arbitrator's decision. (d) The Company may apply to any court of competent jurisdiction for a temporary restraining order, preliminary injunction, or other interim or conservatory relief, as necessary to enforce the provisions of the confidential information and trade secrets agreement between Executive and the Company, without breach of this arbitration agreement and without abridgement of the powers of the arbitrator. (e) EMPLOYEE HAS READ AND UNDERSTANDS SECTION 12, WHICH DISCUSSES ARBITRATION. EMPLOYEE UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, EMPLOYEE AGREES TO THE EXTENT PERMITTED BY LAW, TO SUBMIT ANY FUTURE CLAIMS ARISING OUT OF, RELATING TO, OR IN CONNECTION WITH THIS AGREEMENT, OR THE INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE, BREACH, OR TERMINATION THEREOF TO BINDING ARBITRATION, AND THAT THIS ARBITRATION CLAUSE CONSTITUTES A WAIVER OF EMPLOYEE'S RIGHT TO A JURY TRIAL AND RELATES TO THE RESOLUTION OF ALL DISPUTES RELATING TO ALL ASPECTS OF THE EMPLOYER/EMPLOYEE RELATIONSHIP, INCLUDING BUT NOT LIMITED TO, THE FOLLOWING CLAIMS: (i) ANY AND ALL CLAIMS FOR WRONGFUL DISCHARGE OF EMPLOYMENT; BREACH OF CONTRACT, BOTH EXPRESS AND IMPLIED; BREACH OF THE COVENANT OF GOOD FAITH AND FAIR DEALING, BOTH EXPRESS AND IMPLIED; NEGLIGENT OR INTENTIONAL INFLICTION OF EMOTIONAL DISTRESS; NEGLIGENT OR INTENTIONAL MISREPRESENTATION; NEGLIGENT OR INTENTIONAL INTERFERENCE WITH CONTRACT OR PROSPECTIVE ECONOMIC ADVANTAGE; AND DEFAMATION; CONFORMED TO ORIGINAL SIGNED 8/11/03 (ii) ANY AND ALL CLAIMS FOR VIOLATION OF ANY FEDERAL STATE OR MUNICIPAL STATUTE, INCLUDING, BUT NOT LIMITED TO, THE AMERICANS WITH DISABILITIES ACT OF 1990, THE FAIR LABOR STANDARDS ACT, AND ANY LAW OF THE STATE OF CALIFORNIA; AND (iii) ANY AND ALL CLAIMS ARISING OUT OF ANY OTHER LAWS AND REGULATIONS RELATING TO EMPLOYMENT OR EMPLOYMENT DISCRIMINATION. 13. No Oral Modification, Cancellation or Discharge. This Agreement may be changed or terminated only in writing (signed by Executive and the Company). 14. Withholding. The Company is authorized to withhold, or cause to be withheld, from any payment or benefit under this Agreement the full amount of any applicable withholding taxes. 15. Governing Law. This Agreement will be governed by the laws of the Commonwealth of Massachusetts (with the exception of its conflict of laws provisions). 16. Acknowledgment. Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement. 17. Attorneys' Fees. Executive shall be reimbursed his reasonable attorneys' fees incurred with respect to the negotiation of this Agreement. {Signature Pages to Follow} CONFORMED TO ORIGINAL SIGNED 8/11/03 IN WITNESS WHEREOF, the undersigned have executed this Agreement on the respective dates set forth below: EXECUTIVE /s/ Paul A. Ricci Date: As of 8/11/03 ------------------------------------- Paul A. Ricci Chairman and Chief Executive Officer COMPANY /s/ Robert G. Teresi Date: As of 8/11/03 ------------------------------------ Member of the Board -10- EX-10.2 4 b48103ssexv10w2.txt EMPLOYMENT AGREEMENT-GERTH Exhibit 10.2 [LOGO ScanSoft(TM)] May 23, 2003 David Gerth Dear David, Congratulations! It is with great pleasure that I confirm our employment offer, in the position of a Vice President of Finance. Your tentative start date for your new position is Tuesday, May 27, 2003. On or about August 15, 2003 I will recommend to the Board of Directors that you be promoted to the position of Chief Financial Officer. Your starting annual base salary will be $225,000 paid on a semi-monthly basis. In addition to your base salary, you will be eligible to participate in the 2003 Employee Bonus Plan, which pays a target of 40% of base salary, pro-rated according to date of hire. Once you have signed the offer letter, I will recommend to the ScanSoft Inc. Board of Directors, a New Hire stock option grant of 400,000 shares. Details of this grant will be provided to you when the grant is finalized. You will become eligible to receive six months severance package in the event that the company for any reason other than cause terminates your employment. Specifically in the event of a change of control and your position is eliminated within 6 months of the event you will be eligible to receive twelve months base salary plus immediate acceleration of any unvested stock options. As a full-time employee, you will be eligible for our comprehensive benefits package. You will also be eligible to participate in the 401(k) plan effective the start of the quarter following your date of hire (anticipated to be October 1, 2003). The enclosed material outlines all of our benefits to which you are entitled as a ScanSoft, Inc. employee. Please be advised that ScanSoft, Inc. is an employment-at-will employer and this offer is not to be construed as an employment contract. This offer is contingent upon your satisfying the conditions of hire, including providing proof of your eligibility to work in the United States. Please read it carefully and call me if you have any questions. D. Gerth Offer Confirmation Letter Page Two We, at ScanSoft, Inc., are proud of our reputation and we feel confident that you will be a positive addition to the Management Team, while the position will afford you the opportunity to grow your professional skill set. David, we would appreciate it if you would confirm your acceptance of our employment offer, by signing this offer confirmation letter and returning it to my attention as soon as possible. If you have further questions regarding our offer, feel free to contact me at 978-977-2125. Further questions regarding the new hire process or benefit programs should be directed to Dawn Fournier, Vice President, Human Resources at 978-977-2417. I look forward to our working together and your joining the ScanSoft, Inc. organization. Sincerely, /s/ Paul Ricci - ---------------------------- Paul Ricci, Chairman & CEO /csr co: D. Fournier Employee File Enclosures/Forms: Employment Eligibility Verification form, Benefits Summary, Non-Compete, Proprietary Information, & Conflict of Interest Agreement. I ACCEPT THE OFFER OF EMPLOYMENT AS STATED ABOVE: /s/ David A. Gerth May 27, 2003 - ------------------------- ------------------------- New Hire Signature Date of Acceptance EX-31.1 5 b48103ssexv31w1.txt SECTION 302 CERTIFICATION OF THE CEO Exhibit 31.1 CERTIFICATION I, Paul A. Ricci, certify that: 1. I have reviewed this quarterly report on Form 10-Q of ScanSoft, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ Paul A. Ricci ----------------------------- Paul A. Ricci Chief Executive Officer and Chairman of the Board EX-31.2 6 b48103ssexv31w2.txt SECTION 302 CERTIFICATION OF THE CFO Exhibit 31.2 CERTIFICATION I, David A. Gerth, certify that: 1. I have reviewed this quarterly report on Form 10-Q of ScanSoft, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ David A. Gerth ------------------------ David A. Gerth Chief Financial Officer EX-32.1 7 b48103ssexv32w1.txt SECTION 906 CERTIFICATION OF THE CEO & CFO EXHIBIT 32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Paul A. Ricci, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of ScanSoft, Inc. on Form 10-Q for the three month period ended September 30, 2003 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of ScanSoft, Inc. By: /s/ Paul A. Ricci ------------------------------- Paul A. Ricci Chief Executive Officer and Chairman of the Board November 14, 2003 I, David A. Gerth, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of ScanSoft, Inc. on Form 10-Q for the three month period ended September 30, 2003 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of ScanSoft, Inc. By: /s/ David A. Gerth ------------------------------- David A. Gerth Senior Vice President and Chief Financial Officer November 14, 2003 -----END PRIVACY-ENHANCED MESSAGE-----